What MGAs Should Know About Carriers’ Due Diligence for Programs

Smart program administrators know that aligning themselves with financially-strong insurance carriers can help attract good clients to their program. While the process of evaluating a program relationship takes more time and effort than deciding on an individual risk, the right program relationship can be significantly more rewarding in the long-term for both the carrier and the program administrator. The secret to getting a program launched in a reasonable amount of time lies in the program administrator preparing a very detailed submission up-front and the carrier executing a well-organized due diligence process.

Every carrier that receives a program submission performs a preliminary screening to determine if the opportunity warrants the next, more time-consuming step: the due diligence process. Due diligence helps the carrier verify the program’s profitability and, perhaps more importantly, clarify if the program administrator’s people, business objectives, experience, market knowledge, and systems are a good match for the carrier. During the process, representatives from underwriting, claims, actuarial, finance, compliance, and information technology assemble to provide a point-of-view on the opportunity from their specific area of expertise.

Audit Process

The due diligence audit gives the insurer’s team direct access to the program administrator’s operation and people. This is when the insurer will evaluate the strength of the program administrator and determine if its staff possesses the knowledge, discipline, business acumen, and sense of “team” necessary.

The full audit team should be present at all sessions as data pertinent to one group, such as the underwriters, is often also useful to another, perhaps the actuaries. While underwriters and actuaries conduct their evaluations differently, both are interested in rating methodology, changes in rating factors, use of credits and debits, and other variables; this information can provide insight to underwriting discipline and determine the program administrator’s level of control. Historical exposure and claim counts are critical for actuaries to review, but these same data are used by claims department representatives to determine the number of claims professionals that will be required.

The carrier’s on-site audit gives the program administrator a great opportunity to “size up” the carrier and test its audit team’s understanding of the information provided in the program submission. A strong carrier demonstrates a fluent understanding of the program administrator’s operation. The program administrator should never feel that the audit team sees the process as just another audit assignment.

The audit begins after each member of the insurer’s team develops their audit approach. Here are the major areas of the audit:

• Underwriting. Underwriters will review the program administrator’s risk selection, exposure control, and pricing procedures, as well as the accuracy and promptness of its servicing processes. While underwriting guidelines and authorities are important to read, proper assessment of how the program’s underwriters carry out their duties can only be accomplished by reviewing files and talking with the underwriters.
• Claims. Claims professionals are an important part of the due diligence team, even when the carrier may decide to have claims handled externally. Claims professionals assess the quality of historical claims handling, including the effect case reserving practices, selection of outside counsel, and other policies may have had on historical results. Claims professionals will focus on larger claims and any allegations of bad faith, as well as the handling of routine claims. Fairness, proficiency, service, documentation, and expense control are some of the key areas of review.
• Actuarial. Actuaries will analyze the program’s historical claims counts, severity, latency, and development patterns, among many other items. Substantial actuarial work is generally done prior to the on-site due diligence. Having the actuaries participate here gives them a “per account” view of a program administrator’s pricing discipline and identifies trends in the marketplace.
• Finance. Finance professionals will examine the program administrator’s accounting systems and procedures, among other tasks. This provides an in-depth analysis of audited financial statements, aged receivable reports, disaster recovery plan, recent bank reconciliation, and the invoice system. A program can look good on paper yet still fail if the accounting process is flawed.
• Compliance. Compliance professionals will identify state-specific service requirements particular to the underwriting territory, as well as licensing requirements. This touches on many of the critical elements for a successful program – especially for programs issuing admitted paper. The compliance team will review rate filings, experience rating plans, Office of Foreign Assets Control compliance, and statistical reporting. Compliance is critically important to carriers and this view must be shared by the program administrator.
• Information technology (IT). IT professionals evaluate the program administrator’s systems for underwriting, processing and data transfer. IT also reviews the security of the administrator’s system to identify potential issues associated with privacy of client data.

Due Diligence Report

The culmination of the due diligence process is a report that summarizes the opportunity. This provides the rationale behind the insurer’s decision to align itself – or not – with the program administrator and will serve as a “road map” for implementation if the insurer moves forward. A very detailed program submission from the program administrator, as well as a well-organized due diligence process by the carrier, ensure both parties can get to a decision quickly and with little fear that something unknown will ruin the deal. In fact, when the program due diligence process is properly executed, the due diligence report lays the foundation for a mutually beneficial, long-term business relationship.