Disclosure in the segment is weak with few numbers publicly available, but over the last few years MGAs – which write ~$60bn of business – have been outgrowing the in-house underwriting at insurers.
Part of that growth reflects a cyclical shift of business into the E&S market where MGAs play more heavily, but there are structural drivers too that are set to remain in place as the cycle fades.
In growing so strongly, MGAs have confounded the bearish predictions of some in the sector that there would be a day of reckoning when the market hardened, and carriers looked to repatriate their risk taking. There is no arguing now that MGA growth was a soft market phenomenon.
As well as taking market share, MGAs are also coming to represent an increasingly high share of shareholder value in the sector, mirroring the relative value migration seen over the five years from insurers to brokers.
Capital has ascribed relatively more value to the brokers, with the consequence that most outperformers on total shareholder return in the sector have been intermediaries, as figures provided by Oliver Wyman show.
Many models will continue to be run in parallel, but it seems likely that we will see a proliferation of businesses looking to generate their value by servicing and partnering with MGAs – think fronts, but also balance sheet players looking to run a “deconstructed” insurance model like SiriusPoint by providing operational support and seed capital.
And, reflecting these dynamics, other insurance companies could follow Fidelis in exploring a “bifurcation” where they look to unlock value, open new pools of capital and unleash entrepreneurialism by separating into MGA and balance sheet arms.
A talent drift to MGAs and the relative ease of technology development with a blank piece of paper, as well as the greater speed of movement in a less bureaucratic environment, represent structural factors that create scope for outperformance.
But arguably the biggest driver of a shift in the balance of power towards M&A is the distorting influence of an increasingly large and influential private equity sector, which finds non-balance sheet investing fits better with the risk-reward characteristics it is looking for.
As hybrid distribution/underwriting businesses, MGAs share the model advantages of the broker in that they lack the same volatility of earnings and high capital consumption and can take significant leverage. All of this points to the likelihood of an acceleration of a migration of value towards underwriting businesses primarily underwriting for outside capital.
The attractiveness of the sector to PE was most recently illustrated by Carlyle’s US record M&A deal to acquire NSM from White Mountains for $1.8bn, equivalent to roughly 18x Ebitda and 1.5x premiums written.
For a long time, the top of the market on MGA – and private broker multiples – has been called including by me, but even with macroeconomic carnage, rising interest rates and a decelerating P&C cycle, there is no sign of valuation pressures emerging yet. And that reflects rock-solid PE – and to a degree strategic – confidence in the growth potential and defensiveness of the MGA segment.
The advantages of the MGA
There are four factors undergirding the bull thesis around MGAs, which can be neatly divided in two.
The first three represent advantages that MGAs have over traditional insurance companies, which create scope for a positive delta on underwriting results. The fourth is private equity’s decision to ascribe increased value to MGAs.
Aon data suggests that the underwriting results of the MGA space have been better than the market aggregate over the last decade, despite property MGAs causing some damage.
1. There is a talent drift from insurance companies to the MGA market.
Anecdotal evidence is growing that stronger underwriting talent is starting to gravitate towards MGAs, with scope for this personnel movement to accelerate.
Aon’s US MGA and program solutions leader Cory Schilling, the lead author of the definitive market report on MGA trends, told Inside P&C: “There’s been an incredible shift of talent to the MGA world, and we expect to see continued migration”.
That movement reflects MGAs’ ability to incentivize staff with equity and options. In addition, there is a cultural appeal to working at smaller, younger companies where underwriting is demarcated from the unglamorous work on licensing, compliance and capital that sits with balance sheet players.
As the industry passes through a generational shift with baby boomers retiring, and the economy continues to valorize the entrepreneur, this only looks set to intensify.
Particularly, in the specialty areas where MGAs tend to play, the biggest differentiator between different firms’ underwriting performance – and the bottom to top decile spread is typically 10s of points on the combined ratio – remains talent.
2. As start-ups – or younger, less complex businesses – MGAs have an advantage over legacy insurers in technology development.
Multiple sources have told Inside P&C that technology development in large insurance companies, with legacy systems and processes, is incredibly challenging despite their significantly greater financial resources.
MGAs are often able to start with a blank sheet of paper, and can move more quickly due to shorter approval chains. They are also able to attract a higher calibre of technology staff.
Despite the InsurTech hype machine’s best efforts to suggest otherwise, technology is typically not transformative at MGAs, but includes underwriting dashboards to improve decision-making and lower touch processing to improve operational efficiency.
3. MGAs can move quicker to launch new products to take advantage of market dislocation and target pockets of opportunity.
Just as MGAs benefit from their relatively small size and more streamlined governance on technology, they have an advantage when it comes to product launches.
Sources have said that MGAs are able to get a new team and product up in running in three to six months, versus a timeline in a large insurance company that can be 12-24 months.
The ability to more effectively exploit market opportunities to secure excess returns is a major advantage in a sector with persistently low returns and a high degree of cyclicality.
4. Private equity is ascribing increased value to MGAs, driving opportunities for outsized wealth creation in the segment.
There has been a huge run-up in valuations for MGAs, with “platform” MGAs moving from around 10x adjusted Ebitda five years ago to 12x-13x a couple of years ago, 14x-16x in 2020-21 and ~18x this year. Smaller MGAs have also ramped up to low-double-digit multiples.
