Is Fronting a Win-Win for MGAs?

In this article, we continue our discussion about fronting arrangements. In our previous post, we focused on the relationship between fronting and fronted carriers, including the benefits of this type of relationship, the risks associated with it, and the governing regulations. However, fronting might include more than just these two parties. Another party that might be motivated to enter into a fronting arrangement is a managing general agent or MGA.

Who is an MGA? In simple words, an MGA is a business entity with authority to underwrite premiums, handle claims and negotiate reinsurance agreements on behalf of the carrier. The California Insurance Code §769.81 defines an MGA as a “person, firm, association, partnership, or corporation who negotiates and binds ceding reinsurance contracts on behalf of an insurer or manages all or part of the insurance business of an insurer (including the management of a separate division, department or underwriting office) and acts as an agent for that insurer whether known as an MGA, manager, or other similar term, who, with or without the authority, either separately or together with affiliates, produces, directly or indirectly, and underwrites an amount of gross direct written premium equal to or more than 5 percent of the policyholder surplus as reported in the last annual statement of the insurer in any one quarter or year together with one or more of the following: (1) adjusts or pays claims in excess of an amount determined by the commissioner, or (2) negotiates reinsurance on behalf of the insurer.”

What are the benefits of MGA agreements? MGA agreements may result in several benefits both to an insurer and to the MGA. When the MGA enters into an agreement with the insurer, it immediately gains access to all markets the insurer is already licensed in and provides an opportunity to leverage the insurer’s rating while not needing to worry about writing capacity and capitalization requirements.

From the carrier’s perspective, the key advantage of working with the MGA is the MGA’s expertise. An MGA brings an established book of business in specialty areas the carrier has no such expertise or presence in that can turn into a consistent revenue stream resulting in higher profits. Given the MGA’s familiarity with the business and underwriting authority, it is given, the need and the cost of bringing this expertise in-house for the insurer gets almost eliminated. In addition, MGAs often have lower operating costs that can result in substantial savings to the insurer since underwriting and claims handling processes and expenses associated with them are shifted to the MGA.

What are the possible relationships between the carrier and an MGA? There are multiple scenarios this relationship can create. Predominantly, it depends whether or not a carrier is genuinely interested in taking on risk from the business produced by the MGA. If not, the relationship will most likely result in a fronting arrangement, where the fronting insurer will cede practically all the business to a different reinsurer. In this case, there is no risk to retain as the insurer is merely a pass-through for the business being compensated for providing its paper by earning a fronting fee. On the other hand, if the carrier is interested in taking the risk, the business the MGA produced will be ceded under more traditional reinsurance treaties, where the carrier will retain part of the risk and will be exposed to a share of the losses that MGA’s business generates.

Who has the “skin in the game”? In both of these scenarios, the party who has real interest in the business is the reinsurer who ultimately assumes the risk under fronting or other reinsurance arrangement. This reinsurer may be a true independent partner or may be a captive risk-bearing insurer created by the MGA. It is common for reinsurers created by the MGA to incorporate outside the United States, where the capital requirements are lower and regulatory environment is less challenging. If this is the case, it is in the MGA’s best interest to produce high-quality business that results in minimal losses. When the reinsurer is independent, the MGA might not be as motivated by the profitability of the book of business since the MGA’s captive is no longer subject to sharing risk associated with it. Even though MGAs do an excellent job in their niche areas resulting in high-quality and profitable business, monitoring the relationship by each of the parties involved and including a contract provision allowing monitoring is vital.