‘Red Flags’ to Watch For When Choosing an MGA Partner in a Bad — and Good — Economy or Market

In today’s tough economy and prolonged soft market, some insurance firms are likely to get into financial trouble. Smaller wholesalers and managing general agencies (MGA) may be at risk. Their ability to stay afloat with working capital could be a challenge, says Kevin Donoghue, managing director for Mystic Capital Advisors Group LLC, a New York-based firm that provides financial consulting services to the retail insurance, wholesale insurance and financial services industries.

If an MGA loses a market or loses key insurance lines, the fallout could make it difficult for those groups to stay in business, Donoghue says. “But if it’s a sizeable wholesaler or MGA, or one that’s been around for a long time with a few different markets, then it’s generally one of the stronger players,” he added. Donoghue advises agencies to always have backups to their primary markets, especially when they are placing surplus lines business because “anything can happen.”

In this interview with Insurance Journal’s Andrea Wells, Donoghue outlines a few “red flags” agents should be aware of when trying to gauge the health of their MGA partners. Here’s what he had to say:

What should agents watch out for when questioning whether an MGA is in good financial health or if they are a good firm to partner with? Are there ‘red flags’ to consider?
Kevin Donoghue: Not having much experience in the business is a flag. It’s very difficult for an agent to assess the financial situation of an MGA or MGU because financials are not shared, just as an agency generally doesn’t share their financials. …

Check on references and experience. Checking with the markets they represent is always good due diligence, if they (agents) are not familiar with a certain MGA and they want to write with them. …

Ask for a company referral. Say XYZ managing general agency underwrites on behalf of the Lexington. Don’t be hesitant to ask for a reference from Lexington.

If an agent is talking to an MGA and that MGA tells them that they represent XYZ (carrier), a follow up question is, “How long have you represented them?” And if the answer is a year or two, the agent should find out who they represented before that and how long they represented them.

And here’s the point, if they represent a company that they have only represented for a few years, and did the same previous to that, it’s a bad business practice because they are probably burning markets. That’s a huge red flag.

We look at that when we look at the value of an MGA. If they keep switching markets, it’s an indicator that they might not be the best MGA to be doing business with. It certainly begs the question, “Why are you changing markets?”

Any examples of failed companies you can share?
Donoghue: None that have been made public but we work with some that have been in trouble and they needed to secure financing, working capital to stay afloat. None that have gone out of business, but in the past we have seen situations where you have unscrupulous individuals that misappropriate funds, on both the retail side and the MGA side.

It’s always important to do your due diligence on a group before starting to write with them. It’s always good to know that your client, your insured, is actually in place with the insurance company. The MGA may have been paid but you always want to make sure that that payment was remitted on to the company and your policy is in force.

When a wholesaler or MGA is having financial difficulties, what happens? Is the department of insurance involved?
Donoghue: A lot of times when they get in trouble they sell themselves. They try to get out of trouble via sale. If there’s been a misappropriation of funds, then the insurance department would definitely be alerted to it.

And then there’s just that gray area where they are not able to sell or they haven’t found the sale so they are kind of using fiduciary funds to operate their business, having yet been caught due to playing the float. So sometimes it’s difficult to know who’s in solid financial shape and who’s not.

Given the current financial crisis and soft market, and heightened pressure to increase revenues, is it more likely for someone to be dishonest now than in the past?
Donoghue: I don’t know that it’s more likely for someone to be dishonest if they weren’t dishonest to begin with. It’s almost like “what cloth are you cut out of?” With the times, and the soft market, if you get into financial hardships there’s more pressure to do something that is probably inappropriate. But for the most part, in insurance, you are still dealing with the 90 percent plus that are honest folks but there’s 10 percent out there that give the rest a bad name.

If an MGA or even a retail agency is having financial difficulty, what chance do the owners have of securing capital to help given today’s credit markets?
Donoghue: Well there are good operations out there that lend. So to the extent that they are in trust and they have solid business practices and they just need working capital, there’s potential that they can get there. If they need money tomorrow, they are going to have a difficult time finding it.

But if they are looking ahead and saying “I might need a working capital loan in 90 days” and plan ahead, I think some of the banks out there, InsurBanc being one of them, could try to see if they could bridge the gap.

On the retail side, another bank out there, Westfield Bank in Ohio, lends to agencies. There are groups out there that will lend to an agency that will make it a little easier than going through a traditional banking facility.

Are you seeing an uptick of firms looking for capital these days?
Donoghue: Yes, in the last couple of years I think there’s been somewhat of an uptick just because revenues are soft and people haven’t maybe downsized their staff appropriately. But lately there seems to be less softening going on. If anything it seems to be bottoming out so that could be helpful. So to the extent that they have right-sized themselves right now they might benefit from an uptick in pricing.

If an MGA did go under, closed its doors, or was selling, how should the clients be handled? Would the MGA look for another firm to buy the book?
Donoghue: Ideally they would. So to the extent that they have the ability to sell, they are not financially impaired to where a sale price would be less than the debt they are in, they can generally find an avenue to sell and maybe make some money on it.

If an MGA goes under, it’s not necessarily the end of the world as long as that underlying insurance has been placed with a company. You know, it’s when they went under and didn’t place the coverage (that’s a problem). For the most part, the underlying insured shouldn’t be at risk if the policy was placed and underwritten properly. If the MGA fails the policy is still in force.

If an MGA were to fail, how might the end customer view the retail agent who placed the account?
Donoghue: I think anytime you have a change in a market, the underlying insured is going to wonder why, so it could look bad on the agent.

But for the most part, as long as the agent verifies that the underlying insurance is in place and it’s with a credible company, the agent should be in good shape. They have done their job. They have maintained the confidence of their client to the extent that there is an intermediary that went under during the course of business.

To the extent that agents don’t do due diligence, and they haphazardly place risk with groups that they are unfamiliar with, then they would have exposure. … It’s always important to do some background on the owners and their experience.