If we look back to the early days of delegated authorities, they were a means of a carrier expanding their territorial reach without having to invest in building an expensive network of regional and overseas local offices. This allowed them to distribute their products (initially fire insurance) to a broader audience, feeding off their agents’ local knowledge and expertise, both in terms of marketing and distribution and in meeting their local regulatory requirements.
Delegated authorities were also a way of improving efficiency on open market business. If underwriters were routinely agreeing to proposed terms on a flow of risks, these could first be converted into a broker’s bulking lineslip and then into a delegated binding authority.
The Lloyd’s and London market were able to grow successfully using the delegated model, building substantial books of overseas business and punching way above their weight compared to their local domestic competition.
So, traditionally the value to the market of the intermediary was as the introducer of the business or the business relationship which triggered the creation of contracts of delegated authority designed to manage a flow of homogenous business.
While the mechanics are essentially still the same today, the delegated model has come a long way since the early days not least because many MGA’s or Coverholders (I use the terms interchangeably) have become more sophisticated and are no longer simply acting as a point of distribution for the insurer’s products. If the MGA is acting simply as a distribution point delivering a product possibly via an IT platform, then the intermediary’s role might still be restricted to that of introducer and possibly manager of the flow of funds with no further day-to-day role in managing the relationship.
However, in the context of a more sophisticated carrier/MGA relationship, where the MGA is taking greater responsibility for sourcing and underwriting a book of business, the intermediary should be an integral part of the value chain, fully involved in managing all critical areas of the delegated authority process.
Examples of where the intermediary should add value in these types of contract are cited below:
Marketing, sourcing and introducing new potential clients. In Lloyd’s, traditionally brokers were seen as the marketing arm of a syndicate. Now that many syndicates have dual Lloyd’s and company platforms this model has changed somewhat as markets are doing more to promote themselves and engaging more actively in their own marketing. To be successful therefore a delegated authority intermediary needs to source business or forge relationships that are different to, or potentially more valuable than, the connections that a carrier can make on its own.
Preparing the business plan/underwriting submissions. This is a discipline that, if done well, can add huge value to the early phases of structuring a new delegated authority. More common in the reinsurance treaty world, this has equal resonance in delegated authority relationships. By focussing on the opportunity and precisely what the proposed business will to look like, many if not all of the obvious questions from prospective markets can be answered in advance. An experienced intermediary will be able to guide the process to make sure that enough detail is prepared to cover all aspects of the proposed new relationship. The underwriting submission needs to recognise and cater for the different audiences within a carrier who will need to be persuaded including underwriting, actuarial, catastrophe modelling (if applicable), compliance and claims.
Stress testing the plan to increase chances of success: Through the process of preparing a detailed underwriting submission, the core assumptions behind the business plan should be challenged and stress tested, often resulting in critical aspects being refined, changed, or even considered for the first time. The conclusion of this should be that all parties will have greater confidence that the final plan can be achieved. Presenting a well-rounded plan that addresses all aspects of the proposed deal is also much more compelling to a risk taker and increases the chances of finding capacity, hence there is enormous value if the intermediary is able to properly orchestrate this time-consuming exercise.
Negotiating terms with leading markets. The is the most critical time in the formation of a new delegated authority contract, the consummation of the relationship, when the key commercial contractual terms will be set such as limits, pricing and breadth of coverage, the producer and coverholder commissions and profit commission that will be payable, together with the working mechanics of the contract such as term, notice period etc.
Alignment of interest. The role of the intermediary in the context of a sophisticated MGA relationship is quite different to that of a transactional individual risk broker in that the interests of the Coverholder, intermediary and carrier are much more closely aligned, with all parties wanting to structure a contract that survives the test of time.
Sourcing and placing a new delegated authority contract of any meaningful size takes time, often many months, and considerable effort on the part of the intermediary. This investment, including opportunity cost, will only start being paid back when premium flows under the delegated contract and it can take multiple years before the return is positive. The intermediary is therefore motivated to structure contracts that properly work for both carrier and Coverholder as only those contracts will survive for the long term.
Achieving equitable terms. If the intermediary does a good job on a delegated authority, the terms of the binding authority must be seen to be fair to both sides. For the contract to survive, clearly it is a given that the product will need to be commercially viable or it won’t sell. However, if the terms of the binding authority contract are weighted too far in the carrier’s favour, the Coverholder will always be motivated to find another market willing to offer improved terms. Equally if they are weighted too far in the coverholder’s favour, the carrier will naturally seek the earliest opportunity to renegotiate the contract or they will be more inclined to walk away in a moment of stress.
If the intermediary does a poor job and the there is an imbalance in the terms of the delegated authority it can also affect the underwriting result; for instance setting the pricing too high for the target insureds or paying the producers less commission that the competition can result in anti-selection, and leaving room for other markets to offer better terms to the Coverholder can result in them being motivated to switch their better business to those other markets.
Incentives to deliver underwriting profit. There is always a debate to be had about how much up-front profit should be embedded within the base Coverholder commission and how much should be tied into the actual performance of the portfolio. The purist will argue that a Coverholder should be covering costs with commission and profits should come from PC’s. The counter argument is that a carrier is capitalised to be able to smooth underwriting results over different classes and over market cycles whereas as a Coverholder must meet shorter term needs out of cash flow which can make it harder for it to manage any significant volatility in earnings. There is no right answer here as each circumstance is different but generally speaking if the existence of a profit commission is going to have a serious influence on the underwriting behaviour of the Coverholder it needs to make a material difference to their net result such that they are willing to forego premium growth (i.e. commission income) in favour of selecting risks that will achieve the desired underwriting result.
