Binders by the book

When they go wrong - and any type of London market business can backfire occasionally - delegated authority, or 'binder' contracts, are often very painful indeed. The cost of failure not only affects a syndicate's results but, more importantly, its reputation and underwriters. This is why Lloyd's is right to insist on much tighter syndicate monitoring of their managing general agent and managing general underwriter arrangements.

This aspect of the incoming delegated authority regulations has received less attention than it deserves. Yet the Lloyd's Corporation is driving a culture shift in the way syndicates track their binder business, with considerable implications for actuarial analysis. Looking at the changes positively, they have the potential to give underwriters much more control over their portfolios, enabling them to change strategic direction more rapidly in response to unfavourable trends or imbalances in their books of business. These regulations should be welcomed and viewed as minimum requirements.

Inherent underwriting hazards

Binder contracts amplify the hazards inherent in all Lloyd's underwriting, and there are several reasons for this. Firstly, assuming an underwriter has minimised the operational risk of delegating his pen, with the associated risk that the MGA may not follow the guidelines and rating plan, the next big issue relates to the length of the communication chain. This can increase the time it takes for bad news to reach the underwriter, giving the liabilities more time to accumulate. When the underwriter finally takes decisive action, several months of pain are still generally in the pipeline over which they have no control.

To overcome this weakness, the regulations seek to improve monitoring in two respects. Syndicates will have to demonstrate a more up-to-date knowledge of their MGAs, and it will have to be far more detailed.

Underwriters will have to demonstrate not only that they have the right information, but that they are acting on it. Although the corporation has yet to be specific, certain information is likely to be vital for each underlying policy including: inception and expiry dates; policy limits and excesses; business class and type; gross premiums and the underlying exposure base; claims as they arise; plus all premium rating factors.

For example, a professional indemnity policy may require additional information, such as state/territory, underlying inception date, size of firm, annual fees, company age and prior claims history. The information should be supplied on a continuous or, at least, monthly basis.

Although a minority of MGAs provide this kind of information at present, it will have to become standard. The challenge will then be to put this data to good use so it is clear what is really going on inside a portfolio; the London market is still learning how to store, retrieve and analyse large volumes of data. How many syndicates, for example, could use such information to measure the performance of individual lines of business and alter the parameters of the rating plan, to allow for existing and new relativities, in order to achieve target returns?

This type of analysis demands an appropriate IT system and the technical skill set to analyse data. However, the task can be made considerably simpler by using the right kind of software.

The reserving of MGA/MGU arrangements is another area often overlooked, yet is crucial from a monitoring standpoint for both underwriters and managers. In order to achieve the optimum benefit from the reserving exercise, it must be performed at a sufficiently detailed level. Each syndicate will need access to individual claims data with a link to the policy information.

This will enable London underwriters to adjust the business and rating plans if the account starts to slip and will, therefore, help to mitigate the scale of losses.

Once this information is available, the syndicate can subdivide the account into appropriate reserving groups defined by business class, rating factor, and any other dominant policy features. The claims can also be split into loss bands in order to remove the distortion of larger claims and more accurately allow for claim trends. Reserving can be performed using standard actuarial techniques and can accurately allow for detailed changes in exposures and mix of business.

The benefits of taking these steps go well beyond being able to demonstrate that the rules are being complied with. It should facilitate more measured strategic decisions relating to underwriting policy and make it possible to identify weaknesses and concentrate on profitable areas.

With more detailed data and the correct software, the syndicate will be able to track the mix of business and premium rates being achieved against the original business plan and rating manual in as much detail as it has defined. This will enable the lead underwriters to co-own the underwriting problem from their desks in London. For too long now, the MGAs have not been robustly challenged on the detailed make-up of the rating plan they write on behalf of London.

This can be done using a process known as segmentation, which is a common technique used for personal lines insurance. Segmentation analysis can compare relative claims experience between different segments and the impact of different rating factors. Multivariate analysis can be applied so the effect of each factor is isolated and underwriters can look at the pure effect of each rating factor.

The market should take an upbeat view of these regulatory reforms, seeing them as an opportunity to improve the way business is conducted, rather than an imposition from above. Too often in the past, delegated authority or schemes business has been a case of the blind leading the blind. Anything that throws light on this often murky corner of the market should be welcomed.