COM3
Wayne Keller – Arch Insurance Company
Cameron Vogt – Munich Reinsurance America, Inc.
2007 CAS Ratemaking Seminar
March 8, 2007 - Atlanta, GA
MGA's Managing for Success 1

Agenda
• Overview of MGA/Program Business
• Due Diligence Process
• Managing a Program
• Summary
MGA's Managing for Success 2

Overview
• Program Administrator (PA)
– An agency that provides some or all of the following services:
• Marketing
• Underwriting
• Binding
• Policy Issuance
• Premium Collection
• Data Processing
• Loss Control
• Claims Management
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Overview
• Program Administrator (PA)
– Independent contractor, not a branch of the company
– Could be called managing general agent
(MGA), managing general underwriter (MGU) or simply general agent (GA)
– Aggregator of retail agents and insureds that meet business model for program
– Some larger PAs employ an Actuary
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Third Party
Administrator (TPA)
Overview
Insurance
Company
PA/MGA/MGU
Retail/Wholesale
Agent
Policyholder
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Reinsurer
5

Overview
• Program Business
– A well defined and narrow segment of insurance marketplace
– Company interfaces with PA only
– PA “controls” business
– PA assumes some underwriting risk
– Specialized coverage
– Proprietary rates and rating factors
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Overview
• Other Attributes of Program Business
– Life span of program varies
– Premium rolls on and off in large, identifiable blocks
– Meaningful expenses at both end points.
• Due diligence process at the start
• Run-off expense without premium income at end
– Expired programs can pile up and strain current resources
– The universe of established PAs is limited and known.
– More parameter risk than a book of business produced directly through retail agents.
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Overview
• Why discuss MGA/Program Business?
– Significant Market Segment
– Past Failures
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Overview
• Causes of Past Failures
– Soft Market
• E&S Programs lead the market
• Binding Authority granted to agency who’s compensated based on premium volume.
– Inadequate Controls
• Too Much Binding Authority
• Lack of Monitoring
– Lack of Understanding regarding all aspects of the deal
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MGA's Managing for Success 10

Introduction to Due Diligence Process
• Due Diligence Process consists of two phases:
– The decision to write the program; and
– Preparing the program for operation
• Initial program conditions (e.g. rates, underwriting guidelines, audit schedules, forms and other contractual items) are crucial to program success
• The due diligence process is interdisciplinary
• A due diligence process that is arduous has advantages.
– The programs that succeed in the process know that the company’s program portfolio is of a high quality.
– A high quality portfolio implies stability and longevity for the company in the program business and stability and longevity for each PA within the company’s program portfolio.
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Initial Program Guidelines and
Selection Criteria
• Business model:
– aggregator of small risks
– niche market
– timing play
• Premium volume threshold
• Successful business plan
• Excellent reputation
• Strong PA financials
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Initial Program Guidelines and
Selection Criteria Cont’d
• Competent underwriting and program management skills
• Existing market presence
• Agent participation keyed to profit-sharing return
• Agreement on Avoided classes
• Program Structure
– Fronted or not
– Reinsurer participation
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Program Submission from Program
Administrator
• Marketing Plan
– Staff experience and background
– Historic and expected premium volume
– Distribution of premium by line of business
– Major competitors
– Size of potential market
– Program aspects that differentiate it from other programs
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Program Submission from Program
Administrators Cont’d
• Current Program Structure
– Existing carrier
– Admitted / non-admitted
– policy forms
– policy limits profiles
– current capacity limits
– reinsurance structure
– commission and other compensation
– claims handling
– loss control
– processing and systems capabilities
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Program Submission from Program
Administrators Cont’d
• Underwriting considerations
– Changes to program exposures
– Pricing of new versus renewal business
– account retention
– Submit/Quote/Bind ratios
• Producer Profile
– Agency history
– insurance protection (fidelity, E&O)
– licenses
– agency financials
– Producer profile questionnaire
• Submission is reviewed by Program Area Management
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Underwriting Review
• Review and audit of information contained in submission
• In depth discussion of Business Opportunity
– Discussion of current program
– Fit with company business model
– Alignment of interests between company and PA
– Reason for PA changing carriers
• Discussion of general U/W guidelines with PA
– Excluded risks
– Premium caps
– Referrals
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Actuarial Review
• Major Objectives include:
– Appropriateness of current rate level
– Appropriateness of rates and rating factors
– Any characteristics of program that might affect profitability e.g., CAT exposure or high severity
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Actuarial Review
• Much of the process involves:
– Collecting data from PA
– Validating the data
– Selecting industry data to augment PA data as needed
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Actuarial Review - Losses
• Claims runs evaluated at several evaluation points to facilitate construction of loss and claim development triangles, and for auditing summary loss data
• Loss descriptions used to identify underlying exposures
• Large loss listing with detailed descriptions
• Obtain industry LDFs (as needed) by studying loss data.
