A Guide to Writing E&S Business - Development of the Wholesale/Retail Market Resource

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Chapter 1: Development of the Wholesale / Retail Market Resource

We must first understand why the Wholesale Market exists and why, despite regulators’ attempts to regulate it out of existence, the Wholesale Market continues to be a force in property and casualty insurance.

An Explanation of Underwriting Cycles

At a CIC Agency Management Institute lecture, Avrohm I. Wisenberg, Chairman of Delta Insurance Group and Past President of AAMGA, explained the five phases of the underwriting cycle.

“The first,” he said, “is characterized by good underwriting, agent cooperation and adequate rates. During this phase, business is profitable. As a result, insurance company management gets enthusiastic and sends out the word that it wants volume; ‘get the business, cut policy rates."

“Phase two,” he said, “is characterized by insurance companies going into new fields, underwriting barriers being removed, big gross lines being taken on hazardous risks, and package policies discounted 70 percent or more.”

Phase three, which Wisenberg termed “the result phase,” appears several years later. During the “result phase,” surpluses are depleted and loss experiences are disastrous.

“Phase three sets the stage for phase four. The ‘cleanup and pullout retirement phase’ is the hardest phase of all. During phase four, an underwriter’s mind is ‘like a parachute; it only works if it’s open."

Phase four will lead to phase five, where company management begins to see profits, and phase one starts all over again. “It will come,” said Wisenberg, “in spite of everybody’s determination that it will not.”

The technical reason for underwriting cycles lies in the relationship among capital, surplus, loss and expense ratios and written premiums, and their impact on the financial standing of property and casualty insurers.

A very important factor which affects surplus and loss ratios is reinsurance. Perhaps no single factor in the financial structure of property and casualty companies has a greater degree of influence upon market capacity. In fact, reinsurance has a direct effect upon the “hardness” or “softness” of primary insurance markets.

Reinsurance

Reinsurance is a critical issue for Wholesalers. It provides them with the capacity necessary to underwrite the unique exposures that the Retail agent cannot place in the standard markets, thereby meeting the special insurance needs of the client. With reinsurance, the original insurer cedes or passes on a portion of a risk to a reinsurance entity in consideration of a premium payment. This premium payment is made by the original insurer to the reinsurer for the reinsurer’s assumption of a portion of the risk. It is insurance to the original insurer for either a quota share of the amount or an amount in excess of the limits of liability which the original insurer can prudently retain based upon its financial capacity.

Reinsurance, Process and Significance

Reinsurance can be carried out in two different forms. The first is a “treaty,” a contract between an original insurer and a reinsurance entity which automatically covers all risks of a defined category, amount or type. An original insurer may have “treaties” with more than one reinsurer for varying amounts.

The second form of reinsurance is called “facultative” reinsurance. This type of reinsurance is negotiated between the original insurer and the reinsurer on a risk-by-risk basis.

Reinsurance treaties normally are negotiated on an annual basis. However, periods of adverse loss experience and competitive marketing practices may require primary insurers to negotiate reinsurance treaties at relatively frequent intervals. Renegotiation usually requires that four major areas of the reinsurance treaty be reviewed. These areas are the net retention, limits of liability, risk acceptability, and premium rates.

These same four factors are important considerations in the placement of individual facultative reinsurance.

Interim negotiated reinsurance treaties may require the primary insurer to assume a larger limit of liability under the “net retention” portion of the new treaty. At the same time, the reinsurer may reduce the maximum limit of liability within the treaty and declare certain types of risks ineligible for reinsurance coverage.

These revisions in availability, limits of reinsurance and premium costs directly affect the marketing abilities and capacities of the primary insurers. When primary insurers lose their ability to “cede” or transfer a substantial portion of a risk to the reinsurer, their market capacity can be severely impaired. Withdrawal by reinsurers from further acceptance of specific risks also diminishes the marketing capabilities of primary insurers. Finally, when reinsurance premium costs are escalated, the rates charged by primary insurers are directly affected. Subsequently, premium rates are increased at the Retail level. In summary, without adequate reinsurance facilities, primary insurers literally are eliminated from an active, competitive position in the Property and Casualty insurance market.

