The insurance market is attracting tech-savvy entrepreneurs from outside the industry, often funded by venture capital. These new insurtech solutions are changing how customers communicate with their agents, pay premiums, and file claims. A popular method of entering the insurance landscape is to establish a managing general agency (MGA) and deploy their technology with the help of insurance carriers holding the risk.
But while the agent-consumer interface looks dramatically different than it did just a few years ago, the notion that technologies will be plugged in and produce superior results or increase the policyholder’s experience is a road that must be carefully navigated.
Carriers are result-oriented and know their business. Establishing a partnership with a carrier and producing policies as an MGA presents challenges for entrepreneurs who are accustomed to a faster pace of business and unfamiliar with some of the financial and regulatory characteristics of the insurance marketplace. We will highlight a few key critical areas requiring attention.
Chief among the issues we see in this marketplace is a lack of understanding of the concept of fiduciary responsibility.
As an agent, you are a fiduciary for policyholders, and you have a fiduciary responsibility to steward the premium dollars until remitted to the carrier. The MGA must maintain trust accounts for the premium payments policyholders remit, separate from your company’s regular operating bank account. You may not comingle premiums and operating funds or use premiums to fund operating expenses. In other words, there is no such thing as “borrowing” from the trust account to pay a bill of the MGA.
In a typical relationship, premiums the MGA has collected also include negotiated commissions. Premiums net of the commission are sent from the trust account to the carrier. Commission can be segregated into your operating account at the time premiums are deposited into the trust account or can be left in the trust and transferred to operating accounts in the future. Leaving commission in trust maintains a conservative balance in the trust. Remember, funds must be transferred to operating accounts before you can pay bills or use the funds for other purposes.
We cannot stress enough how important this is. In other businesses, commingling certain types of revenue may be a bad business practice, but it’s a mistake that can be corrected. In the highly regulated insurance industry, it can mean loss of your license and even jail time.
Another issue that becomes tricky for some MGAs is that of commissions.
Most carriers will negotiate sliding scale commission based on loss experience. A typical arrangement will provide a standard commission with a downward slide for poor loss experience. For example, if the agreement allows for a 25% commission with a 5% downward slide to 20%, the commission retained at 25% may be reduced to 20% if targeted loss ratios are not achieved, resulting in an additional obligation of 5% owed to the carrier.
In this example, the agency is entitled to retain a 25% commission, but with no or little operating history, the difference between stated (25%) and minimum commission (20%) should be deferred until the agency can be certain they will hit the target loss ratio.
MGAs often need cash to fund growth and invest in technologies. The stated commission is often spent by the time the contract ends, and the loss ratios are evaluated. When this happens, the MGA may be left with an obligation they were unaware of or overlooked. For this reason, many carriers are requiring collateral from the MGA to cover the credit risk. Typical collateral is in the form of a letter of credit in favor of the carrier, representing an additional expense and capital requirements to be met.
Without operating history, carriers hold most of the cards until MGAs can show strong underwriting results. It is important to review and understand all aspects of the agency agreement.
If you are considering entering the MGA market, or you’re already there, follow some basic rules of the road:
- When negotiating an agreement with a carrier, be conservative in your estimate of premium production and results.
- Establish a start date that is a few months out, even if you think you’ll be ready to sell before then. Be sure you have enough capital to help you through those months.
- Once you start producing, until you have sufficient history, only recognize your minimum commission into income.
- Retain commission or record a liability for an amount over the minimum commission. Track production and accrue deposit premium if minimums are not expected to be achieved.
- Factor all costs of the arrangement into your model to determine your profit potential.
- Work with a bank with a trust account department. Most do but ask about it before you establish a relationship.
- Work with an accounting firm that works with insurance companies and understands the regulatory environment, the accounting insurance carriers require, and the carriers’ monthly and quarterly reporting requirements.