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The Trouble with Giving Away the Pen

Larry Schiffer | June 1, 2001

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Managing general agents have always been used to provide special expertise to insurance/reinsurance companies. However, they are often viewed negatively. This article discusses some of the problems that arise in a managing agency relationship and suggests viable solutions.

Insurance and reinsurance companies occasionally enter into agency relationships with non-affiliated third parties. These agents or intermediaries may receive underwriting submissions, issue insurance or reinsurance policies, collect premiums, and/or pay claims, but take no underwriting risk. These third-parties are sometimes referred to as managing general agents (MGAs) and managing general underwriters (MGUs).

MGAs and MGUs are used by primary insurers, excess insurers, and reinsurers to assume business in exchange for a percentage of the premium written. Licensed MGAs and MGUs have always been used to provide special expertise and management to insurance and reinsurance companies that ordinarily would not be able to assume certain types of risks without their assistance.

MGAs and MGUs, however, often are viewed negatively because of the actions of a few unlicensed and unregulated agents and intermediaries. A number of the insurance insolvencies during the 1970s and 1980s involved, in part, the over-reliance by inexperienced insurance companies on MGAs to produce business for them. Much of that business was produced at inadequate rates and, when the losses came in, the companies were unable to pay the claims and became insolvent. These insolvencies sparked a widespread regulatory response, which resulted in the required licensing of managing agents, mandatory provisions in agency agreements, and other regulatory oversight mechanisms.

Most MGAs and MGUs take their responsibilities very seriously and perform their essential agency roles in a highly professional manner. Most also follow a professional code of conduct and work together in trade associations like the American Association of Managing General Agents to insure that all professional MGAs and MGUs understand their responsibilities and act in the best interests of their principals.

Like in all commercial relationships and professions, however, sometimes there are a small minority that bend or break the rules for their own benefit. While this is the exception and not the rule, it is these few "bad apples" that tend to garner the headlines and sometimes make doing business difficult for the majority. The following problems arise out of these minority situations. These problems should not arise when dealing with a professional MGA or MGU that abides by the "best practices" advocated by the industry.

So Why Do Business with an MGA or MGU?

The main risk/reward issue that an insurance or reinsurance company faces when deciding to become involved with a managing agent is the scope and nature of the authority granted to a third-party to assume risk on the company's behalf. Put more bluntly, when an insurance or reinsurance company gives away its pen, it runs the risk that the pen-holder will write business at low rates or of low quality just to put premiums on the books to increase its management fee.

Do all MGAs and MGUs do this? Of course not. Have there been some that have? Yes. Greed, coupled with lack of control and oversight, often leads to the abuse of the agency by the MGA or MGU.

The short answer to the "giving away the pen" problem is the same as it was following the insolvencies of the 1970s and 1980s. The insurance or reinsurance company entering into the agency agreement must make sure that the agreement conforms to the regulatory requirements, that the authority granted is limited and controlled with clear and specific guidelines and limits, and must maintain a constant vigil over the business being assumed. Easy to say and, apparently, hard to do.

This article will explore a few of the issues that arise in a managing agency relationship. Recent disputes concerning MGUs provide the backdrop for this discussion.

Letters of Authority

MGAs and MGUs often obtain letters of authority so that they can prove their right to assume business on behalf of their principals. These letters of authority can become troublesome if not carefully drafted. Recent cases reveal that the typical letter of authority is a "to whom it may concern" letter on the stationery of the principal with a broad grant of authority to the agent to write a class of business. These letters often do not restrict the authority to the specific facility or pool managed by the MGA or MGU, making it appear that the holder of the letter has absolute power to write that class of business for the principal for all purposes. More importantly, these letters rarely have an expiration date, leaving the impression that the authority is forever.

Who Has Authority To Sign?

One of the safeguards that an insurance or reinsurance company can put in place when using a managing agent is the requirement that it must sign the original contracts. An offshoot of the signing requirement is the ability of the company to reject the contract written by its MGU within a set period of time. The problem with these safeguards is that unless third parties are aware of them, they may only apply between the principal and agent, and may not bind the third party.

In recent cases, this issue has become even more complicated because of multiple levels of the agency relationship. Assume a company is part of a pool of reinsurers and signs a broad authority letter granting the MGU managing the pool the authority to write a certain class of business for it. The company means for the authority letter to apply only to the MGU's authority as pool manager to assume business for the company as a member of the pool. But if the letter does not so restrict the grant of authority, what happens when the MGU asks the company to front a particular reinsurance contract that it plans to retrocede to the retrocessional program it set up for the pool, but does not plan to put the contract through the pool?

In one case, the company made it clear to the MGU and to the cedent that it must sign the reinsurance contract, and would only do so if the retrocessional support was in place. The cedent, in fact, insisted that the reinsurer sign the contract and would not accept the MGU's signature alone. When the deal fell apart, the cedent sued, claiming that the MGU's signature on the slip was sufficient to bind the reinsurer and relied, in part, on the general letter of authority. Here, because the contemporaneous correspondence and documents setting forth the course of conduct of the parties, the court easily rejected the cedent's claim. [AIU Ins. Co. v Unicover Managers, Inc., Nos. 3784, 3785, 2001 NY App Div LEXIS 3593 (1st Dept Apr. 10, 2001).] But had there not been clear evidence that the cedent would not agree to the contract without the reinsurer's signature, the broad authority letter would have clashed with the reinsurer's claim that it had to sign the agreement for it to be accepted.