Primary Difference Between the Retail
and Wholesale Markets

The fact that Wholesalers offer specialized marketing capabilities underscores the need for Retailers to be aware of the particular markets available through the Wholesaler. In addition to standard markets, the Wholesaler has direct access to excess and surplus, nonstandard and specialty insurers. There may be times when the coverage requested by a Retailer can be provided only through the use of manuscript or narrative forms. The use of these forms requires an explanation and definition of the insurance protection provided by the Wholesaler.

States have differing licensing, filing, reporting and premium tax requirements for non-admitted and alien carriers that require additional knowledge by the Wholesaler. These are discussed in greater detail in Chapter V, Licensing Rules and Regulations. With the exception of the state of New Jersey, there is at this time no protection under state guaranty funds for insureds of non-admitted companies.

In most states the Wholesale Market is relatively free from regulation. This permits carriers to use their own forms and rates. The result can be a great variance in policy forms, coverage’s, modes of premium payments, cancellation rights and policy warranties. Retailers rarely have direct contact with Wholesale insurers and relatively little knowledge of the Wholesale markets. Therefore, Retailers must rely to a great extent on the professionalism of the Wholesaler. Conversely, because the Wholesaler has no direct access to the insured, the Wholesaler must depend upon the Retailer for complete and accurate information on the risk to be insured. This absence of direct communication is peculiar to the Wholesale Market.

Making Full Use of the Wholesale Market

It has been the custom of Retail agents to consider the Wholesale Market solely as a source for non-admitted markets, excess and surplus lines and special risks. To continue viewing the current Wholesale Market in the same somewhat restricted fashion is inappropriate. While the existing market continues to provide traditional facilities, it also offers standard markets and innovative specialty lines that meet existing needs, i.e., Kidnap and Ransom insurance, Expense of Hostile Takeover protection, Financial Guaranty, and Vendors Special Interest coverage’s. Changing market requirements have created new sources to meet the needs of the insurance buyer.

Retailers who are not aware of the expansion of the Wholesale Markets are restricting their marketing potential. The extended resources and capacities offered through the Wholesale Markets provide an exceptional competitive opportunity to the Retailer. In order to realize the total possibilities of the Wholesale Market, it is recommended that the Retailer arrange for a preliminary discussion with the Wholesaler whom they have selected. This meeting will accomplish a recognition of the needs and procedures of both entities as well as the identification of the additional marketing facilities which could become available to the Retailer. The Wholesaler can also recommend other market sources which may be required to satisfy the Retailer’s needs. Through an open exchange between Wholesaler and Retailer, the full potential of an affiliation can be more completely understood.

Marketing Issues

The Retailer must be aware of a number of marketing issues that occur when placing insurance in the Wholesale Market. These include:

Restricted market availability
Finding Wholesale Markets
How to use Wholesale Markets
Qualifying the Wholesaler
Authority of the Wholesaler
Access to the Wholesale Insurer

The following checklist should be used in selecting the Wholesaler:

Is there an agency contract or producer agreement?
What are the stipulations of the agency contract or producer agreement?
How long has the Wholesaler been in business?
Is the Wholesale agency owned by an insurance company, investment company or individuals?
What is the professional experience of the principals in the Wholesale Agency?
Does the Wholesaler maintain active membership in a trade association or professional organization, i.e., AAMGA, NAPSLO, IIAA, PIA, CIC, CPCU or any state Surplus Lines Association?
Does the Wholesaler have the professional designation, Certified Managing General Agency (CMGA) or the Certified Insurance Wholesaler (CIW) which details a commitment to continuing education?
CMGA: www.aamga.org/education/designations/CMGA
CIW: www.aamga.org/education/designations/CIW
What are the areas of specialization of the Wholesale agency?
Does the Wholesaler offer primarily commercial or personal lines markets?
What companies does the Wholesaler represent?
What is the volume and growth of the Wholesaler?
Does the Wholesaler verify the financial solvency of the carriers represented?
Does the Wholesaler maintain adequate Errors and Omissions coverage?
What services does the Wholesaler provide to the Retailer?
What payment terms are offered by the Wholesaler?
Are there minimum annual production requirements?