• CAT losses
• TPA history: changes in TPAs with dates.
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Actuarial Review - Premium
• Policy listing by year
– Premium by coverage or LOB
– Premium by policy limit
– Premium by state: CAT potential
– Premium by class: ISO or program specific
– Audit summary data
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Actuarial Review – Premium Cont’d
• Evaluation of rate level change history
– Individual policy rating methodology
• Rating “grid”
• ISO base rates with company LCMs
• Individual risk rating
– Comparison of same policy from year to year.
– Comparison to rating benchmark, e.g.CIAB
– Review the rating history for a well selected sample of insureds
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Actuarial Review – Premium Cont’d
• Identify underlying exposures, classes or coverage, e.g. premises versus products GL or type of truck; light, heavy etc. or type
• Evaluate exposure trend
– Bureau statistics
– BLS statistics
• Discuss pricing monitoring with PA
• CAT exposure for modeling
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Actuarial Review – Other
Considerations
• Program expenses
– Many expense items are contractually defined
– State premium taxes, if admitted
– TPA fees
• compensation formula
• evaluation based on type of claim and claim counts
– Upfront commission
– Expected Profit commission
– Loss control fees
– Brokers fees
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• U/W Profit (Reflect parameter risk?)
• Investment income
• Benefit and cost of reinsurance protections
• Review of underlying rates and factors
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Accounting Review
• Review of Agency financials
• Discussion of minimum net worth requirements
• Discussion of performance guarantees with PA
• Review of agency financial controls
• Background check on principals
• Review of agency physical plant
• Discussion of premium trust and segregation of assets with PA
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Accounting Review Cont’d
• E&O insurance
• Fidelity insurance
• Financial audit schedule
• Cancellation procedures
• Use of collection agencies
• If acting as TPA:
– approval and timeliness of payments
– recovery of subrogation, salvage and deductibles
– control and use of loss funds
• Advise on state premium tax and assessments
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Summary to Program Division Head
• Commentary on PA personnel and history
• Discussion of Business aspects of submission
– The motives of each party
– The benefits to each party
– Possible areas of conflict
• A general description of the program including:
– Underlying exposures
– Coverage forms
– Limits
– Deductibles
– Geography
– Other unique and critical aspects
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Summary to Program Division Head
Cont’d
• Comments on any deficiencies in the submission
• Preliminary Program specific U/W guidelines
• The Actuarial report with rate level indication and other observations
• Required reinsurance with company retentions, proposed reinsurance structure and reinsurance cost
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Summary to Program Division Head
Cont’d
• Pricing targets, estimated premium volume and proposed premium caps
• Expected TPA and costs
• Type of PA IT system, know deficiencies and possible certification problems
• Proposed start up date.
