The Huge Expansion of Managing General Agencies

I have been doing a fair amount of work regarding the expansion of MGAs, particularly the new kind of MGAs, which have much in common with some reciprocals, risk retention groups, and captives.

Then I read an AM Best article that covered Evan Greenberg’s (Chubb’s CEO) thoughts on MGAs. He stated that he thinks MGAs are being severely overused. In his report to shareholders, the Best article quoted the following: “As agents, they don’t retain underwriting risk. Instead, for a commission, they bind others–insurers, reinsurers, hedge funds, private equity–to risk gathered from retail and wholesale brokers who generally do business with them because they offer cheaper prices and commissions.”

He went on to state, “This ecosystem also includes broker underwriting facilities, or treaties, that brokers use to lay off coverage automatically to insurers for additional commission. When you add it up, risk can pass through four or five layers of intermediaries, who all take commissions before the risk finally gets to the ultimate risk-taker.”

Without question, an ecosystem has been built to exploit the industry’s vulnerabilities, and shame on carriers for executing such awful strategic plans that created an environment so easily and profitably exploited.

This is bad for honest agents and consumers on multiple levels, as Greenberg detailed. Wealth is built on volume, not quality underwriting. The incentive is to push through as much premium as possible because there is no accountability for these entities when the risks go bad. I do not believe most retail agents understand how sophisticated and rich these models are–or, in many cases, that they may be unethical. It certainly creates a problem regarding the availability of adequate surplus to pay claims.

A simple example is if four or five entities are being paid commissions, then expenses are too high, leaving less profit to fund surplus unless the underwriting is so exquisite that loss ratios are significantly low enough to offset higher expenses.

Some reciprocals are taking the equivalent of commissions but calling them something different. In addition to regular commissions paid to regular agents, and maybe also themselves, they charge much higher administrative fees. These fees are not paid to third parties but to affiliated companies typically owned by the same shareholders who own the reciprocals.

For example, for every $100 of premium, $20 is immediately withdrawn by these affiliated companies. Then, if the reciprocal has borrowed money, which is common, it often borrows from the same people, and interest rates are often between 8% and 13%. Then sometimes there are other fees. Before the first claim is paid, 30%-50% of premiums have already been withdrawn.

‘Without question, an ecosystem has been built to exploit the industry’s vulnerabilities, and shame on carriers for executing such awful strategic plans that created an environment so easily and profitably exploited.’

Many of these reciprocals are located in difficult states, and when they can’t pay claims post-hurricane, they walk away leaving the guaranty fund and policyholders holding the bag. The ultimate risk-taker is only partially the shareholders. It is mostly the states and policyholders.

Another example in the Captive, Risk Retention Group (RRG), and Self-Insured Group (SIG) world is with program management. There is more than a modicum of self-dealing, in which a program manager will double-, triple-, or even quadruple-dip on expenses. In these organizations, there are often legitimate expenses for simply managing the program–actuarial, TPA, auditing, safety services, and reinsurance. After all, someone must be paid to manage the program, and these entities are supposed to be highly focused on safety, and reinsurance is almost mandatory.

The problem arises because the program manager makes a de facto commission without risk, so the incentive is to increase volume and find other ways to take on de facto commissions. Unethical program managers may arrange for their affiliated companies to provide safety services, as well as the TPA and other services, or they may obtain kickbacks. Kickbacks are affordable, too, because if the program manager does not manage expenses well or does not put out competitive bids for services provided, fee creep is common as vendors come to realize the program manager does not care, provided volume is not negatively impacted.

The result is that expenses climb to the point where profits are eliminated, and without profits, surplus growth is limited or deteriorates.

Regardless of the vehicle, this separation of reward and risk is a problem. Years ago, carriers quit giving “The Pen” to distribution entities paid on commission volume because the temptation was just too great for most of the humans involved. Clearly, that lesson has been forgotten, in part because so many entities have drunk the Kool-Aid and believe their underwriting models are infallible. The upside to these models far outweighs the downside, and I admire the brilliance applied in identifying this business opportunity. But it is not good for the industry and consumers. Greenberg is correct.

There is little oversight of these models’ expenses. The DOI’s are not concerned until there is a solvency/impairment issue. The governing boards of the risk-taking entities often consist of people who know little, if anything, about running insurance companies.

Carriers, as Greenberg intimated, are to blame because they have allowed this environment to be created in the vacuum of the hard market. This hard market created a permanent shift on many different levels. Too many carrier executives think traditional carriers will regain their strengths as the market softens, but they will not. They gave up market and power permanently.

Even excluding the loss of quality underwriting control, they gave up control by enabling networks to grow so large, resulting in additional compensation without any material benefits from most networks. The same goes for paying large entities more money simply because they are large and have leverage. The majority of carriers have permanently lost power over distribution and some underwriting. This vulnerability has become a risk to insureds as well because the distance between compensation and risk is too great. As Greenberg said, we’ve seen this before, and the result is not good.

My advice to agents is to conduct thorough due diligence on the underwriting and expense controls of all these markets, especially if you are placing clients in captives, reciprocals, RRGs, and SIGs. To insureds, get a good agent who will do the due diligence for you. To regulators, please start paying more attention. To carriers, quit pretending you’re in a better position than you are. Begin by reading the AM Best article referenced at the beginning.

Burand is the founder and owner of Burand & Associates LLC based in Mountainair, NM. Phone: 719-485-3868. E-mail: chris@burand-associates.com.