These are the more typical multiples, but the extreme upside scenario has also been illustrated by UK-based, cyber-focused MGA CFC, which was valued at £2.5bn ($3.5bn) and more than 40x Ebitda late last year.
Valuations have ramped up across all sectors across the last decade or so, driven by low interest rates and fuelled in part by the remarkable growth of the private equity sector (although insurance fee businesses have moved faster).
But insurance fee businesses have also increasingly been seen as attractive investments by private equity, reflecting the success they have had in retail broking over that period where IRRs in the 20s have been achievable.
PE interest has increasingly spilled over into the MGA space over the last few years. In part, this reflects the fact that an MGA looks like a retail broker if you squint. They are not capital intensive, have good cash conversion, provide (somewhat less) stable earnings, and take leverage well (if not as well).
In addition, PE has gotten increased comfort that MGAs will avoid the doomsday scenario of lost paper due to their success in trading – and growing – through a period of intense underwriting remediation.
And, with ~30 consolidator platforms already working the retail broking space, the market is highly crowded – which can make MGAs and other insurance fee businesses like claims services look relatively attractive.
Last of all, PE is obviously chasing the broader thesis set out above around secular growth, driven by outperformance through talent, technology and speed of movement.
The important caveats
There are important caveats to this bull case. First, MGAs are not going to conquer the US commercial lines market and crowd out insurers from writing their own business.
Market share cannot grow indefinitely because not all business is suited to MGAs. Most MGAs are putting out lines that top out at $25mn, so they aren’t going to write large risk-managed property programs, huge builders’ risk deals, or most other lines that require major capacity.
The MGA’s true advantage is also in niche products requiring specialist knowledge and distribution relationships. By definition, there are a limited number of such niches, even if new products like transactional liability or new industries like cannabis offer growth frontiers.
The other vulnerability is some of the underwriting capital that has been drawn into the sector over the last couple of the years. As other capital – with Lloyd’s the primary example – drew back, reinsurers stepped in to try to secure the upside in primary pricing.
Some of these are well-rated reinsurers looking to originate risk more directly, but others are unrated reinsurers collateralizing their obligations and putting counterparty credit risk into the system. Some sources believe this is a fault line that could be exposed in years to come.
In addition, no MGA has yet achieved real scale. The largest MGAs in the market are in the $1bn-$3bn premium bracket, or more like $2bn at the upper end if you exclude warranty-heavy Amynta.
Dual CEO Richard Clapham and exec chairman Kieran Sweeney have confidently said they can build the MGA they lead to $5bn of premium, and that there are no obstacles to scaling a global MGA. But until someone can do that, it remains a prove-me point, with challenges around what remains primarily an exercise in the annual raising of underwriting capital.
Like the broader sector, all MGAs are also surveying an environment that looks set to become more challenging. Rate rises are decelerating, inflationary pressures already evident in short-tail lines could start to bleed into long-tail, and growth is set to become harder as the economy struggles.
Given that many of the MGAs are leveraged buyouts, they may struggle more than insurance companies from tighter money and, of course, they lack the slow-burn benefit of higher yields boosting investment income.
However, the biggest question surrounding the long-term prospects of the fast-growing MGA sector is as old as the model.
Those that are more skeptical in the carrier community are concerned around alignment of interest – they are anxious about the agent-principal problem.
The fear is that underwriting decisions are being made by companies and underwriters that are incentivized to drive volume to maximize Ebitda rather than to create underwriting profit.
Obviously, there are checks to this. MGAs must be able to generate results that will give them sustainable access to capacity. But bad news emerges on a lag, insurance companies often respond slowly and all the MGAs need to do is find one more schmuck willing to step in with paper. All of which is to say that capacity withdrawal should provide discipline – but it has only rarely done so in recent years.
There have been experiments with remuneration more weighted towards profit commissions, or with sliding scale commissions – but MGAs tend to resist such remuneration where they can because it inhibits debt leverage.
Alignment mechanisms like captives and Lloyd’s syndicates are being set up by the cyber InsurTech MGAs and CFC, but valuations on exit based on Ebitda remain the overwhelming driver of economics for the owners of the MGAs.
Some MGA executives also stress that long-term track records and trading relationships militate against this – and they do where they exist – but the vulnerability is built into the market. As an insurer, you can provide your capacity to someone. They can get rich building an insurance fee business and selling it, and they can leave you holding the bag on underwriting losses with none of the equity upside.
(SiriusPoint’s shrewd answer to this latter danger has been to ask for warrants or equity in the MGAs it backs.)
Ultimately, the incentives in the MGA world create risks for (re)insurers backing their underwriting. And for that reason, even if you buy the overall bull thesis as a carrier and want to lean into it, stock picking and/or spread are going to remain absolutely crucial to success.
But whether they think they can successfully separate the long-term winners from those seeking a quick buck, in the coming years (re)insurers will all have to reckon on a US commercial lines market where MGAs play a bigger role than ever before.
Inside P&C provides unparalleled market intelligence on the entire US P&C market – from small commercial and personal lines right through to reinsurance and Bermuda. Redeem your complimentary 14-day trial for more premium content from Inside P&C.
Scan here to download the app