Managing General Agency vs. Insurance Company Disputes: Why Does History Continue to Repeat?
Managing General Agency vs. Insurance Company Disputes: Why Does History Continue to Repeat?
By Dale C. Crawford
For the potential arbitrator or consulting expert, the phone call always goes in one of two distinct directions. As soon as the caller identifies him/herself as an attorney, the conversation quickly turns to the business at hand:
I represent Honesty Insurance Company. Three years ago, my client entered into an agreement with Reliable Managing General Agency to write business. We have found that Reliable violated the agency agreement in multiple ways, failed to disclose required information, and may have fraudulently withheld funds owed my client. We have filed for arbitration under the terms of the contract for damages and premium funds owed.
— or —
I represent Reliable Managing General Agency. Two years ago, my client agreed to represent Honesty Insurance Company to produce business. We have carefully followed every term of the contract, made all records available to Honesty, and remitted all premiums as required. Now Honesty cancelled the contract, failed to pay earned commissions and profit sharing, and has filed suit.
The dispute resolution process then follows; and may be a lengthy and expensive conflict for both sides. While litigation is a natural and expected result in the insurance industry, what makes these different is that this is not over benefits from an insurance policy; rather one between two business partners. Additionally, what makes these unique is the frequency and repetition of the same issues-violation of contract terms, lack of disclosure, and misapplication of funds. Anyone involved in this type of dispute resolution and who has been in the business for a significant time has seen the identical scenario repeated for many years. Why is it not infrequent for the term MGA to be inherently associated with downright corruption or fraud and why do these battles continue to develop among experienced industry executives on both sides? ¹
First, a caveat is necessary that cannot be overemphasized. There is a wide and successful industry of MGA’s that have been in operation for many years, and enjoy lucrative symbiotic relationships with specialty carriers operating in this environment. The business is usually written through insurers with rate and coverage flexibility. These are a vital part of the industry that are creative, innovative, and fill gaps left by the standard carriers. These are an important and necessary part of the property- casualty industry. In contrast to the stable, long-term relationships with specialty carriers are those that are the typical breeding grounds for disputes. Several characteristics are common in these circumstances:
1. A contract that applies only to program business. Instead of broad, across-the-board surplus lines business of general liability, property, and auto, these will have narrow restrictions— typically, some singular line of business. It may be some form of professional liability, contractors of a certain type, or some narrow industry. The focus is a relatively small group of homogenous exposures.
2. A lack of operating history of the program. These are usually a new venture, perhaps with a producer who has access to the prospective group and expectations to expand on what may be a small base of accounts that is anticipated to grow considerably with an insurance program tailored to the coverage objectives of the members.
3. A producer—either retail or MGA— that has relatively little or no experience in managing a program. The owners of the MGA may have some experience with the business, yet operating without underwriting authority—the business has been previously written in the traditional system of submission and individual acceptance by the insurers.
4. The insurance company joining with the MGA has no previous history with the type of business to be written. A personal experience comes to mind—a large retail jewelry chain owned an insurance subsidiary the sole purpose of which was to provide insurance for merchandise sold and financed. This was low limit, first party coverage that the store required borrowers to carry during the term of finance. A new MGA convinced the insurer to give it authority to write commercial umbrella liability through a complex web including a reinsurance broker and reinsurer that would fully protect it from ultimate loss. The results were predictably disastrous. The reinsurers denied coverage and attempted to rescind. This example was not all that unusual, making a leap from property coverage on financed jewelry to commercial umbrella through MGAs. For added measure, this took place during a highly competitive era in the industry when competition was brutal, where rock-bottom terms and pricing were necessary to write business.
Anyone involved in the excess and surplus lines or reinsurance industries has seen these scenarios play out at least since the 1970s. Yet attorneys, arbitrators and consulting experts still see these happening. Since the same issues continue as the core of these disputes, there have to be reasons why history repeats itself time and again. Based on thirty years of observations within the industry and an additional dozen in dispute resolution, here are a few conclusions. First, from the standpoint of the MGA, these are entrepreneurs out to create a market niche for themselves and build a successful business. Properly managed and if successful, they can be quite rewarding through commission income, contingent bonuses based on underwriting results, and building a business with a substantial value. For an insurer, it can be a potentially attractive enterprise as well-a chance to expand into new lines or classes of business and increase profits. Why then do so many go so wrong?
