MGAs face fresh challenges as market hardens

A hardening market has been the desire of many for some time, but as Charles Manchester, chairman of the MGA Association and CEO of Manchester Underwriting Management (MUM), says: “Be careful what you wish for.”

That won’t stop many drawing a long sigh of relief as the challenges of a long soft market come to a close. But Manchester says MGAs will need to watch out for a new set of testing circumstances arriving alongside the firming market.

For MGAs capital is scarcer in specialty lines than it was two years ago, he says, adding that MGAs will need to prove their worth by “answering the questions they should have always had to answer properly”.

He explains: “When a capacity provider asks them, ‘What do you do? How do you add value? Why should I back you?’, they need to have a story that makes sense, and they need to do it and not focus purely on the top line.

“MGAs now need to make an underwriting profit. I think that during the long soft market that wasn’t always paid attention to. If you’re an MGA with your back years looking pretty unpleasant, then it’s not necessarily going to be an easy time for you.”

MGA Pioneer Underwriting, launched in April 2011, could be described as a firm that has not had an easy time. The MGA has gone from 16 classes to just four, as 12 lines have been discontinued. Earlier this month (February 2020), K2 Insurance Services agreed a deal that will swallow up Pioneer making it the cornerstone for K2’s new international platform. Ultimately, the deal means Pioneer is likely to disappear.

Certain lines have faced challenges for a while: cargo, marine hull, yacht business and professional indemnity.

Manchester says: “Professional indemnity is probably the single biggest line that MGAs write. At the last count there were 60 markets out there that were capable of writing professional indemnity. This is an area that has not made money for years. There are islands of profitability, but overall the market has lost money. In fact it has been devastatingly bad for some.”

But he says that in general a hard market is a good thing “because you can’t have a permanent soft market where everybody’s always losing money”.

However, there is a caveat, he says: “In the hard market, yes you’re going to get price rises and narrower cover, [but] the effect of that is that MGAs have premium income limits, so even if you renew your book, if you add 50 percent to your renewal terms over a period of a couple of years you’re going to be pushing up against your income limits. Even if your capacity providers stay with you, and you’ve got no other issues at all, then merely by increasing price, you’re going to have pressure on your growth.”

And capacity providers won’t stay with everybody. Some providers get into difficulty that has nothing to do with the MGA. One example of this is Neon Underwriting, a subsidiary of American Financial Group (AFG), which was placed in run-off in January 2020 when AFG decided to leave the Lloyd’s of London insurance market.

Manchester points out that Neon backs a lot of MGAs. “Among the MGAs they back I’m sure there’s some bad ones, but I’m sure there’s some good ones too that make lots of money.

“They’re now going to be out there in the market looking for new capacity, they may have trouble.”

As the market continues to harden, the focus for MGAs will be on “getting capacity that will stay with you for the future” and allow profitable growth.

External market shocks are another area that could hit MGAs. “The wildcard at the moment is the coronavirus”, says Manchester, speaking to Intelligent Insurer in the first week of February 2020. “If it turns out to be a relatively damp squib, then great. But if it isn’t a damp squib we don't know what effect it will have on the world economy.”

The casualty crisis in the US is another issue coming down the road that is expected to hit MGAs as well as the wider sector. Think opioids and child abuse cases in the states.

“Some of the things that have led to that will replicate themselves over here [in the UK and Europe] as well. I think that casualty lines, or long tail lines in particular, have been probably under reserved systematically through the last few years of the soft market. So I think we're going to get a combination of deteriorating results in casualty over there [in the US], coupled with the need to strengthen reserves.”

And some will always question whether the MGA model itself is working. Many MGAs are in specialty lines, Manchester says, which tend to be affected by corrective action. “They’ve seen quite substantial rate rises, I’d be surprised if insurers don’t make money out of MGAs in this [current] market, equally the MGAs that survive the challenging times should do alright as well.

“I’ve been saying for years, long before Jon Hancock [Lloyd’s of London performance management director] came along with his Decile 10, for an MGA to work it needs to add some value. If it’s adding value, then it will be adding even more value in the current market. So the MGA model works fine, the problem is when people don’t use it properly.”

This happens, he says, when insurers back MGAs that aren’t really adding anything to the value chain. If commission is being paid to somebody in the chain, such as an MGA, they should be doing something that will give insurers a better result than if they tried to do it themselves. Or MGAs should bring in profitable business that insurers couldn’t get themselves, he explains.

“The difficulty is, particularly in the long soft market that we’ve had, that insurers have backed quite a few MGAs where really they were just looking for top line [gross sales] by doing it, almost abrogating responsibility for underwriting profit and encouraging the MGAs to write top line. And if anybody writes the top line whether they’re an insurer or MGA then it’s going to end in tears.”

One MGA that has a model that steers it away from this kind of issue is Volante Global. Manchester says its remuneration structure makes it very interesting. Insurers cover the initial cost of the MGA, then the underwriting profits make the insurers and Volante profits. Underwriters at the MGA only make profit commission if they deliver profit for capacity providers.

“Another way of looking at it is that the insurers are funding the initial growth period, the early years of the MGA while it’s building itself up, but that makes it more of a joint venture between insurers and MGA. It’ll be interesting to see if it’s successful or not.”

He says that if it is successful it could be an alternative to commission based remuneration structures, which have been criticised for rewarding MGAs inappropriately, as the more you write the more commission you make. “Then there is the temptation for top line underwriting and that has been balanced by the pursuit of profit commission,” says Manchester, “but of course profit commission normally comes some time after the business is written, whereas the upfront commision comes immediately and pays the bills.”

Looking at 2020 and beyond, the MGAA chair highlights development opportunities ahead.

“These days, new MGAs are very often insurtech operations. Generally insurtechs don’t have the balance sheet ability to take risk themselves, maybe they will do if they grow exponentially, but at the moment at birth they don’t. The people who were looking at disrupting were probably expecting to be able to take risk whereas now they very often find themselves constituted as an MGA, so that is one interesting area.”

There are plenty of projects out there taking advantage of things like artificial intelligence and machine learning to look for patterns in business in the market that wouldn’t have been possible without advances in technology. “Conceptually there are a lot of things that can be done that couldn’t have been done five years ago,” he says. And with the greater agility and specialist expertise that MGAs are renown for, the long talked about tech revolution for insurance could well blossom in their ranks as MGAs make the most of new market conditions.