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Impact of AM Best performance assessments of delegated underwriting authority enterprises on the insurance industry and insurance regulators

On February 1, 2022, AM Best issued the Methodology and Criteria for the Performance Assessment for Delegated Underwriting Authority Enterprises . A Delegated Underwriting Authority Enterprise (“DUAE”) is a blanket term to reference managing general agents, managing general underwriters, coverholders, program administrators, program underwriters, underwriting agencies, direct authorization, and appointed representatives. The DUAE role in insurance distribution is essential as they generate growth, provide specialized market expertise, and undertake administrative functions. The essential nature of the DUAE and their impact on insurance operations and distribution of insurance products necessitates this type of assessment.

At this time, AM Best is anticipating performing the first performance assessments during the first quarter of the year 2022. A DUAE will receive a performance assessment by AM Best if requested. Certainly, insurance entities doing business with a DUAE could suggest a performance assessment, though the request needs to come directly from the DUAE entity. This would also apply in situations where a State Insurance Department would prefer an insurer’s DUAE have a performance assessment conducted. The performance assessments are intended to provide a tool to the market to differentiate and evaluate entities considered DUAE. This purpose should drive value perceived by DUAE entities in receiving these performance assessments as a strong assessment could differentiate them from other entities, while a lack of assessment could be perceived as a negative by insurers.

Ultimately, the performance assessment is intended to be assigned to DUAEs with underwriting authority with a top priority for underwriting risks. The completion of the analysis leads to a recommended performance assessment and outlook. In addition to the performance assessment, an outlook of positive, stable, or negative will be assigned to the DUAE.

  • A positive outlook indicates that the continuation of favorable trends may lead to a positive change in the performance assessment
  • A stable outlook indicates that if current trends continue, movement in the performance assessment is unlikely
  • A negative outlook indicates that the continuation of unfavorable trends may lead to a negative change in the performance assessment

The process consists of the following six steps:

  1. Collect information and engage with management
  2. Analyze documentation
  3. Arrive at the pa recommendation
  4. Assessment committee
  5. Disseminate results (public or private)
  6. Monitor activities

The inclusion of an assessment committee is for the purpose of ensuring consistency across the performance assessments. The committee will receive the recommended assessment and outlook and vote on the results. After voting, the DUAE receives the results and can determine if it should be public or private.

The criteria and methodology recognizes that the different types of entities that comprise DUAEs that have unique characteristics. As such, it is believed that the application of this methodology is sufficiently comprehensive in capturing the key factors that are necessary to assign a performance assessment to any of these entities. The performance assessment is designed to be comprehensive, consisting of quantitative and qualitative, assessment of (1) underwriting capabilities, (2) governance and internal controls, (3) financial condition, (4) organizational talent, and (5) depth and breadth of relationships. This is not a financial strength rating.

  • Underwriting capabilities: considers factors such as quality of underwriting, underwriting results, underwriting competitive advantage, proprietary data and analytics, commission structure, claims management, experience of underwriting staff, technology in the underwriting process, and limitations on exceptions / risk appetite
  • Governance and internal controls: considers alignment of interests, systems, audits and other management reports, polices and procedures, disaster recovery plan, key person risk plan, service measures, binding contracts, broker contracts, and partnerships with TPAS
  • Financial condition: covers an analysis of financial results and metrics and financial strength and impact from related parties
  • Organizational talent: factors in tenure, training programs, executive experience, and organizational structure
  • Depth and breadth of relationships: considers number of programs and markets, consistency of relationships, geographic reach, and retention of clients

Each of these areas will receive an assessment of Exceptional, Excellent, Strong, Fair, or Weak. Points are assigned to each of these assessments. underwriting capabilities, governance and internal controls, and financial condition points are 10, 8, 6, 4, and 2 for each of the five assessments while organizational talent and depth and breadth of relationship points are 5, 4, 3, 2, and 1 for each assessment. Higher point totals are associated with the better assessments; with the overall performance assessment based on the sum of the five areas of assessment with an overall performance assessment assigned as:

  • Exceptional [PA-1], 34-40
  • Excellent [PA-2], 27-33
  • Strong [PA-3], 20-26
  • Fair [PA-4], 13-19
  • Weak [PA-5], up to 12

So what, if any, will be the impact of these performance assessments of DUAEs on the insurance industry and insurance regulators? First, it gives an evaluation tool to the industry to differentiate from the options for outsourced product distribution and underwriting services. Outsourcing has been a staple of the insurance industry and captured the attention of insurance regulators. Whether investment managers, claims administrators, reinsurers, and DUAEs; insurers outsource key functions of their business in order to gain the perceived benefit of efficiency and/or expertise they do not have internally. This outsourcing comes at a cost in addition to the service fees. The outsourcing of key functions requires the insurer to give up control and exposes them to counterparty risk; which requires mitigation.

Specific to DUAEs, the performance assessment will provide insurers and their regulators with a data point to evaluate the counterparty exposure within product distribution and underwriting. If these performance assessments become more common practice; insurers could establish risk mitigation that sets a minimum performance assessment score or the existence of a score for the DUAEs to be considered a service provider of the insurer. The performance assessment methodology and criteria developed by AM Best establishes an evaluation framework that can be used by insurers, regulators, and consultants in assessing independently the DUAEs in a consistent manner.

Also, the evaluation of the performance assessment’s relevance needs to consider the current environment in which business and insurance operates. During the COVID-19 pandemic, insurers had an entirely new counterparty exposure; which manifested in services providers closing business due to negative financial impact they experienced in the pandemic. Even if the service provider did not shut down, negative financial impacts could have impacted the service provider’s performance. Currently, we are operating in an environment that is facilitating employee movement and impacting entities that have traditionally experienced the benefit of employee retention and the development of institutional knowledge. This performance assessment tool with its areas and considerations reviewed within should provide an assessment of these new risk exposures.

Ultimately, if performance assessments of DUAEs gains transaction; whether through DUEA perceived value or based on the insurer demands, we can use these assessments to consider this unique and consistent counterparty risk exposure. The performance assessment criteria and methodology provides a framework for independent assessments by insurers, regulators, and consultants of the DUAEs in question. Insurers in particular can use this as part of their risk appetite assessment of counterparty exposure in product distribution and underwriting; similar to the considerations given reinsurance counterparty financial ratings as a best practice in insurance. Finally, consistent performance assessments will improve the overall performance of DUAE services as evaluations are more readily available and insurers look to contract for services with DUAEs with strong assessments.

For more information on these topics, or to learn how Baker Tilly’s Value Architects™ can help, contact our team.

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