How MGAs Employ Captive Insurance To Support Program Business

Managing general agencies (MGAs) with well-defined books of business take pride in their understanding of the business sectors they serve. Whether they specialize in underwriting companies in the construction industry, consumer product manufacturing, or any other industry vertical, they apply their market segment expertise to underwrite accounts that address the specific risks faced by the insured.

MGAs are increasingly considering the captive insurance concept to access additional capacity, capture a share of underwriting profits, and, at the same time, maintain insurer relationships to leverage the insurers' admitted and/or status and geographical state footprint. The MGA-owned entity is often structured as a reinsurer, assuming underwriting risk from the standard market insurance company.

Typically, MGAs refer to each book of business as a program and operate within the program space. That's an environment where the MGAs control the business they handle and seek an insurer to act as their partner, leveraging the insurer's authority to transact business in any given state. The MGA will function largely as an extension of the insurer, handling the front-end work such as quoting, binding coverage, issuing policies, and collaborating on claims with a third-party administrator.

The partnership approach with the insurer reflects the MGA's desire to control a book of homogeneous risks and to take advantage of the insurers' regulatory form and rate filings. The utilization of a captive is driven in part by the desire to share in the underwriting profit yielded by the program. Establishing a captive allows the MGA to take on a specified portion of risk, usually a set quota share percentage, such as 10 or 25 percent, with the remainder of the risk being held by the insurer partner or further shared with the broader reinsurance market.

Reinsurers appreciate the approach because it signals the MGA is confident enough to share in the risk as well as the revenue and aligns the interests of all parties. Regardless of the percentage of risk the MGA agrees to assume, it incentivizes them to strive to keep the program profitable and efficient. Should excessive claims reduce the profitability, the MGA will suffer part of the financial consequences.

Here again, the MGA's familiarity with the nature of each program enhances its ability to maximize profitability. Because they understand the nature of the risks, the MGA can pursue risks that align with the scope of the underwriting authority delegated to them by their insurer partner.

The share of risk the MGA is willing to assume through a captive doesn’t necessarily remain static across the life of the partnership. For example, an arrangement may begin with the MGA taking on just a 10 percent quota share of the risk. As the MGA's captive matures and surplus funds grow, improving the overall financial strength, there may be the opportunity to increase its share of the risk over time, expanding its participation to assume a greater percentage share of the program, which allows it to capture a commensurate proportion of underwriting profits.

The use of captive strategies in this fashion by MGAs has steadily increased in recent years and is more prevalent than ever. That's no surprise, given the success both MGAs and their insurance and reinsurance partners have attained using the approach. As other players witness that success, they're eager to implement their own captive strategies.

While the strategy is indeed sound and successful, MGAs that have yet to deploy captives but are considering the opportunity need to recognize it's neither an easy nor fast process. Like anything related to underwriting, the potential for success depends largely on investing significant time in data analysis. Both MGA and potential insurance and reinsurance partners must develop deep knowledge of the specific program to better quantify the associated risks and financial viability from an underwriting perspective.

If an MGA's direct experience with the captive concept is minimal, a practical starting point is beginning conversations with an experienced captive consultant. The consultant's expertise will help the MGA better understand the complex web of reinsurers, domiciles and their regulators, and fronting insurers needed to establish a program that allows the MGA to fully capture the many benefits the arrangement can provide.