As this publication has previously explored in depth, the sector has benefited from a number of structural tailwinds that have contributed to its growth story.
The MGA sector managed to confound wider expectations that it would struggle amid a strong pricing upswing in E&S, where MGAs tend to play more heavily – with the expected mass withdrawal of paper failing to materialize.
Instead, MGAs have enjoyed greater business flows and harder rates – supercharging growth and as such making these cash-generative, low-volatility businesses an attractive proposition for private equity, which landed upon the sector with plentiful capital, cheap debt and an eye on rolling out the M&A playbook developed in retail broking.
We have seen valuations soar to high-teen Ebitda multiples – illustrated by Carlyle’s record US M&A deal to acquire NSM from White Mountains for $1.8bn, equivalent to roughly 18x Ebitda and 1.5x premiums written.
MGAs’ ability to incentivize staff with equity and options, combined with the attraction of working for a nimbler, often tech-enabled growth business, has also seen top underwriting talent gravitate towards these outfits.
However, macro forces are set to challenge those structural advantages – and set the stage for a slow squeeze of the MGA sector and a likely deflation of valuations.
MGAs are cash-in, cash-out businesses – at their simplest, generating income through commissions and premium flow, and paying out in cost – both in staff and overheads, as well as interest payments on debt. Both sides are set to feel the pressure in this new trading environment.
On the cash generation side, the slow waning of rate rises coupled with fading inflation point to a slowing of growth in written premium and commission income.
The micro cycles within the P&C market mean this decline will not necessarily be uniform across the MGA sector – with the extent of this pressure heavily dependent on an MGA’s business mix and specialism.
In particular, the dislocation in commercial property presents a double-edged sword – rates are surging in the space, but most in the sector believe this will also lead to a withdrawal of MGA capacity (as we have already seen with AmRisc). There have also been instances where commissions have been cut, meaning MGAs are also earning less. Those with the highest concentration of coastal property are most exposed to this trend.
On the cash outflow side of the business, the rising cost of debt creates an additional squeeze on P&Ls.
The increased involvement of private equity over the past few years means many MGAs are well levered – sometimes backed with 4x-5x Ebitda of cheap debt to juice returns.
The cost of that debt has now effectively doubled – and while fixed rate arrangements should ward off this squeeze for a period, a swathe of businesses could face refinancing in a significantly higher interest rate environment. Those with floating rate debt will already be feeling the impact.
Meanwhile, wage inflation and the war for talent creates an additional cost overlay for MGAs as talent retention is key for these platforms. Even for those who are tied in with equity, any squeeze on cash raises the scope for reduced employee dividends.
The combination of these forces will put MGA P&Ls under pressure and has led some in the sector to speculate whether this will encourage MGAs to chase top line more aggressively to meet targets and buoy cash flow.
In a slowing market, this could ultimately lead to poorer underwriting performance and threaten paper provider relationships.
Those most likely to weather the P&L squeeze are MGA outfits with scale and margin – as well as robust capacity relationships buoyed by track record and performance.
How quickly these dynamics will play out in MGA valuations is difficult to call.
Higher interest rates and reduced availability of debt should in theory pressure valuations from private equity, who as a result can put fewer turns of debt into deals. There are suggestions in the market that this is already happening – although it should be noted that the industry (and this publication) has continued to call a topping out of MGA multiples only to be greeted with news of another high-end valuation.
There are some MGAs currently prepping for a sale which could provide data points on the trajectory of multiples, including Neptune Flood and Nexus.
Though it is likely that the pressure on MGA businesses will show up slower than in the levered broker space, for example, there is an increasing feeling that the slow squeeze is coming.
After the MGA sector stood up to the typical challenges of a harder market, it may effectively be the central banks that bring them down from their lofty multiples.
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