Premium Caps

A broad grant of authority to an agent to assume business without a premium cap invites the agent to assume as much volume as possible to increase its management fees. The failure to limit the agent's authority to write business may lead to the assumption of a volume of business that far exceeds either party's expectations and may blow through the outward reinsurance or retrocessional program in place for that company.

Termination of Agency

In a standard MGU or MGA relationship, there is no question that the company can terminate the authority of the agent at any time. The agent may have a cause of action for damages for breach of the agency agreement, but the agent cannot compel the principal to continue to allow the agent to act for the company in the face of the revocation of the agent's authority to do so.

Termination of the managing agent also raises other issues. In recent disputes, a series of issues have been raised about whether the termination of the MGU's authority happened before the MGU had committed its principals to assume certain risks. Because of the nature of reinsurance negotiations, multiple fact questions may arise as to when the underlying contract was entered into (when the slip was signed by the MGU, when the covernote was circulated by the broker, when the first premiums were paid by the cedent to the MGU, when the premiums were first accepted by the pool members) and whether the termination of the MGU was communicated to the broker and the cedent.

Another issue is whether the principal has a right and duty to notify third parties (i.e., the industry) that it has revoked the authority of its former agent. If the revoked agent fails to acknowledge that it no longer has authority on behalf of the principal, then it may be that innocent third parties will enter into contracts with the agent assuming that the original authority granted stands.

The MGU Is My Friend (Sort of)

When an MGU is terminated, a delicate issue may arise concerning the company's reliance on the MGU in defending disputes against reinsurers or retrocessionaires who may be disputing business underwritten by the MGU. This situation becomes more complex when the principal may have its own disputes with the MGU about breaches of the MGU's fiduciary duties to the principal and breaches of the management agreement.

In a traditional reinsurance dispute with a reinsurer that refuses to pay, the cedent will attempt to show that the contract is valid and the risks ceded fit within the scope of the reinsurance contract. The reinsurer may raise a variety of issues ranging from contact formation issues, to performance issues, to whether specific risks were properly ceded. The cedent relies on its own actions to counter the reinsurers' defenses.

When an MGU is in the picture, however, the cedent must rely on the underwriting of and representations made by the MGU to the reinsurer. If the cedent terminated the MGU relationship because it believed that the MGU was not performing properly, relying on the MGU may be problematic. Economics, however, likely will dictate the necessity of this "unholy alliance" where a dispute develops with a reinsurer that threatens all recovery under the reinsurance contract. Otherwise, the cedent stands to lose its reinsurance protection and its only avenue of recovery will be against the MGU.

Why, in recent disputes, are cedents standing with their MGUs in seeking recoveries from reinsurers? The main reason is that between its solvent reinsurers and its now terminated MGU, the cedent stands a better chance of recovery against the solvent reinsurers under industry custom and practice. If the MGU relationship was such that the termination of the MGU puts the MGU out of business, the likelihood of recovery from the MGU is minimal.

Why Didn't You Tell Me?

Non-disclosure and material omission often are legal issues that arise in disputes between reinsurers and cedents involved with MGAs or MGUs. One issue that has arisen concerns the duty of the MGU to disclose to the company the possibility that the reinsurers secured by the MGU may not support the business that the MGU plans to underwrite for the company.

In one recent case, the MGU was a pool manager that had arranged for retrocessional protection behind a reinsurance pool. The MGU wanted the company to provide it with a special facility that would assume business and then retrocede nearly all of that business to the preexisting retrocessional program. While the MGU was negotiating this new facility, it is alleged that some of the retrocessionaires began to complain about the business the MGU had been ceding to it from the pool and threatened to terminate the retrocessional protection.

The MGU never mentioned anything to the company about its discussions with the retrocessionaires, and the company agreed to give the MGU the new facility. Shortly after, the entire program blew up, and some of the retrocessionaires sought to rescind the retrocessional agreements, including whatever coverage may have been provided to the new facility.

The company settled with the retrocessionaires and sued the MGU and its corporate principal for misrepresentation. While the case against the MGU was sent to arbitration, the claim against the corporate principal remained in court where allegations of personal misrepresentation of the facts about the retrocessional program are being litigated. [Reliance Ins. Co. v Unicover Managers, Inc., No. 00 Civ. 0791 (LLS) (SD NY Jan. 4, 2001).]

Under agency principles, an MGU, as an agent, owes a duty of loyalty and faithfulness to its principal. The company in the case described above relied on the MGU and never independently verified the status of the retrocessional protection that the MGU claimed to have secured. While trust among business partners is critical to any relationship, proper due diligence is necessary to maintain that trust, especially where, as a retrocedent, you anticipated retroceding the bulk of the business assumed.

Concluding Thoughts

This article merely touches upon a few of the issues concerning MGAs and MGUs. As insurance and reinsurance professionals will recognize, most of these issues could be avoided by the careful drafting of agreements and by closely monitoring any authority granted to an MGA or MGU.

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