• Decision is made on second phase of due diligence
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Phase 2 – Program Implementation
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Development of Program Underwriting
Criteria
• Negotiation of deal structure
• Underwriting guidelines
• Referral criteria
• Individual risk eligibility criteria
• Underwriting audit schedule
• SIR criteria
• PA authority by lines of business
• Program geography
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• Prohibitions in general and by line of business
• Required reports from PA
• Required underwriting information for each retail risk
• Rules for Retail underwriting practices
– Quote good for 30 days
– Application of loss control
– Fully completed applications
– Premium audit
• Retail Underwriting file requirements
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Policy Forms review
• Manuscripted policy forms unique to the program
• Reviewed by Underwriting, Claims and
Legal
• Must be filed, if admitted
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Development of Filings
• Applies to Admitted programs only
• Creation of countrywide manuals
• Actuarial review of underlying rates and factors
• Filing strategy
– Priority states
– DOI regulation by state
• Compliance review of filings
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Development of Filings Cont’d
• Filing regulation
– File and use
– Use and file
– Prior approval
• Typically most forms and rates are previously filed bureau products. Only the program specific rates and forms are filed
• The filing process is costly and time consuming.
• The filing process is one of the “hooks” that ties the PA to the company.
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Systems Review
• Software
– Analyze PA systems and their capabilities
• Policy information
• Financial reporting
• Rating engine
• Claims system, if TPA
• Outside reporting, NCCI , DMV
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Systems Review Cont’d
• Software Cont’d
– Create interface with company, if necessary
– Suggest third party vendor, if necessary
– Testing -Various policy issuance scenarios are run with the PA system and the results in the company system are reviewed for accuracy and completeness.
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Systems Review Cont’d
• Hardware
– Ability to interface with company
– Ability to handle expected tasks
– Print capability
– Internet access, e.g. T1 line
• Disaster recovery plan
• Protocol for ensuring data quality
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Claims Review
Initial Review
• Candidates for Claims Handling:
– TPA from company approved list
– “Outside” TPA that meets program’s unique needs
– PA
– TPA / PA mixture
• Review of claims logistics
– Types of claims and effort needed to handle.
– geographic spread of claims handling
MGA's Managing for Success 41

Claims Review
Initial Review Cont’d
• Description of Program coverage and its impact on claims handling
– Discussion of policy forms or endorsements that is unique to the program.
– Discussion of special perils, e.g. mold
• Size of claims inventory and claims flow
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Claims Review
Selection of TPA
• Review of PA candidacy
– Review of PA physical plant
– History of PA relationships with prior carriers
– Organizational structure and resumes of claims personnel
• Level of PA claims service
– Timeliness of contact with claimant, investigation and settlement
– Claimant satisfaction
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Claims Review
Selection of TPA Cont’d
• Supervision
– Relationship between PA management and claims personnel
– Relationship between PA and insurer
• Reporting level
• Written reports on claims
• Overall Documentation
– Hard copy files
– Claims system
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Claims Review
Selection of TPA Cont’d
• Quality of Investigation
– Investigation procedure by type of claim
– Use of outside vendors, by geography or type of claim
– Investigation documentation
• Photographs
• Recorded statements
• Action plans for further investigation
– Timely contacts
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Claims Review
Implementation
• Claims Authority:
– Line of business
– $ amount
– Special situations
• Set up claims audit schedule
• Litigation Management Guidelines
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Claims Review
Implementation Cont’d
• Licensing requirements by state (licensing for claims handling? Yes, for many states)
– Some states reciprocate (i.e. these states will recognize the license of certain other states), but some do not.
– Expensive and time consuming.
– Some states require a presence in their state to be licensed.
– A vendor with in-state presence can be used
– State unfair claims practice laws.
– Continuing education to retain license
– Compliance audits licenses
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Claims Review
Implementation Cont’d
• ALAE/Medical Case Management/Independent
Adjusters
– Independent adjusters
• Management of
• Level of use
– Impact of unique program coverage features on
ALAE, e.g. construction defect or pollution claims.
Claims that are expensive to handle, if not expensive to settle.
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Claims Review
Implementation Cont’d
– Compensation for TPA
• Typically a flat fee per claim feature. Varies by LOB
• Can be time and expense under certain circumstances
– size of claim
– specified type of claim
• Can be % of premium
• Cradle to grave service. Breakdown in relationship could mean moving claims and extra expense.
