Christopher Miller, partner in McGill and Partners’ structured solutions team, outlines how managing general agents (MGAs) can differentiate themselves in a hard market
MGA numbers keep rising: is it sustainable?
The MGA marketplace has continued to be dynamic, with huge potential and growth outpacing the general insurance market. We see no saturation point in the near to medium term, given: 1) the abundance of capital within the (re)insurance sector that still needs to be put to work; 2) the increased frustration and reassessment of traditional carrier-centric career paths for high-calibre talent; and 3) the proliferation of hybrid fronting carriers, MGA incubators and specialty technology providers that collectively have lowered the barriers to entry for establishing an MGA, by offering fast-tracked and capital-light paths to entrepreneurship. These individuals, who may have been hesitant in the past to break off from the perceived ‘security’ of working for large and well-established carriers and reinsurers, now have very little reason not to make the jump and to forge their own paths.
A saturation point, if it does come, in our view will be a consequence of exhausting the highest level of talent. This will be the pivot point in the cycle as the overabundance of capital starts to eventually drop down naively to support mediocracy, and poor results inevitably follow.
Is capacity providers’ appetite for MGA partnerships undiminished?
We see no reduction in capacity seeking to support best-in-class MGAs, given their unique position as the most efficient transformer (often more efficient than an insurer in their chosen risk area) of risk between the underlying insured and capital. Where we do see a trend is with the capacity vehicles themselves, with a shift from the legacy carriers to those that are purposedly built around MGAs as the transformer.
Many MGAs have previously lost support from their capital provider due to insurance market sentiment about MGAs adding frictional costs to the value chain instead of reducing it or enhancing value (this is not a view McGill and Partners shares). Duplicate roles and costs can be problematic if not contemplated upfront in a traditional MGA/carrier relationship. This is most often an issue with legacy carriers, which have well-established and broad infrastructures, often built to service their traditional business. However, when at a later point in time that same carrier also looks to distribute through MGAs, some of those roles, and the associated costs, are redundant with the MGAs’ own infrastructure.
Interestingly, this is less of an issue for some of the new carrier entrants into the MGA space. Many of these startups deliberately have come to market with lighter-touch infrastructures, knowing from the outset that they will build their book through specialist MGAs that can provide their own, and often purpose-built, infrastructures and servicing platforms.
What market factors could cause carriers to limit partnerships with MGAs?
While highly unlikely, a dramatic and expedient shift in customer buying behaviour could potentially impact the need for carriers/capital to rely on MGAs as the preferred transformer of risk. If the majority of customers shifted overnight to buying insurance directly from the ultimate risk bearer, then the real or even perceived value of the MGA model, in its current form, could be diminished by removing one of their most valued attributes – distribution. That said, this seems a remote risk for MGAs as the cost of acquiring customers directly is extremely costly and inefficient today. The MGAs could also pivot to a direct-to-consumer (DTC) model if and where it made sense, and further the adoption of the DTC model has been quite slow within the US.
Which markets have growth potential for MGAs and carrier partners?
In recent years, MGAs have largely geared themselves towards SME businesses, and the insurers have been happy to let them service this sector for reasons including cost/expense reduction on high-volume portfolios. Additionally, reinsurers are now proactively seeking out MGA-produced SME business to help offset or counterbalance the reduction in ceded premium they have witnessed, as traditional carriers manage their capital more efficiently.
For the reinsurer, this means a reduction in ceded premium and an increase in relatively ceded volatility. Acquiring large blocks of diversified, non-correlated and low-volatility SME business from an MGA offers the reinsurer a highly efficient way to quickly hedge the inherent volatility embedded within their portfolio. Further, MGA-produced SME business is location-specific and geographically diverse. Thus, a reinsurer that is overweight to one particular territory or peril can easily rebalance their portfolio by acquiring blocks of MGA-sourced SME business within very defined locations.
What are the implications of a hard market for MGAs?
Counterintuitively, a hard market for an MGA operating within the legacy carrier model can be problematic in that these partnerships are not built to allow for significant year-over-year premium growth. While most welcome a market where exposures stay flat but rates increase, for the MGA the resulting increase in written premium often puts them at odds with their capacity partners due to artificial premium caps, the carriers’ own capacity constraints, or the resultant growth of one particular line of business becoming overweight within the portfolio.
The irony for the MGAs and the underlying carriers alike is that a hard market is the time when the underwriting margins should be the most favourable, yet the year-over year premium/capacity constraints limit or diminish the ability to take full advantage.
This constraint within the legacy carrier model is one reason you are starting to see a shift of the more sophisticated MGAs to either seek out and build: 1) program-specific capacity vehicles (structures that rely on syndicated reinsurance capacity sitting behind a hybrid fronting carrier); or 2) alternatively partnering with newer and purpose-built specialty carriers that operate with a more fluid capital structure, including a heavy reliance on syndicated reinsurance, and thus can be more opportunistic than that of their legacy carrier peers. Under both models, the value for the MGA is that the syndicated reinsurance capacity becomes fungible, meaning that the capacity can be turned up or down as market conditions dictate.
In a hardening (re)insurance market where capacity becomes constrained, these approaches provide the best-in-class MGA with much greater control over access, and the availability of fresh capacity in contrast to operating under the legacy carrier model. For a quality MGA, this access to fresh capacity has a material ‘knock-on’ effect. The MGA is able to scale opportunistically and gain market share while its competitors struggle to maintain their capacity. By scaling in a hard market, the underwriting results are more easily improved and the improvement has a greater economic impact as it is on a larger absolute basis. Eventually, the MGA is rewarded with increased market share, margin expansion and a materially higher valuation.
What must individual MGAs do better to remain relevant?
The most dramatic trend we are seeing across best-in-class MGAs, as they seek to differentiate themselves and stay highly relevant to their capacity partners, is around transparency. While MGAs have always provided relatively apparent value around distribution and specialty underwriting, the more veiled flaw of the model centres around the lag, inconsistencies and opaqueness of the data reporting. The desire and ability to provide almost real-time transparency across the MGAs book to their capacity partners is one key area that distinguishes leading, underwriting-based MGAs from that of more production-oriented MGAs. Those that operate in a fully transparent manner will be the winners of long-term, multiyear capacity.