This article was first published on the EC3 Legal website prior to its merger with Birketts on 30 April 2020.
MGAs, once regarded as the “new kid on the block”, are rapidly becoming the third insurance sector and a real cost effective way for insurers to access distribution and transact SME business efficiently. MGAs are leading the way by embracing new technologies, emerging capital and identifying new distribution opportunities.
What is an MGA?
MGA means Managing General Agent and covers any person and/or entity who manage the underwriting function for an insurer acting always as agent of the insurer and not that of the insured. MGAs are now the vital link connecting wholesale insurers with specialist retail distribution. MGAs are useful for traditional insurers as they provide professional underwriting services but most importantly access to niche and specialist markets without the need to set up their own distribution channels. The role of a “Managing General Underwriter” (MGU) differs slightly as the latter offers not only underwriting and access to distribution but also a whole range of other services not least actuarial and analytical support. Effectively the MGU business will undertake all the functions and services customers in the same way an insurer would; but with the one crucial difference they do not bear risk nor manage regulated capital.
What form of entity?
It is most likely that a limited company or a limited liability partnership will be used. LLPs have become increasingly fashionable. Each structure has its own distinct advantages. For the purposes of regulation, both will be treated the same but tax and ownership issues will often prevail for either corporate structure, and you are advised to seek advice before committing.
The ultimate decision one needs to make when deciding which corporate structure best suits the proposed business plan and by this we mean at the outset of the business one needs to determine what is its intended future. Is the business intended only to be a short term proposition, or do you wish to keep the business running as a medium to long term vehicle? Is a capital value is to be sought in the future, and if so, which entity will create the greatest value for the initial investor(s).
The main features of both corporate structures are set out below.
Limited Liability Company
A limited liability company has a separate legal identity from its shareholders. The business can only cease to continue following the winding up of the company. If you plan to grow a business, then a limited company is a good legal entity to use since it offers the flexibility to sell shares to outside investors. However, you should be careful about who you allow to become shareholders of your company. Shareholders will share in the ownership and possibly the decision making of your business.
As a shareholder your liability is limited to the amount invested in the company. You risk greater losses if you stand as a personal guarantor for any of the company’s debts and if the company goes into liquidation with debts, the creditors are paid out of the sale of the assets of the company. Under normal circumstances, creditors have no legal right to obtain repayment from the directors or other shareholders of the business. The debts of the company should not affect the directors’ personal credit ratings.
A limited liability company can raise capital by acquiring a loan or issuing new shares in the company. When selling a stake in the business to a key manager, you may decide to tie him in, or introduce bad leaver provisions. Unlike private companies, a public limited company can sell their shares openly on a market such as the London Stock Exchange. A private company cannot offer shares to the general public. To set up a private limited company, you will need to register with Companies House.
Limited Liability Partnership (LLP)
Limited liability partnerships are most often set up by professional services firms such as accountants or solicitors but once again can be used in the MGA space. An LLP is a corporate body with its own legal identity and capacity and as such requires registration at Companies House. A limited partnership has the organisational flexibility of a partnership but offers limited liability to members. Members are self-employed and taxed in the same way as in an ordinary partnership. Annual accounts must be prepared and filed, and there are other requirements similar to those for a limited company.
What sort of regulated vehicle is required?
The first regulatory consideration for the new MGA is to consider what kind of business will be conducted and transacted through the vehicle. It is widely assumed that the conduct of intermediated insurance business is always regulated under the Financial Services & Markets Act 2000 (FSMA). However, not all insurance business is regulated business. By way of example, commercial or reinsurance risks outside the EU do not fall within the act and as such there is no legal requirement for the conduct of such business to be undertaken within a FSMA authorised intermediary, although may be preferable, and advice should always be sought.
There are two methods of undertaking regulated MGA business in the UK:
- Direct Authorisation – this process can take up to six months, requires detailed business plans and the provision of much information to be submitted to the FCA in respect of business controls, Board composition, systems, PI insurance and the business process. It is a long and sometimes expensive process, and the continuing costs of regulation thereafter should not be ignored.