The answers are frequently found in the essential nature of the enterprise itself. For the insurer, this is most often an introduction into a new class of business in which it lacks an experience base. Instead of a building its own internal institutional knowledge, this is delegated outside the organization to the MGA. Thus the insurer does not have and is not acquiring the overall comprehension and subtleties of the business; instead it relies on the MGA while remaining responsible for the results. If properly analyzed, what would induce an insurer to enter into such an arrangement? The answer appears to be opportunity—an insurance executive envisions the chance to enter a new line of business and increase volume with projections of significant profits. The real attraction is that this can be done with virtually no effort or upfront cost to the insurer. The expansion can be accomplished without adding personnel, office space, and processing facilities-the insurer only has to take the premium and the MGA performs all the functions, often also processing claims. This attractiveness tends to mask the real danger—the inherent hazard in transferring underwriting authority outside the building. The prospective insurer is often provided an additional sweetener— the MGA obtains reinsurance to protect the reinsurer from loss. This can be structured as total protection, where all underwriting risk is reinsured, or the issuing carrier retains only a small participation. In the former, the insurer then becomes only a front and receives a fee of a certain percentage of premiums; in the latter, risk is significantly minimized.
When these ventures borne of mutual optimism begin to lose luster, it typically results from claims activity. Losses occur that exceed the anticipated levels. Based on the severity and circumstances, the insurer may simply terminate the contract and walk away. Often, however, the problems may escalate dramatically. If there is reinsurance, that protection may prove illusory. In some cases, the reinsurance never existed—the MGA simply did not obtain the protection. In others, the reinsurer denied liability based on fraud or misrepresentation or may have become insolvent. Then the insurer finds that not only are the losses more than projected, the protection it relied upon does not exist. Typically once problems have been identified, the insurer will conduct an underwriting and financial audit. Based on the results, arbitration or a lawsuit may soon follow.
When the dispute escalates to outside resolution, the issues are typically complex and focus on numerous aspects—violation of the MGAs authority including underwriting classifications and pricing; failure to report and disclose; and often include misappropriation of funds. An arbitration panel or jury must sort through these and decide whether the MGA was guilty of the allegations or whether it was nothing more than underwriting results worse than anticipated; in other words, simply a business deal gone badly. In numerous observations over the years, there seems to be an element of truth both ways. Some were downright fraudulent, with egregious violations of underwriting authority and absconding with premiums. Others were more benign, and appear to be little or nothing more than poor underwriting experience. In the latter instance, instead of acknowledging an unsuccessful—albeit costly—business relationship, the executive or management team responsible for the MGA venture may be under pressure; thus the desire to “make the MGA pay” for its transgressions and recover the underwriting losses.
Since these scenarios have been repeating for at least 40 years, is there any reason to believe that insurers will adopt the necessary vigilance to refrain from granting underwriting authority for classes of business in which they have no experience and that MGAs will universally act with total adherence to all contractual requirements? The answer is likely no different than the high tech or housing bubbles preventing future financial calamities. Perhaps the most fundamental reason is the inherent foundation for conflict where the MGA is charged with providing the vigilance necessary for successful underwriting while being compensated based on commission.
It bears mention here that this has been addressed—the National Association of Insurance Commissioners has adopted the NAIC Model No. 225, known as the Managing General Agents’ Act which sets restrictions on the powers that may be granted to MGAs. Each state has adopted this in some form. ² The extent to which this will eliminate these disputes remains to be seen.
Just as on page one describing traditional, long-standing MGA arrangement of writing multiple lines and classes with experienced partners on both sides, there can be legitimate opportunities in new ventures. How can there be potentially successful prospects for both sides, while protecting the insurer and creating a successful business for the MGA? Here are a few basic tenets:
Above all else, understand the business. If an insurer has no internal expertise in a certain class or line of business, consider long and hard before making an entry by delegating underwriting authority to an outside entity. If a decision is made to go forward, underwrite the business just as if it were part of the internal underwriting function. Audit, audit, audit. Both parties benefit by the insurer visiting frequently to review files and financial records. Underwriting audits should include declined submissions to show exactly how the contract provisions are being applied. At the same time, have an open and continuous dialogue between the MGA management and the responsible executives at the insurer.
Document, document, document. The importance of documentation cannot be exaggerated. First, the MGA agreement should be a comprehensive road map for all aspects of the operation and should be followed. Additionally, any exceptions or side agreements should be immediately written and communicated to the other side and internally to both organizations. Any discussions resulting from visits should likewise be memorialized. In the event of a dispute, it is to the advantage of both sides to have a complete paper trail of all agreements.
Insurance is a microcosm of the increasingly complex global venture of finance, and there will continue to be opportunities for creative entrepreneurs who identify needs, design solutions, and establish long-lasting effective partnerships. These observations are intended to aid those who will have the opportunities and desire to participate.
¹ The term Managing General Underwriter is often used synonymously with Managing General Agency. The two will be used together here and referenced as MGA.
² For a complete text of the Act, go to www.naic.org.
