The Fine Print
When insurance buyers seek out hard-to-place risks — coastal property-catastrophe insurance in coastal Florida, for instance — they turn to a retail broker who in turn seeks coverage from a wholesale broker with access to surplus lines insurers or other specialty markets.
Trouble may ensue, however, if the agreement between the retailer and wholesaler are unwritten or otherwise unclear. Too often, that is the case.
Mark Robinson, co-founder of national law firm, Michelman & Robinson, LLP, and chair of the firm’s insurance industry group, said that “it is alarmingly common for wholesale insurance brokers to not have formal written agreements in place with their retail producers, which exposes the wholesaler to potential liability.”
“While some of the key points that should be included in a written agreement are rather obvious — commission rates, payment of premiums, etc. — other essential terms such as the scope of binding authority, special cancellation provisions, and ownership of expirations can be much more nuanced, and should be spelled out in detail so as to mitigate the risk of conflicting interpretations,” he said.
Robinson noted that “it is critical that wholesaler/retailer agreements contain a mutual indemnification provision as a safeguard against third-party claims resulting from one party’s negligent acts, errors or omissions, or breach of duties under the agreement.”
In terms of commissions, for instance, “It’s pretty obvious [the rate should be spelled out], Robinson said, but contracts also need to spell out whether there is a right to change the commission rate paid to the retailer by the wholesaler at some stage.
Bernie Heinze, executive director of the American Association of Managing General Agents (AAMGA) in King of Prussia, Pa., agreed.
“In an age where lawsuits are quick to follow on the heels of many adverse coverage determinations, it is extremely important that these specific roles and responsibilities and expectations are specifically delineated, and it’s necessary that each party to the transaction understands their legal and contractual responsibilities,” said Heinze.
“It’s important to understand that it’s the carrier that has expressly conveyed and delegated its authority to bind risks in accordance with its underwriting guidelines and its risk appetite to the wholesaler, which serves the role of the defacto branch office of the insurer,” he said.
“In order to be in compliance with the statutory obligations of the insurer and its duties to the market,” he said, “the wholesaler has to be sure and the retailer similarly must be certain that the lines of demarcation between them have been established and understood.
“This would also include the issuance of certificates of insurance and endorsements to the policy, which are derived specifically from the authority the carrier has conveyed to the wholesaler,” Heinze said.
These certificates and endorsements can essentially change the coverage grants of the policy, Heinze noted.
Robinson said that “if the retailer thinks they have binding authority and represents to the risk manager, ‘This is bound. No worries,’ it could turn into a complicated legal issue.
“The agreement should expressly provide that the retail producer has no authority to bind, make, alter, vary, issue or discharge any insurance policy, extend the time for payment of premiums, waive or extend any policy obligation or condition, or incur any liability on behalf of the wholesaler or the insurers,” he said.
An attorney/consultant who has worked with insurance brokers for more than 25 years, and requested anonymity, said that in the 1980s, representatives of both retail and wholesale tried to address concerns over these sorts of agreements, with some organizations proposing a model contract.
Nothing came of the various initiatives, the attorney noted, due to the disparate nature of the wholesale universe, which includes small independents, national firms and boutiques.
Particularly problematic issues related to wholesale/retail broker contracts are commission, regulatory and licensing requirements, and the fulfillment of premium tax payment obligations.
Another area of complexity was that wholesale brokerage community agreements can vary widely between individual organizations, he said.
Particularly problematic were commission, regulatory and licensing requirements, and the fulfillment of premium tax payment obligations, he said.
Some of these difficulties may have been eased or resolved by the passage of the Nonadmitted Reinsurance Reform Act in 2010, he said. The NRRA states that only one state, the home state of the insured, can regulate and tax a nonadmitted transaction.
That’s not to suggest that conflicts cannot still emerge if the correct contract language is not in place. Quite the contrary in fact, he said.
Multiline insurance companies have begun to rethink the way they are selling commercial insurance to large organizations, with plans to offer more complex commercial products packaged together with products sold to individuals.
Such plans come as a response to competition from so-called aggregators offering various sorts of insurance and health benefits products to large employers, as well as individuals, said Michael Herman, principal for advisory services with KPMG LLP.
“There’s this convergence happening that is forcing a lot of companies to rethink how they sell across lines, from commercial property/casualty to consumer P&C and life-based products,” he said.
“[The bottom line is:] Don’t complain when the roofs leaks if you chose the cheapest contractor.” — Dan Holden, manager of corporate risk and insurance at Daimler Trucks North America
The ease with which some of the newest entrants to the business can offer coverage online is fueling the trend, he said.
“Millennials in particular perceive P&C insurance as commodities, thinking, ‘I can evaluate price with relative ease, and make a decision on my own,’ ” Herman said. “P&C companies are looking at ways to differentiate their products and services as a function of this commoditization and intense competition.”
