How to build a successful MGA

Once regarded as the ‘new kid on the block’, the number of managing general agents in the market continued to grow, even throughout the Covid-19 pandemic.

With these firms seen as a cost-effective way for insurers to access distribution and transact small and medium-sized enterprise business efficiently, not even the events of the last few years could halt underwriters establishing this type of business.

To succeed, in the past, many claimed all wannabe MGA founders needed to do was spot a gap in the market, grab the cash to serve that niche, and build on the relationships they already had in the industry to deliver products and services.

But given the current economic headwinds and hard market, is that all it still takes to get an MGA off the ground?

Be unique

Being unique is essential in today’s market, according to John Dawe, delegated partnerships director at RSA Insurance, who says an MGA needs to find its own space where it can obtain presence and meaningful scale.

He says: “It may seem attractive to target mainstream classes of business, which have a large customer base to attack, but competing against established players in a crowded space places pressure on margins and challenges long-term sustainability.

“An MGA will ideally have identified and specialise in a niche not well served by the more established players, which creates a sound basis to provide fair value for all parties in the delegated chain. The MGA should be able to demonstrate that they have the underwriting and pricing technical know-how to compete and win in their chosen specialism, supported by strong technology and management information that allows them to plan, track and actively portfolio manage their suite of risks to deliver pre agreed target loss ratios.”

In addition, Dawe says to stand any chance of turning an idea into a successful MGA, the founder needs to have realistic ambitions regarding scale, with a clear plan to access distribution that will deliver their ambitions whilst complementing the achievement of target returns for their capacity provider.

Ready to launch

There are lots of different ways to go about setting-up an MGA, and before assessing the various options and support available, Tim Quayle, managing director of OneAdvent, says you need to understand what your end game is.

He adds knowing what is most important to you – for example, independence, annual bonuses or exit value – is key to getting off to the right start.

He encourages wannabe MGA founders to work through the following step plan:

1. Work out how you are going to fund it and what you want out of it.
2. Document your idea, the value you are bringing and why you think it works as an MGA.
3. Create a financial model to see whether it stacks up and test your assumptions with experienced people in the industry.
4. Go and talk to capacity providers and see what appetite there is for your plan.
5. Assess the various MGA platforms and options for launching your MGA. Find one that fits your business and can provide you with what you want out of it.

When it comes to the entity and regulatory permissions needed to set-up shop, there are a few different structures available and, according to Quayle, the road you go down really comes down to ownership of the value that you are creating.

He says: “Some platforms will enable you to essentially set up as a virtual business, where you capture the economic value of what you are doing but without a legal entity to hang it off. However, the most common form is to set up a limited company.”

MGAs operating in the UK market need to either be directly authorised by the Financial Conduct Authority or they need to be exempt from authorisation through being an appointed representative of another directly authorised firm.

According to Quayle there are pros and cons to both, for instance, becoming an AR is a faster way to launch your business and benefits from the support of a principal that can guide you through the policies and processes required.

ARs are not directly responsible to the regulator, which means they can focus on the core business proposition while the principal ensures regulatory compliance which in this industry can be a huge hurdle for many aspiring MGAs.

While an MGA structure can be established very quickly from an entity perspective, David Cooper, director of executive search firm Stephens Rickard, notes underwriting cannot commence until a formal binder (provision of risk capital or capacity) has been agreed and formally established.

Raising money

So once you’ve got the expertise and regulatory go-ahead to get your MGA onto the runway, how do you convince the market your bright idea will create value, will really take-off and is therefore worthy of financial support?

According to Cooper, once again the key thing is having something unique or unusual in terms of distribution and/or product – ideally both.

He says: “In a hard market, there’s no place for ‘me too’ ventures, which had proliferated during the last soft market, and an MGA is the perfect place for innovation.”

Cooper adds securing capacity is difficult in the current market so it’s critical that the underwriting leaders have a strong reputation in the market backed by a track record delivering profitable results.

He says: “Their reputation will also be a major factor in their ability to attract further talent from the market.

“Private equity or venture capital are a common route for capital raising so when going down this route having an executive team, CEO and chief financial officer with prior experience working with private equity and venture capital can be advantageous.”

Matt Scott, co-founder of Insurance DataLab, says each funding journey will be different, but one consistent theme is that the founders will need to demonstrate a keen understanding of the market and their product: “Data will be key here, whether that be statistics about market performance and key competitors and major players in the sector, or of the MGAs own projected financial performance.

“By having a breadth of key performance indicators (KPIs) covering underwriting and customer experience, founders will be able to demonstrate a depth of understanding that helps to give confidence in the project.

“Investors will also want to see a passion for insurance and the solution being built, and something that makes the business and its leaders stand out from the crowd.”

The nature of funding is key as the most successful MGAs have quality long-term capacity partners behind them, according to OneAdvent’s Quayle.

To secure long-term partners, Quayle says MGAs must have a good understanding of what value they are bringing to the table.

He says: “Whether that’s a new distribution channel, a complementary product or deep sector expertise, this must be kept at the core of their plan.

“The successful MGAs we have worked with are the ones that build gradually, demonstrating growth but not losing focus on underwriting results, all the while ensuring they continue to invest in the infrastructure and capabilities to support that growth.