For a fully delegated authority to survive, most importantly it needs to make an underwriting profit for the carrier. The intermediary’s role is to steer the parties to an agreement that provides motivation for the Coverholder to achieve or exceed the agreed target levels of profitability.
Treaty vs. Delegated Authority intermediary. A treaty reinsurance broker placing proportional reinsurance is in a similar position to the intermediary placing delegated authorities although, as they are one step further up the food chain there is less certainty of longevity in the relationships. In a non-proportional relationship however, while the broker benefits from long-standing client and market relationships, the broker is arguably in a more transactional role as they are negotiating the best deal for their client in a stand-alone contract with fixed risk transfer parameters.
Building capacity, placing subscription contracts. Intermediaries can build capacity by combining multiple capacity providers (inside and outside Lloyd’s), to create a better product for an MGA than any one carrier might be willing or able provide on its own. This could be by adding additional limits or aggregate capacity or by combining different coverage lines. The beauty of subscription placements is that the individual shares of capacity providers can migrate over time based on appetite and ability, but the end-product can remain relatively stable. The intermediary is positioned to pre-empt and manage these changes in capacity.
The intermediary is also responsible for ensuring that all markets are aligned to one set of common terms under the delegated authority. Even under a consortium arrangement, there is usually a need for someone to act in the intermediary role to manage the communication and coordinate the process. It is very hard for a market to arrange a subscription placement on their own.
Claims. On any contract with any claims frequency, the process for adequate claims handling needs to be put in place correctly from the start given the impact that this can have on underwriting performance not to mention the stress it can put on the carrier/Coverholder relationship if it goes wrong. A good intermediary will ensure that this critical element of the placement is properly addressed. If the carrier is taking total charge of the claims process then the intermediary might be less involved however for any contract involving a Third Party Administrator or with a subscription market, a good intermediary will devote equal attention to making sure the claims process is properly structured from the outset. The intermediary should then also make sure that their senior people are engaged in the claims process, making sure it is working properly and being willing to step in and negotiate changes if necessary, in the same way they would with an underwriting issue. Sadly, in the London broker market, claims management is often considered as less important than placing, possibly as it is viewed as a non-revenue generating cost.
Managing the communication. Like most relationships, in the early days when things are going well and both parties are excited about the deal that has been done, there is arguably less need for help from a third party. In these days there is often a desire for more direct contact between the parties as the relationships are developing and everyone wants to get to know each other better. The intermediary’s role is to nurture the relationship but at the same time not to get squeezed out of too many conversations otherwise it can be hard to catch up and impossible to communicate with other participating markets.
A good delegated authority relationship should be more like an employment contract with regular communication to avoid surprises. A good intermediary makes sure that this communication and reporting process works in practice so that the Coverholder has plenty of warning if substantial changes are proposed at renewal or if a carrier is contemplating withdrawing their capacity.
When the going gets tough. When an intermediary can really add value is at moments of stress in the carrier/coverholder relationship for whatever reason, be that underwriting performance, audit and compliance or carrier specific issues. This is when the intermediary can help take the emotion out of the situation, listening to each party’s frustrations but communicating in a clear way the information that needs to be shared. They can also provide context to the debate as either party might make bold statements that could inflame the conversation whereas the intermediary can add additional details to explain why the particular request or position is so important to that party. In these situations the solutions often require both parties to be slightly unhappy however when someone is in a direct negotiation it can be very difficult to apply the brakes and stop at only being slightly unhappy.
Servicing. All business in Lloyd’s has to be submitted via a Lloyd’s broker or service company whose responsibility it is to co-ordinate the placement and handle the flow of data, premium, and claims funds. For both Lloyd’s and non-Lloyd’s markets, it makes an enormous difference if the intermediary is committed to ensuring that transactions are checked and processed correctly the first time, particularly where there are multiple years and sections under a contract. For non-bureau markets it is essential that payments are properly matched up to individual transactions with all the correct back-up provided. The workload for all parties increases when things aren’t clear or are done wrong and this checking and reconciliation process is often an overlooked function that the intermediary performs.
Why so difficult to get data? While contracts of delegated authority may be complex, they are rarely complicated however, it is extraordinary how hard it seems to be for information to be provided as specified within the timeframes set under the contract. A good intermediary will be very active in making sure the obligations are met on both sides of the agreement thereby minimising the possibility of friction developing.
There are initiatives underway in the London market to streamline the data transfer process for routine monthly records of bound business (e.g. DA Sats) and there is no doubt this will help improve accuracy and efficiency, particularly on the more straight-forward contracts. On more complex arrangements however, the Intermediary will continue to perform a valuable role working with the Coverholder and carriers to create and share bespoke Management Information relevant to the underwriting performance of the individual programmes.
Conclusion. In this changing market environment, understandably there is growing pressure on insurance risk takers to demonstrate to their capital that they can be trusted to return positive margins. Expenses are clearly a large part of the equation and excessive acquisition costs are often cited as the reason for markets being reluctant to delegate underwriting authority.
To answer the question of whether the delegated authority intermediary represents good value, every part of the function they perform needs to be looked at in context of the examples set out above. If the intermediary is doing their job properly, there should be a better chance that the business relationship between carrier and Coverholder will survive longer due to the stronger underlying profitability of the business and the costs of the carrier should be lower due to the work being performed by the intermediary.
In an optimum world under a delegated authority, each party to the transaction should be handling the functions assigned to them with as little duplication as possible. It is the intermediary’s job to make sure this happens and to act as the glue that binds the partnership between the Coverholder and the carrier. If this partnership is successful, then the true value of the intermediary should be self-evident.
This article was originally published by Insurance Day, on 07.04.2020, see the original post here.