MGAs will need to keep up with the moving target as events unfold
As managing general agents (MGAs) meet this month for their annual gathering, they do so at a time when the property/casualty insurance marketplace is in a state of tremendous upheaval. First, there are the repercussions of September 11, which turned a slightly hardening insurance market into solid rock. Reinsurance companies, which were considering raising premium levels and imposing restrictions on coverages prior to September 11, approached January renewals licking their wounds and determined to cover their assets. The words "terrorist exclusion" stood out in reinsurance contracts like the words "questionable deductions" stand out in an IRS audit notice. And, like those who receive such IRS notices, primary insurers were helpless to do anything but cross their fingers.
Reinsurers are able to make unilateral decisions, but primary insurance companies are subject to state regulations which, in many cases, forbid terrorist exclusions. Primary insurers are looking to the federal government to provide some backup reinsurance program to protect the property/casualty insurance market from total wipeout should another attack occur. At press time, that relief has not been forthcoming.
Then came Enron. That debacle did not result from some terrorist attack committed by faceless enemies determined to crush capitalism. Quite the contrary. Those responsible for Enron were part of the capitalist system, and their actions are now being questioned in the press, by state insurance and banking regulators, by the Securities and Exchange Commission (SEC) and by the solons on Capitol Hill. There were no air strikes, such as those that destroyed the World Trade Center and damaged the Pentagon. This destruction was caused by the stroke of a pen, or rather the strokes of many pens. Nevertheless, the effects on the property/casualty insurance marketplace are equally as devastating.
While September 11 ultimately affected most lines of insurance--property, casualty, aviation, workers compensation, business interruption and more--Enron has affected very specific lines, such as directors and officers liability, surety coverages, accountants liability, and fiduciary liability. It also brought into question the status of independent auditors and the possible conflicts that may exist between independent auditing and consulting services.
So what does all this mean to MGAs? Well, it means that MGAs are facing challenges in today's marketplace unlike any they have ever faced before. It's all well and good to say that in tight markets MGAs become more in demand by retail agents and, therefore, MGAs have some beneficial opportunities to grow. But looking at the other side of the coin, MGAs cannot sell what companies are not offering.
Let's take surety bonds, for example. Surety bonds have been a vital part of business in America for more than 100 years. They assist businesses by securing the performance of obligations, not merely on construction, but also on other responsibilities, such as paying compensation benefits to insured workers. So, the stronger the surety bond industry, the stronger the business environment.
Lynn M. Schubert, president of the Surety Association of America (SAA), says that commercial surety protects against someone's failing to fulfill a contract or obligation, such as workers compensation self-insurer bonds, license and permit bonds, public official bonds, judicial bonds in civil proceedings and fiduciary court bonds. The license and permit bonds are vital to the transaction of business in the United States, she says, because they provide guarantees that people who apply for licenses to operate a commercial establishment are qualified. Very often, those commercial establishments are serviced by MGAs under program arrangements. "The applicants for license and permit bonds can be anything from a bar and restaurant, a health care facility, notary public, lottery dealers or even health clubs," says Schubert. "A few years ago, there was a great deal of publicity regarding health clubs that signed people up to full-year contracts and then went out of business before the year was up, leaving its members out significant dollars. Today, health clubs must post bonds to get a license to assure that they will be there for their members or that the members will get the money back from the surety company."
So how financially secure is the surety industry and how are September 11 and Enron affecting the business? As far as the general condition of the surety industry, Schubert maintains that it is solid. "The surety industry is committed to protecting consumers and the public interest through surety bonds. The industry is well regulated and safeguards are in place to minimize losses. Bonds will continue to be available to meet the needs of American business," she says.
"We have not yet seen any significant surety claims coming out of September 11, but a great many surety companies are subsidiaries of larger parent property/casualty companies. So, if the parent is affected, the surety subsidiary is also affected. But, despite the huge losses, the property/casualty industry has come out of that disastrous event still strong. What will happen if there are other terrorist attacks depends very much on whether the industry gets support from the federal government in terms of some kind of reinsurance backup program."
Enron, however, is another situation. Schubert said that she "was aware" of some litigation involving Enron and some surety companies, but that she did not know enough about the litigation to feel comfortable commenting.
In fact, J.P. Morgan Chase, on behalf of a significant number of banking interests, is suing several surety companies in federal court in the Southern District of New York. The details of the allegations are not clear yet, but reports say that some surety bonds and letters of credit that backed up a significant number of transactions the investment banking firm had with Enron--generally called pre-paid forward transactions--are being questioned by the issuers of those bonds. The total number of the transactions affecting J.P. Morgan Chase is said to be about $1 billion. How will this situation affect the availability of surety bonds? Time will tell.
September 11 does not appear to have had a major effect on D&O insurance, although doubtless there will be some claims down the road. But, here again, Enron is a different story. The Enron situation raises questions regarding the extent to which board members are obligated to unearth possible fraud among a company's senior employees. More seriously, it has raised a number of questions as to whether D&O coverages are worth anything.
Recently, two companies--Royal Insurance Co. of America and the St. Paul Mercury Insurance Co., subsidiaries of Royal & Sun Alliance and The St. Paul Cos., respectively--were reported to have filed separate actions in United States Bankruptcy Court of Manhattan, saying that they relied on information that contained "material misrepresentation," when issuing D&O policies to Enron. They are seeking to get out from under any D&O claims that may come about because of Enron's situation. If they succeed in their filings, and if the nine other insurers that wrote D&O coverage for Enron follow suit, that would mean the roughly $350 million that Enron thought it had for its directors and officers was, in fact, non-existent.
MGAs need to know about these latest developments, not only because they may affect market conditions dramatically in that some insurance products may become unavailable, but also because in the current hard market, MGAs are attempting to strengthen their relationships with retail agents more than ever before. Therefore, MGAs will need to instruct retail agents on what to look for when obtaining a surety bond for a client or purchasing D&O coverage. All the rules are changing, especially in the area of independent audits.
In a recent White Paper released before Congress by the Consumer Federation of America, Howard Metzenbaum, chairman, said: "The Enron scandal proves conclusively that a top to bottom overhaul of the system (outside auditing) is needed if we are going to bring light out of the darkness." The White Paper recommended to Congress that it take action to restore independence to the outside audit, banning an audit firm from performing non-audit services to companies for a fee. It also recommended restoring legal liability for auditors who abuse the public trust.
In today's environment, therefore, MGAs must work with the retail agents with whom they do business to help them deal with the changes that are taking place. MGAs that do program business will themselves need to keep abreast of new responsibilities in a changing surety and D&O marketplace. *