Herman said that multiline companies are currently formalizing plans to package commercial products together with certain forms of personal lines such as auto or motorcycle insurance, which their clients’ employees may be interested in.
More and more multiline firms that have relationships with organizations with 1,000 employees or more are looking to lower distribution costs while increasing revenues and policyholder counts this way, said Herman.
“I’m having conversations with a lot of multiline insurers considering this [cross-selling] model,” he said. “They’re saying, if we bundle our products together and sell to a ‘captured’ customer set, we’ll win more, larger deals at a lower cost of sale than we did in the past.”
Traditional brokers will simply have to adapt and learn to sell these new portfolios, he added, or insurers wanting to own and retain more customers might decide to sell to these new commercial/personal lines programs on a direct basis.
Herman noted that the trend in question is a response to premiums shrinking in both the life and property/casualty spaces over the past several years due to competition from aggregators of different kinds and the perceived commoditization of the insurance product.
Where It All Started
For the past 10 to 20 years, companies like ADP and Paychex have harbored insurance units supplying employers with more than just the human resources and payroll-related services these firms were originally known for.
Both ADP and Paychex offer workers’ compensation insurance, for instance, and both companies allow clients to fund their workers’ compensation premiums on a pay-as-you-go basis each month, which allows employers to avoid surprises at year-end, said Paychex VP of Insurance and HR Solutions Services Kevin Hill, based in Rochester, N.Y.
“We now collect [customers’ workers’ comp premiums] on the same frequency as their payroll, which could be weekly, monthly, semi-monthly, or any number of frequencies. We began doing that about 15 years ago, and were pioneers in the market in that sense.”
ADP and Paychex both sell various types of commercial insurance, with Paychex offering commercial auto insurance, for instance, while ADP’s Automatic Data Processing Insurance Agency Inc. (ADPIA) has automated its certificates of insurance offering for workers’ compensation clients that want to access these forms on-demand.
ADPIA is also rolling out a benefits administration platform for its small business insurance clients that integrates payroll, employee benefits and insurance carrier systems.
A New Breed of Aggregator
In the last two or three years, several new types of aggregators have also emerged.
“For several years now you’ve seen rampant growth of venture capital investment in this space,” said Jarett Weinpel, vice president of product management for ADP Insurance Services.
“There are several start-up companies offering platforms [to employers] that support employee onboarding, benefits administration, time tracking, Affordable Care Act reporting, and more,” said Weinpel.
Some of these companies started as pure-play technology platforms that are earning revenue by becoming the insurance broker for an employer to receive the associated commissions.
Others are organizations with established HR or payroll platforms that expanded into insurance brokerage and benefits administration to offer their clients additional resources.
ADP, for example, was a pioneer in this technology space that expanded into insurance.
“We have established a stand-alone Insurance Services business that is independent, but integrated with our technology platforms, and has provided advisory services for over a decade,” said Weinpel.
But expanding into the insurance space has drawbacks. Zenefits, an online HR software, payroll and benefits company, announced the layoffs of 17 percent of its workforce.
VentureBeat.com recently reported that Zenefits is facing scrutiny over the way it sells insurance policies to small businesses, with a recent BuzzFeed report indicating that more than 80 percent of its deals in Washington State were done by unlicensed brokers. This led to company co-founder and CEO Parker Conrad stepping down, replaced by COO David Sacks.
According to Bloomberg, “Zenefits makes software designed to simplify and automate such HR tasks as health insurance signups. … Under founding CEO Parker Conrad, it also made software that allowed its employees to skirt state regulatory requirements, the company now admits.”
This is the precisely the sort of thing that makes Dan Holden, manager of corporate risk and insurance at Daimler Trucks North America, skeptical when it comes to newcomers professing to offer a solid insurance product.
“As for the general trend, I think payroll vendors view [insurance sales] as an untapped revenue stream. They want to make it as seamless as possible for their existing customers who already believe one insurance company is no better than the other. It’s just a matter of price. A rose is a rose, etc.
“Unfortunately, the buyer may find out later — once a claim has been filed — they got what they paid for.
“[The bottom line is:] Don’t complain when the roofs leaks if you chose the cheapest contractor,” Holden said.
Despite a trend away from traditional brokers toward aggregator companies, ADP’s Weinpel believes “things will settle out over time as companies realize that the technology is only as good as the expertise of the insurance adviser behind it.”
“A small error in plan selection or contribution strategy can erode the benefits of productivity gains from even the best technology platform tenfold,” he said. &
Cyber Captives Increasing
Risk managers are increasingly thinking about captives for cyber coverage due to the availability of better benchmarking data as well as the existence of more year-over-year trend analysis.
Five years ago, Marsh had few clients using captives to house cyber risks.
Last year, the number grew to 20, said Mike Serricchio, senior vice president for Marsh’s captive solutions practice. All were Marsh-managed captives with cyber risk policies along with other coverages.