– Discussion of the overall cost to PA of claims operation
– Expense of claims system and collection of claims data
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Claims Review
Implementation Cont’d
• Reserves
– Level of authority
– Documented reserving philosophy or best practices.
• Negotiations/Settlements/File Closure
– Rate of file closure
– Documentation for extended claims
• Salvage/Subrogation/Deductible Recovery
– Meeting statutory reporting requirements for S&S
– Pursuit of deductibles
• Claim system
• Loss Run Review
– LOB distribution by loss and claim
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Review of Program Reinsurance
• Design of protections
– Existing treaties
– Program specific placements
– Use of facultative reinsurance
• Approval of reinsurance contract wording
• Reinsurance negotiation
– New placement
– Fitting new program into existing treaty
• Oversight of relationship with reinsurer
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Licensing
• Admitted = agent, licenses requires for all states in which the agent operations
• Non-admitted = broker, no licenses required
• Company appoints PA in all states of operation
• No relationship with retail agents
• Compliance area audits licenses
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Contracts
Underwriter: “We need to adjust your contract.”
Agent: “The contract cannot be changed. It is like a marriage vow.”
Underwriter: “The contract is not for the marriage. It’s for the divorce.”
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Contracts Cont’d
• PA is sent contract, reviews and replies with comments
• Contract forms the basis for subsequent audits and program termination
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Contracts Cont’d
• PA Contract Features
• Premium trust account
– PA nets out commission and places remainder in account
– An account for company separate from other insurers
– Transmission
• By company via signatory
• By PA
– company retains right to timely statements
– A time limit is placed on remittance of premium by PA to account
– Agent is liable for collecting all “uncollectible premium”
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Contracts Cont’d
• Insurance coverages required
– Fidelity for theft of funds held in trust
– Error and omission for negligence by PA in performance of his duties
– Auto Liability to protect principals’ financial solvency
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Contracts Cont’d
• Security
– Used for:
• Non-servicing of policies
• Non-payment of premium
– Accomplished thru:
• Letter of credit, evergreen in negotiated amount
• Personal guarantee
– 1st party
– 3rd party
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Contracts Cont’d
• Profit Sharing Commission
– Based on agent experience
– Actuarial input into design
– Size of commission and commission threshold in formula should motivate PA
– Payment of commission and company goals
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Contracts Cont’d
• MGA is defined in statute.
• An MGA is an agent that;
– Purchases reinsurance
– May settle its claims
– Has binding authority
• MGA typically represents more than one company
• An MGA’s responsibility includes:
– Periodic reporting of audited financials to state
– Posts performance bond with state
– Has profit commission terms regulated by state
• An MGA may choose this status due to lucrative fees and the power claims handling confers upon the agent
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Contracts Cont’d
• PA contract is not renegotiated annually.
Only certain appendices are:
• Items attached to standard contract as amended:
– Underwriting guidelines
– Profit commission
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Contracts Cont’d
• Claims contract features
– Handled by the claims area
– Since there are few TPAs, the contract issue is simplified.
– Claims funding, Claims trust account
– Annual contracts with same anniversary date as PA contract.
– “Cradle to grave” fee
– Fee determined from schedule that depends on type of claim.
– Fee subject to negotiation
– Fee schedule varies by programs
– Fee schedule used to estimate TPA fee for pricing
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• Initial program conditions are crucial to program success
• Parameter risk is potentially large
• Start up expense is meaningful (esp. filing and IT
• Need to create common incentives
• Monitor everywhere else
• Contract defines all phases of relationship
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Risk-Sharing
• Types:
– Captives / Rent-a-Captive
– Profit Sharing Commission
– Sliding-Scale Commissions
• How much is appropriate?
– Review PA’s financials
– What would 1 or 2 years of bad results do to the PA?