- Acting as an Appointed Representative – here, an already regulated intermediary (the “Principal” which may be a broking house) effectively supports the start up MGA business taking on all the regulatory responsibility and liability from day one. The process of appointment and approval by the regulator takes little time, and the costs are considerably less.
Which of these routes is preferable will depend on the circumstances and business class of the MGA. However, supporting start ups through the appointed representative route has become increasingly popular. And it is not only authorised intermediaries offering to do this now, as a handful of other providers are now offering full start up and turnkey options as well.
Costs initially and on-going can obviously be an issue with each of these and choice of business partner should be selected wisely and with care. Independent providers are not aligned to broking houses, and thus are not likely to be potential competitors for MGA’s clients going forward, which is an obvious attraction but many of these providers do not have the name and associated goodwill that goes with the established intermediaries, often they will require an equity stake in the business and questions of service delivery may arise.
The other aspect of undertaking London market business is Lloyd’s accreditation which is outside the scope of this article. However, the Principal may be required to provide Lloyd’s passes, and some service providers are not able to offer this.
Preferred route to market
In our experience, the preferred and chosen route to market is the Appointed Representative route and it is perhaps not difficult to understand why when you consider the fact that the UK has the most highly regulated and expensive intermediary regulatory regime in Europe. These costs, and the time taken, are often seen as prohibitive for start up businesses, where budgets are tight, and the futures relatively uncertain. In the longest soft market experienced in the UK, this is perhaps inevitable. Perhaps matters will change when the market eventually harden?
This article now focuses on what is needed to set up a Appointed Representative structure for a finite period of three years and thereafter applying for full regulatory status.
The principal legal agreements are as follows:
- Incorporation documents – when registering a company, the following are required: 'Memorandum of Association’ – this confirms that the subscribers wish to form a company under the Companies Act and agree to become members of the company. In the case of a company that is to have a share capital, they undertake to receive at least one share each. The document must be in a prescribed form, be authenticated by each subscriber; must be delivered to Companies House together with an application for registration of the company and the new company’s articles of association and a legal statement signed by all initial shareholders agreeing to form the company; and ‘Articles of Association’ – state how the company is run, governed and owned. The articles can put restrictions on the company’s powers – which may be useful if shareholders desire safeguards to ensure directors will not pursue certain courses of action, at least without shareholder approval. Written rules concerning the running of the company agreed by the shareholders, directors and the company secretary.
- Shareholders’ Agreement – this regulates the rights of the shareholders between themselves dealing with constitution of the Board, dividends policy, transfers of shares and “restricted matters”. This is usually a list of those material things upon which all shareholders need to agree. The Principal may wish to consider whether it wishes to be a shareholder or have an appointee on the board. This is a matter of individual negotiation in each case. It is suggested that if such an interest is taken, it is for less than 20% as this is a FSMA threshold controller limit going forward. This avoids issues of accounts consolidation under accounting rules. However, there is also usually a mechanism by way of options that allow for this stake to be bought or sold on a pre-agreed basis at a certain future date or upon certain agreed events occurring.
- Appointed Representative Agreement – this agreement is very important as it is the agreement that gives the MGA authority to operate. However, it should also give the Principal full protection against MGA breaching FCA regulations and full rights of inspection. However, it should be understood that no policies or cover notes are issued by the MGA and that all premiums and claim monies are accounted for within the Principal, not the MGA.
- Turnkey agreement – this agreement provides for all of the back office arrangements and is largely uncontested. There are a number of pressure points, which typically include: (i) PI insurance – The MGA will be insured on the Principal intermediary’s insurance and should be obliged to pick up the total cost of claims not covered by such insurance in respect of its own defaults (including excesses and deductibles). It should also pick up the additional premium cost arising as a result of such claim. (ii) Employees - The Principal will not want to pick up any costs of MGA’s employees of any nature or any liabilities relating to those employees ceasing to be employees of the Principal. The Principal should ask for an indemnity against these. (iii) Run-Off - termination can occur in many ways. However, the Principal has the regulatory responsibility for the run-off of polices underwritten through it by MGA. Consideration should be made by the Principal as to whether to request that a claims provision be set aside for this.