“MGA build-outs take time. They need a sufficient runway of working capital, so they are not continually turning their attention to the next fundraise. Without the confidence of ongoing funding, MGAs can be driven to make the wrong short-term decisions.

“Long-term flexible partners are key to building out a successful MGA. Not everything will go to plan, so it’s important to build long term relationships with partners who understand that they may need to flex and adapt their support depending on where the MGA is in their lifecycle. MGAs that understand this and leverage the capabilities and skillsets of their experienced partners are more likely to flourish.”

While raising working capital can be a challenge, in the scheme of things Cooper says the amount required to establish an MGA and commence underwriting can be less than £1m depending on the scale of the operation.

The greater challenge, he notes, is finding staff unencumbered by restrictive covenants from a former employer; and securing meaningful underwriting capacity which is likely to stick around for the longer term.

Cooper continues: “The opportunities can be considerable – MGAs with a proven track record can be valued at anything from multiples of eight to 16 times earnings before interest, taxes, depreciation, and amortisation, depending on scale, area of expertise and overall profitability.

Some MGA start-ups are self-funded; some a mixture of self-funding (occasionally via “sweat equity”) and third-party investment, such as private equity, and some via established MGA platforms that can effectively provide a “plug and play” or turnkey opportunity to underwriters.

Cooper says these established platforms offer the lowest risk – but it is rare for the underwriters to own more than 50% of their underwriting cell with this sort of financial backing.

A higher-risk route is to self-fund, leading to a greater share of equity, but as one would expect, this also incurs greater risk for the founder.

Quayle says there are also opportunities to seek investment from a private equity fund or venture capitalist, plus several of the MGAs he worked with are now opting to crowdfund.

Whatever route a founder goes down to fund the business, all the experts Insurance Post spoke to recommend making sure exit plans are in alignment.

Quayle adds: “I would encourage MGAs to look for funding partners who know the sector well and have a track record of providing long-term funding support for MGA businesses.”

Making money

Ultimately, with funding in place, all MGAs must make money to satisfy investors. MGAs make money via underwriting commission – a percentage of the premium underwritten on behalf of the carriers – and via profit commission assuming the underwriting year has generated a profit.

Cooper says the balance between these two elements is key – too much underwriting commission and not enough premium commission can incentivise the MGA to focus too much on top line growth to the detriment of profit: “Insufficient underwriting commission could lead to the MGA being unable to incentivise and attract the best underwriters.

“Carriers are incredibly focused on these dynamics, and smart underwriting systems offering real time data to carriers allows them to accurately monitor their exposure at any time.”

When asked what impact the current economic climate could have on profitability, Michael Keating, chief executive of the Managing General Agents'​ Association, says “very good MGAs” operate successfully in any market conditions as they have the agility to adjust very quickly to changing economic or market factors.

With the rating environment currently positive, Keating says MGAs who are effectively an extension of their insurer partners should be confident in building a good performing underwriting portfolio delivering positive underwriting returns for both them and insurer partners.

With all businesses and as the financial results of the likes of Direct Line show, there are challenges in the current climate given the broader macroeconomic headwinds with inflation, interest rates and so on, with the hardening of markets, Todd Davison, managing director of Purbeck Insurance Services, says to ensure MGA profits are maintained bosses should assess premium rates to see whether pricing can be made more competitive relative to the market.

He also recommended focussing in on underserved markets provided that the data supports the loss ratios and income requirements for insurers.

Take-off

Should underwriters with a unique idea take the plunge and enter MGA market right now or delay their launch plans?

Cooper says MGAs remain valuable in terms of the multiples previously as mentioned, but founders should consider harder market conditions inevitably lead to carriers being more circumspect about which MGAs to support and to what degree.

He adds: “The better an MGA’s track record, the more specialised the product offering and the more niche their distribution, the greater that chances of riding out a hard market.”

The better an MGA’s track record, the more specialised the product offering and the more niche their distribution, the greater that chances of riding out a hard market.

David Cooper

Purbeck’s Davison says potential founders concerned about whether now is the time to take the plunge into the market should be aware that it takes time and patience to establish a successful MGA: “I would hasten to rush into anything without fully considering the risks, market, operational and reputational impacts of doing so. Reputation is key.

“If the product/services are unique then you may need actuarial support to provide the risk profile and proposed loss models.”

But, MGAA’s Keating believes ultimately the MGA market is extremely buoyant due to the deep and broad underwriting expertise across a wide range of sectors and products as well as the willingness to continue to innovate to meet broker clients’ needs.

He says: “Client buying behaviours and insurance programme requirements are constantly changing and MGAs are best placed to meet these needs.”

Ultimately a good MGA will acknowledge the risks that it is exposed to in the class of business it operates in the current climate, notes RSA’s Dawe, and how these risks could impact on the resilience of the enterprise.

He concludes: “A good MGA and insurer partnership will have clear transparency of these risks as part of ongoing monitoring and will seek to identify how these risks can be leveraged or mitigated if they materialise.

“The key is foresight, planning and close communication between MGA and insurer to be able to ride through challenges and deliver target outcomes over a long-term partnership.”