MGA's Managing for Success 63

Risk-Sharing
• Pros:
– Alignment of Interests (“Skin in the Game”)
• Cons:
– Collateral Requirement
– Shrinks the universe of potential business partners
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Third Party
Administrator (TPA)
Risk-Sharing - Captive
Insurance
Company
Reinsurer
PA/MGA/MGU
Retail/Wholesale
Agent
Policyholder
MGA's Managing for Success
CAPTIVE
65

Risk-Sharing – Captive
• Characteristics:
– Can (somewhat) “mimic” the insurance company’s results
– Insurance Company cedes a share of the business to the Captive
– Insurance Company (or an affiliate) provides stop loss protection to limit the PA’s risk
– Collateral
• Statutory Requirement – Up to the Expected Losses
• Additional Credit Risk – From Expected Losses to Stop Loss
Attachment
– Captive Manager (another expense)
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Risk-Sharing – Sliding-Scale
• Characteristics:
– Profit Commission that also slides downward
– “Provisional” (up -front) Commission usually set in the middle of the slide
– Adjustments:
• Annually
• Include IBNR (Contractually defined)
– Can be multi-year blocks with profit/loss carryforwards.
– Difference between the Provisional Commission and the Minimum Commission is credit risk to the company.
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Risk-Sharing – Sliding-Scale
• Example:
Provisional Commission = 20%
Loss Ratio
40%
50%
60%
Commission
22% (max)
20%
18% (min)
• “Initial” Credit Risk = 2% of Premium (20% - 18%)
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Risk-Sharing
• Collateral Example:
– $10M Program
– 2% downward slide
– Required Collateral = $200,000 (2% of $10M)
• Issues:
– When is it “safe” to release collateral?
– Collateral Accumulates - How much collateral is needed after year 2, year 3, etc.?
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Managing a Program
• During the Due Diligence Process, an
“underwriting box” for the program is created:
– Lines of Business
– Classes
– States
– Limits
– Coverages
– Etc.
• So now what?…
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• Is the PA adhering to the underwriting guidelines?
• Is the PA selecting the right risks?
– U/W Guideline should include a section describing the characteristics of a target risk.
• Is the program achieving the desired results?
– Target Loss and Combined Ratios
– Mix of Business (e.g. State, Class and Limits
Distributions)
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• Monitoring Methods:
1. Individual Account Referrals
2. Reports
• Underwriting Results
• Rate and Price Monitoring
• State and Limits Distributions
3. Audits
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1.
Individual Account Referrals
• Accounts where the PA does not have binding authority
• Criteria defined in the underwriting guidelines
• Typical Criteria:
– Premium/Exposure Threshold
– Higher Limits
– Hazardous Class
– Location (e.g. CAT zone)
– Poor Loss History
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2.
Reports
• Underwriting Results
• Rate and Price Monitoring
• Renewal Ratios, New vs. Renewal Split
• Profiles
– State/Territory
– Limits
– Classes
• Submit/Quote/Bind Ratios
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3.
Audits
• Underwriting
– In-depth file review of a “representative sample”
• Claims
• Financial/Systems
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“You can put wings on a pig, but you don’t make it an eagle.”
- William Jefferson Clinton
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• “Fish or Cut Bait?”
• Considerations:
– Poor Results
– Underwriting Guideline Violations
– Key Person Defections
– Softening Market
– Run-off expenses with no premium income
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• PROS:
– Allows a company to enter a new market segment without significant fixed overhead expense.
– Ease of Entry and Withdrawal
– Special Line/Class Expertise
– Geographic Targeting
– Portfolio Diversification
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• CONS:
– Incentive Divergence
– Systems Mismatch
– Expensive way to do business
– Flight Risk
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KEY TAKE-AWAYS
1. Know your Business Partner – Start with a thorough due diligence
2. Align your interests – Provide the PA with a financial incentive to produce good results
3. “Trust, but Verify” – Monitor, Monitor,
Monitor
4. “Fish or cut bait?” – Have an exit strategy
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This material is not intended to be legal, underwriting, financial, or any other type of professional advice. The reader should consult her/his advisors and attorneys regarding any business or legal issues arising from any particular circumstances with respect to this subject matter.
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