- Employment contracts – these can either be with the MGA, Principal intermediary or both. It is suggested that both is the correct approach, since the employee can be deemed an employee of MGA, and that his employment with the Principal will terminate when the appointed representative arrangement ends without liability to the Principal. This employment with Principal gives the employee the authority to conduct business.
- Loan/ Working Capital Facility - these are often needed because the MGA will struggle for cash for the initial working period of MGA. This facility bides them over for this period, and is repaid from commissions going forward. Alternatively, venture capital or subordinated debt can be provided from external sources. Speak to us to understand more.
Key Considerations when starting a new MGA business
- MGAA – Managing General Agents’ Association- membership Membership is recommended. The MGAA aims to represent and support 75% of the UK MGA market. In recognition of other professionals being well placed to provide valuable support to members in terms of knowledge, information and finance, a limited number may apply for Associate Membership. The MGAA is a not-for-profit organisation that works both within the professionalism framework of the Chartered Insurance Institute (CII) and observes its own code of conduct. The MGAA was formed in 2011 to lobby on behalf of MGAs, to communicate their considerable benefits and to drive best practice. The MGAA, and its board of directors and specialist committees focus 100% on shaping the future of delegated underwriting in the UK.
- PI Insurance This is an issue during and after the creation of the Appointed Representative relationship. The Principal will need to add the MGA to its PI policy but the MGA should bear the cost of this insurance, the excesses and deductibles in relation to claims relating to and originating from its business. The MGA should indemnify against any such exposure whether arising before or after termination and pay the costs of any premiums arising as a cost of its participation in such PI Policy of the Principal. The Principal will also need to make sure that the MGA and its employees remain ready and available to help deal with claims on Principal’s PI Policy.
- Regulatory Risk The Principal will not want any risk of regulatory censure against it, or to bear any cost in relation to the MGA, and will require indemnification against this.
- Run-Off Once the MGA decides to terminate the AR and leave the Principal, the Principal will not wish to bear the cost or conduct the run-off of risks introduced through MGA. Indeed, the MGA will not wish to leave this behind since it is part of its goodwill. Arrangements need to be put in place to affect this transfer. The issue is that the primary responsibility remains with MGA unless the clients novate the entire historic relationship across. This is cumbersome and unlikely to occur. As a result, Principal should ensure that it is protected against this, both in terms of contractual terms and indemnification, but ensuring the run-off PI cover remains in place at the cost of MGA.
- Retention of Business The MGA and its founders will want protection from the Principal that the clients, data and business that are warehoused through the Principal arrangement belong to the MGA. As such, it is proper for MGA to seek restrictive covenants from the Principal that they will not solicit or undertake business after termination for such clients (apart perhaps from regarding the run-off of pre-termination business). Confidentiality is also important.
- Client Monies and Monies Held subject to “risk transfer” Each MGA and its supporting markets are to decide how they wish to deal with premiums and claims monies. The handling of such monies would usually be governed by the FCA’s client monies rules under “CASS 5”. There is no reason why this cannot apply to monies received under a AR arrangement. The AR will receive all of these monies during the AR period and will be the one authorised to handle and deal with client monies. MGA will not hold or receive these. The AR will be responsible for payment of these to the insurers and/or clients. Upon termination, those monies held in relation to the business of MGA must be dealt with properly by the AR. Legally, they cannot be automatically passed across; the permission of the client is technically required. However, many intermediaries choose to do so against undertakings from the transferee to discharge all balances, and indemnity against loss. In practice, this seems to work best. Approval from the FCA to this course of action is recommended beforehand. The alternative for a new MGA is to enter into “risk transfer” arrangements. This is where the insurer accepts that once the MGA has received the premium monies, then it does so at the insurer’s not the insured’s risk. These monies are then NOT subject to the client money rules and the complexities and requirements that follow such status. However, these rules are currently subject to review. This position will need further advices.
- Client documentation – both the AR and the MGA will require access to these both during and after the arrangement. If the MGA is to take these over, the client will need to consent, but if they are transferred, the AR may need to retain access for the purposes of access and dealing with any PI claims and/or regulatory questions or audits in the future.
