Among the most profound changes in commercial insurance over the past decade has been the growing role of managing general agencies (MGAs) as measured by premium volume and by the growing scope of functions they perform on behalf of their carriers and retail agents.

It’s no surprise, then, that MGAs offer more opportunities for credentialed property/casualty actuaries, and one such actuary told attendees at the CAS 2018 Ratemaking and Product Management seminar how she made the transition from a traditional carrier role to an entrepreneurial MGA role.

In a session on “Distribution in the 21st Century,” actuary Emily Gilde related how she spent more than 20 years in actuarial positions with Nationwide Insurance before becoming senior vice president and chief actuary for Ethos Specialty Insurance Services, an MGA subsidiary of London-based Ascot Group Ltd. that was formed in 2017.

Gilde confessed that she had long regarded MGAs as “just like insurance companies, but without any capital,” and potentially a disruptive force within the market for coverage. She explained, however, that she has come to appreciate how MGAs have great potential to increase the efficiency with which traditional carriers can develop and market coverage.

In addition to their well-known expertise in niche underwriting, MGAs are rapidly developing other carrier-like capabilities in compliance, ratemaking, technology and enterprise risk management, according to Gilde. Some are even providing or securing third-party capital to support risk, she added.

“The MGA value proposition extends to many areas of the insurance supply chain,” she said.

Variable Costs

According to Gilde, MGAs enhance capital efficiency for carriers by converting the fixed costs of supporting a coverage program into variable costs. This, in turn, reduces a carrier’s earnings volatility and increases profit, even if the cost of acquiring accounts is slightly higher.

As she sees it, to develop and maintain a program on its own, a carrier will have to acquire the talent and resources needed to support it and bear those fixed costs and commitments through favorable and unfavorable market conditions.

By using an MGA, a carrier can change its underwriting appetite more quickly, knowing that “it’s easier for an MGA to find a new carrier than for a carrier to redeploy those resources,” she said. From the outset of an initiative, she added, “this gives a company an exit strategy.”

Underscoring her point, Gilde demonstrated that a hypothetical program with established annual premium volumes and loss ratios would see a greater underwriting gain and less earnings volatility by paying 13.5 percent commissions to an MGA rather than incurring $500,000 in annual fixed underwriting costs.

That outcome presumes that that MGA can underwrite the business at a lower cost, which is often the case, as MGAs draw upon a wide and fluid network of underwriting talent.

Back From the Brink

Gilde recognized that some actuaries and other specialists might balk at working for an MGA, given the bad reputation they earned a little more than 15 years ago.

“There have been MGAs that crashed and burned on the rocks of bad underwriting,” she said.

“In nearly all cases,” she said, “an overreliance on MGAs was just one issue. Typically, the carrier was also to blame for rapid expansion, extensive reinsurance, systemic underpricing and underreserving, and reckless management.”

MGA operations became more stable and reliable following release in 2002 of a model act from the National Association of Insurance Commissioners for regulating MGAs.

The act, adopted as the basis of law in every state except New York, establishes licensing requirements for MGAs, requires implementation of specific underwriting guidelines and prohibits MGAs from being able to bind reinsurance on behalf of a carrier. Under the model law, MGA reserves and operations are considered the responsibility of the insurer for whom the MGA is acting, and thereby subject to examination by regulators.

In recent years, MGA business has grown rapidly. According to Gilde, MGA direct written premium grew from $24.8 billion in 2013 to $35.1 billion in 2016, not counting MGA premium paid for crop insurance or to the California Earthquake Authority.

MGAs now account for about 17 percent of U.S. commercial lines premium, she added, up from 5 percent in 1999.

Sliding Scale

While bullish on the prospects for MGAs and the possibilities for professionals working in them, Gilde is a skeptic about one trend in the business: the widespread use of sliding scale commissions based on loss experience.

A commission structure that reflects loss experience is designed to share risk between a carrier and the MGA, giving the latter an incentive to underwrite responsibly and avoid the types of failures noted above.

Such a structure shifts earnings volatility from the carrier to the MGA, Gilde said, but MGAs demand higher average commissions as a result, often reducing a carrier’s underwriting gain from what it might have been under a straight but lower commission.

Sliding scale commissions are complex to develop and manage, she said, as they often include complicated carry-forward provisions and typically require interim payouts over years as losses booked as “incurred but not reported” (IBNR) actually emerge.

She added that the underwriting performance of a program in a given year is usually more of a function of market conditions (soft or hard) and random events (such as weather catastrophes) than of the skill of MGA underwriters.

“Is the profit sharing cure worse than the problem it is trying to solve?” she asked. For a full answer, she may have to ask her old self, the former carrier actuary.