He expects to see a relatively large growth rate for 2015, when the final numbers become available.
“It should be no surprise,” he said. “[Cyber] is what everyone is talking about.”
Due to the high-severity of cyber-related risks and risk managers’ desire to handle them in the best possible way, it’s reasonable that some would explore the use of captives, he said.
One reason is the desire to assume a high deductible and/or a higher coverage limit and fund it through one’s captive in order to gain access to reinsurance markets offering cyber coverage. Another is risk managers’ desire to avoid numerous coverage exclusions common in commercial cyber programs.
“Through a captive, you could expand typical commercial terms and cover something like gross employee negligence,” Serricchio said.
“Most cyber policies will do forensics and notification [when a cyber breach occurs] but might not cover property damage, liability to third parties or reputational risk.”
Interestingly enough, he said, there is broad interest in cyber captives across all industries and among large captives with $5 million to $20 million in annual premium, and small captives with less than $1.2 million in overall premium.
But not everyone is seeing the same level of cyber-captive development.
Stephanie Snyder Tomlinson, national cyber insurance sales leader for the Aon Risk Solutions Services Group, said only 1 percent of more than 1,000 Aon managed captive clients in 2014 wrote cyber insurance.
“Cyber insurance goes back to the late 1990s,” Tomlinson said. She does not anticipate an increase in the use of captives for cyber in the near future.
And whereas Marsh sees interest in cyber captives across all industry segments, Tomlinson said Aon is only seeing interest from health care, financial services and retailers.
These are areas with the greatest cyber-related losses, Tomlinson said.
She agreed, however, that one reason to set up a captive would be to get broader-than-usual cyber coverage.
“The cyber solution is not for every single client but if they do have a captive we are engaging with them in having that conversation.” — Stephanie Snyder Tomlinson, national cyber insurance sales leader, Aon Risk Solutions Services Group
Back in 2013, for instance, Towers Watson (now Willis Towers Watson) told Risk and Insurance® that much of the cyber coverage being offered was being done on a claims-made basis, but several of their captive clients were able to write cyber risk insurance using a manuscript policy occurrence form.
Thus, they were able to build up solid reserves in their captive to use for their cyber risk losses down the road.
Oceana Yates, vice president of captives with R&Q Quest Management Services Ltd. in Hamilton, Bermuda, said that her company manages more than 100 captives — none of whom are writing exclusively cyber risk.
“Some captives have an element of cyber included in their current policies, and the larger parent companies are trying to figure out where and what the risks are and how including cyber in a captive may help them to build reserves for that rainy day experience,” she said.
Clients and their parent companies in the health care and retail spaces especially are realizing how monumental these risks can be, said Yates.
But the risks are substantially wider. Hackers shutting down a power grid, for instance — as happened recently in Ukraine — would have a massive impact on company operations and supply chains.
“It’s no longer just about someone attacking an individual company’s computer systems or jeopardizing credit card information but also the terrorism event that shuts down the power plant or other major infrastructure.
“There’s a broadening awareness of the increasing likelihood of those type of events and the need to use a captive to access the excess markets like the market in Bermuda,” said Yates.
Today, it is larger companies seeking to insure significant layers of risk that are using the captive solution.
“Small and medium-sized companies tend to be at the beginning of the feasibility process at this time,” Yates said.
It remains a challenging process, however.
“There is not a significant amount of historical information for actuaries and others to use as the basis for analysis.
“Added to which, each company has its own unique risks and risk management infrastructure in place so the underwriting becomes bespoke on a case-by-case basis,” Yates said.
Aon’s Tomlinson said captives are being “underutilized” for cyber risk, especially considering the growth of the Internet of Things.
“We anticipate there will be 50 billion devices connected to the internet by 2020,” she said.
But all of Aon’s captives are “using standard policy wordings for cyber risk,” even though they could conceivably widen the coverage.
“A cyber captive may be used to include coverages that are not typically included in a retail insurance market cyber policy, such as Internet of Things exposures (property/general liability risks), or reputational risk.
“And yet generally, insurance buyers find it difficult to quantify the consequences of a cyber event, and hence are reluctant to include cyber in a single-parent captive.
“The cyber solution is not for every single client, but if they do have a captive, we are engaging with them in having that conversation,” Tomlinson said.
There are advantages to captive solutions for cyber coverage, however, including:
- To manage pricing;
- To set specific coverage;
- To set limits not available from the retail insurance market;
- To ensure greater control of claims, including expedient payment of claims compared to traditional insurers; and
- To access tax and other financial statement benefits, which may vary from domicile to domicile.
For cyber-only programs, limits available from the retail insurance market cap out at $200 million to $300 million, said Tomlinson.
“Some multinationals want a large tower of protection to perhaps $500 million,” she said.
“Often, it makes sense to use a captive to retain a large retention,” since the retail market may provide limits in excess of that significant retention, Tomlinson said.