The Insurance Stack: A Battle for Margin
The past decade of insurtech innovation has seen tremendous progress including rapid price quoting, advanced analytical underwriting, and the evolution of the MGA. From a 10,000 foot view, the rise of insurtech has had little effect on the $2 trillion dollar US insurance market. Despite a lacking seismic disruption, we believe we’re in the early innings of change. A unique set of global macro forces paired with industry players hungry for growth has set the stage for entrepreneurs to make waves.
The insurance stack is most simply thought of in three layers. Brokers sit on the top of the stack and sell policies to the end consumer. Primary Carriers follow the brokers, underwriting the policies while holding a significant portion of the risk. This responsibility comes with a large operational overhead of maintaining state licenses, employing actuarial teams, and running claims processing functions. Reinsurers sit at the bottom and act as a backstop for the primary carriers, reinsuring their risks against excess losses. The relationships between players up and down the stack are complex with the lines between each layer frequently blurring.
There is also a 4th hybrid layer of the stack known as an MGA or Managing General Agent. The MGA sits between the Broker and the Primary Carrier and serves both functions.
An MGA is a unique type of broker that borrows underwriting authority from a special type of Primary Carrier called a “Front.” (or Fronting Carrier) MGAs are not a new phenomenon in insurance, but their function has evolved over time. Historically, MGAs were utilized as platforms to underwrite niche risks, but today, they frequently serve as a launchpad for entrepreneurs setting out to build full-stack insurance carriers. In many cases, this new breed of MGA is VC backed and promises to bring technological efficiencies to underwriting, customer acquisition, claims processing, or policy retention. The attractiveness of the MGA model is that it allows upstarts to build product and underwrite policies without the need for a balance sheet to hold the risk. MGAs offload the risk to Primary Carriers or work directly with Reinsurers. In addition, MGAs have the opportunity to share in the upside when their successful underwriting generates profits. The biggest drawbacks to the MGA model are found in its lack of control and loss of margin. If a MGA reports a year of bad underwriting losses, the Carrier has the power to simply shut down the program. On average, we have seen MGAs paying 3–8% of their annual premium to their Fronting Carrier. While this % isn’t horrific, every point counts in a lower margin business like insurance.
The risks have done little to deter ambitious insurance-minded founders. As you can see above, MGAs have launched across all lines of insurance with the promise to bring wide-sweeping innovation to the industry. The majority of companies above are VC backed MGAs who offer products spanning from Home and Auto to Pet and Crop insurance.
The evolution of MGAs has been driven by tremendous investment growth. Over the trailing four years, insurtech deal count is up 39% and VC investment in the sector is up 327%. (1) MGAs make up a non-trivial % of total insurtech investment, but are just one piece among a larger pie. Novel data providers, SaaS workflow tools, and insurance specific distribution platforms have been substantial benefactors as well.
MGAs aren’t the only ones evolving, though; Primary Carriers have been increasing in size and capitalization. In simpler terms, larger balance sheets have enabled Primary Carriers to pass less risk-off to their Reinsurers. Between 2014–2018, global Primary Carriers ceded risk at -5% CAGR. (2) Holding this risk enables carriers to own more margin while increasing their profits. Excess capacity among the Primary Carriers is one of the key drivers of MGA growth. In search of alternative ways to expand their premium base, MGAs have proven valuable. Looking further up the stack, ultra-efficient pure-play brokerage platforms are also a hot commodity for Primary Carrier M&A. The most recent display of this demand was seen in Prudential’s September 2019 acquisition of three year old Assurance IQ for $3.5 billion.
Global macro forces have been driving activity across the stack as well. Returns on traditional low-risk investments have dropped to near 0% levels. As a result, large sums of alternative capital have come running to the reinsurance markets in hope of low-risk yield. This inflow of capital has hurt reinsurers’ pricing power and ultimately eaten into revenues. (3) As you can see in the graph above, the % of global reinsurance capital coming from alternative capital sources has been on a steady rise since 2008. The effects have been clear as property catastrophe pricing between 2012–2018 dropped by more than 50%. While rate-on-line pricing declined by 15–20% over the same period. (4) A year of significant losses in 2018 stemmed the tide of falling reinsurance prices, but the long-term effects remain unknown. Entering 2020, new alternative capital flowing into the reinsurance markets appears to have plateaued, but its significant participation is expected to remain strong. (5)
In reaction to changes facing Reinsurers, its players are looking up the stack in an effort to get closer to the risk itself. Searching for alternative revenue streams, Reinsurers are developing new service offerings, while at the same time exploring M&A with Primary Carriers and MGAs as a means of diversification. At the time of writing, eight of the top ten largest Reinsurers had sizable and in many cases growing primary insurance practices. Notably, Swiss Re has grown its primary insurance business to 11% of the group’s premiums, while Munich Re is sitting at an even split between primary and reinsurance. This trend was further amplified in October 2019, when Munich Re solely financed a $250M investment round in the commercial insurtech, “NEXT”. (6)
Brokers, excited by the prospects of the MGA model, are moving down the stack, creating new products, and underwriting their own policies. A recent regulatory study out of London found that 15 of the 73 local commercial brokerage firms are now offering underwritten products through an MGA. (7) We are seeing this trend as a firm first-hand. More than 40% of the recent insurtech brokerage businesses who have pitched Pillar have presented plans to evolve into an MGA, citing increased margin and more control of the sales process.
This is where the battle begins….
- Brokers are leveraging the MGA model to move down the stack
- Primary Carriers are ceding less risk to Reinsurers, while at the same time exploring new distribution channels up the stack
- Reinsurers, hurting from competitive alternative capital, are looking up the stack for new revenue channels
The market forces at play have created an environment where all players up and down the stack are on the move, each hungry for one another’s margin.
We believe entrepreneurs building platforms to facilitate this movement will be among the next generation of insurtech winners. Early leaders like Boost Insurance have begun to make waves in this space. Boost is building the equivalent of an “Insurance infrastructure-as-a-service” platform allowing any broker or distribution player to underwrite, bind, and manage insurance policies. The automation of claims processing, payments, and compliance will be crucial to remove friction from this movement as well. Additionally, we see a huge opportunity for platforms to connect Reinsurers/alternative capital directly to MGA’s APIs fluidly. While these are just a few tools that can help enable more frictionless movement up and down the stack, we continue to explore new opportunities in this space and look forward to seeing how these trends develop over the coming months.
