Diversifying Capacity With New Sources
The growth in written premiums and the number of policies generated by the MGA sector exemplifies the attractiveness of MGAs to existing capacity providers, with more capital supporting MGAs than ever before. A closer look at the data reveals that many changes occurred within capacity source types, and that new sources of capacity emerged.
MGAs seeking capacity, capacity providers competing with each other and investors contemplating taking positions in insurance assets should all be aware of these changes.
Primary capacity sources include:
- The London Market
- Traditional U.S. Domestics
- Alternative Capital
Changing Sources and Shares
The London Market
After Lloyd’s implemented its Decile 10 underwriting remediation plan in 2018, following significant natural catastrophe losses the previous year, London Market underwriters reduced their participation across many areas. MGAs, programs and other delegated authority arrangements were among the most affected by this campaign.
Many MGAs that previously partnered with a Lloyd’s syndicate were not renewed and were forced to move their programs to new capacity, as Lloyd’s significantly slowed the rate at which it approved delegated underwriting authorities (DUAs) with new or existing MGAs. This was especially true of cat-exposed property business.
With greater scrutiny of the DUAs in place for Lloyd’s syndicates, some MGAs reported more friction in the program set-up process. These factors contributed to fewer MGA programs in the U.S. being supported by Lloyd’s and, anecdotally, insurers placing more programs that were previously held with Lloyd’s. Nearly all other capacity sources have been beneficiaries of this shift, including the emergence of non-Lloyd’s markets for MGAs in London.
Recently, several Lloyd’s markets also exited the portfolios of U.S. property MGAs during 2021 to mitigate their overall catastrophe exposure, adding to the expected capacity squeeze for property MGAs during 2022.
We believe that while Lloyd’s will stabilize and return to more regular support of MGAs, the reputational damage will take time to repair. Many MGAs that would have routinely utilized London capacity are now comfortable with their new capital sources. Also, due to the additional cost of doing business via London, many MGAs are likely to avoid restoring Lloyd’s connections while domestic capacity grows.
Large domestic insurers have grown their share of the U.S. MGA market over the past few years. This is partly due to Lloyd’s supply disruption, which arguably only accelerated a trend already in motion.
Large domestics are increasingly interested in the MGA space, attracted by the current trend towards high growth and performance, as well as the more advantageous fee structures (particularly when offering admitted products). As a result, they have made significant investments in building permanent infrastructure to establish and support MGA programs.
For MGAs, working directly with a large domestic rather than indirectly through a syndicated program may be may be more efficient. It creates stickiness on high-performing programs and, importantly, will sustain the staying power of large domestic support in the MGA space.
First, let’s define fronts. Fronting insurance is a term that describes a relationship between two entities: one is an admitted or non-admitted carrier of insurance and the other is an unrelated captive or organization that cannot write regulated insurance coverage. The fronting carrier issues a policy and transfers some or all the risk back to another source of capital such as reinsurance, captives, et al. In 2021, there was a record number of fronting carriers in operation, and we expect growth in this area to continue in 2022. Fronts benefited from the disruption in the Lloyd’s market, which typically supported more challenging classes of business. As the front constituency have increased in number, they have also become more diverse but can be categorized into three distinct types: pure flow-through fronts, active fronts and platform fronts.
- Pure flow-through fronts exist solely to serve as the paper provider for another, or multiple, capacity providers. These fronts rarely, if ever, assume risk. They are not as active in the governance of programs in place. They have seen limited growth in recent years but have many advantages, such as lower expected fees compared to the more active front companies.
- Active fronts are currently the highest growth form of front company. They operate as a traditional front operates, acting as a licensed flow-through source, but with many important distinctions. They are significantly more involved in program governance and oversight, and might design programs themselves or work directly with (or invest) an MGA to source syndicated capacity for a program. Active fronts are more likely to retain some risk themselves. They will likely keep growing, with a possible constraint around sufficient talent and reinsurance capital being available.
- Platform fronts assume most of the activities of active fronts but tend to invest more in technology to support MGAs. These platforms are highly sophisticated and can provide policy administration systems, data and analytics, or marketing support. The support offered by these platforms tends to attract smaller, newer MGAs that lack necessary investment. We believe that the platform front model has potential and will continue to grow.
As with large domestic insurers, reinsurers have a strong appetite for MGA business. Many reinsurers are devoid of direct retail operations that can pose a conflict of interest, and so often have greater strategic flexibility when partnering with MGAs. Most reinsurers have sister companies or subsidiaries that write MGA programs directly.
This situation might change as reinsurers grant authority to an increasingly large number of MGAs, leading to potential overlaps between a variety of products, programs and geographies becoming more difficult to manage. As with large domestics, reinsurers can provide direct support to programs.
It’s worth noting that a growing number of reinsurers seek program reinsurance opportunities behind fronts, compared to those that have standalone program entities.
Third party capital has been active in insurance risk transfer for more than two decades, traditionally through ILS funds. With the rise of front companies, investors can now access MGAs (mainly via active/platform fronts) and participate on MGA programs. We expect this trend to continue. The strong M&A environment has seen many MGAs become private equity portfolio companies and, in some instances, these firms support the underwriting of their assets via captive structures, further introducing outside capital into the MGA market. We foresee alternative capital as lasting, and having its place to support the MGA market.
Risk Assumption and Alignment
Some insurers require their MGAs to assume risk, and others do not; there is no consensus on the importance of doing so. The necessity for ‘skin in the game’ is commonly a function of the age, reputation and track record of the MGA. Newer MGAs can expect stronger requests for risk assumption, while larger, established MGAs do not experience the same push for direct risk alignment.
Most MGAs view indirect alignment – that is, the alignment associated with co-dependence between an MGA and insurer – to be satisfactory. Multiple MGA leaders expressed that they would not operate any differently with a risk assumption mechanism in place than without it.
The mechanisms employed to directly align risk vary, with profit commissions and sliding scales most common. As MGA growth has accelerated, an increasingly large cohort of MGAs has become directly risk-bearing (with downside risk) via captive insurers.
However, we advise caution: Unlike traditional capacity providers, MGAs are not built to assume balance sheet risk. MGAs, especially smaller ones, might be tempted to establish a captive without fully understanding its capitalization, governance and other requirements. Mismanaging a risk-bearing captive could be damaging, if not fatal, for some MGAs.
MGAs are supported with more capital than ever before; Lloyd’s markets exit with U.S. domestic insurers and global reinsurers growing their shares.
Three distinct types of front companies act as MGA partners: pure flow through fronts; active fronts and platform fronts.
Third party capital can access MGA programs via active and platform fronting companies.
MGAs, especially recently formed firms, are called on to assume risk more often; some are opting to use captive arrangements.