Target Markets Takeaways: market boom but capacity and macro challenges loom

Target Markets Takeaways: market boom but capacity and macro challenges loom

19 October 2022

In an increasingly data-driven segment of the market, the raw statistics around the Target Markets Program Administrators Association Annual Summit (TMPAA) in Scottsdale this week support the view that the US MGA and programs sector remains in rude health, with booming growth conditions and record interest.

The Association’s membership of 617 is up 13 percent from 547 this time last year, including 379 program administrators, 83 carriers and 155 service providers.

And Target Markets president John Colis – also the CEO of Euclid Program Managers – told attendees: “We have every expectation that this growth trend will continue.”

A total of around 1300 delegates – up 30 percent on last year – plus an estimated several hundred unregistered “lounge lizards” at the Westin Kierland, represent a market that is now estimated by the TMPAA to be well ahead of $70bn in 2022.

That represents a growth rate of more than 30 percent since 2020 (see chart).

So far so good. But where last year’s event was unanimously bullish in tone – fueled by a near giddy excitement as market participants returned to face-to-face meeting and deal-making after a hiatus during Covid-19 – this year there are clearly some major challenges that need to be navigated to keep the US programs sector on its strong growth trajectory.

Here are our Ten Takeaways from the 22nd Annual TMPAA Summit…

1. Deal activity strong

The first observation wandering the Westin Kierland was of the buzz of activity. And while (as we detail below) there are headwinds beginning to form in some segments of the market around the supply of capacity, there is no real sign of any slowdown in the volume of program deals coming to market. Program insurers (traditional and hybrid/fronting) are continuing to see a strong pipeline of programs and MGAs, MGUs and program administrators are continuing to innovate and launch new programs. Demand for specialty, niche product remains strong and the fundamentals that have driven the need for innovation and solutions from the US programs sector are if anything intensifying as awareness of a wider range of increasingly complex risk grows.

2. E&S re-hardening…

One clear tailwind for the MGA and programs sector in the US has been the surge of business that continues to flow from admitted carriers into the non-admitted or E&S sector. And if anything that is only expected to grow post-Hurricane Ian as standard lines carriers with challenges around reinsurance and balance sheet constraints, as well as concerns over development of prior-year liabilities continue to retrench. The message from CIAB from wholesale brokers was that the E&S market is re-hardening and the current phase of the cycle will extend for a couple more years at least. That was seized upon by Target Markets delegates, with the MGA sector closely aligned with the E&S market, writing more than a third of its premium volume.

3. Carrier UW talent influx continues

There also appears to be no let-up of the exodus of senior specialty underwriting talent from traditional carriers to MGAs. This phenomenon – in part fueled by investor interest in the sector, the growth in large underwriting platforms with de novo programs at wholesalers and retailers, and the emergence of incubator platforms – has been a driver of expansion in the programs sector. And conversations this publication had with a wide range of industry executives in Scottsdale highlighted a large pipeline of new programs and MGAs involving teams and individual underwriters leaving carriers and drawn to entrepreneurial opportunities across a range of platforms.

4. But capacity concerns grow

At least partially offsetting the bullishness around growth opportunities was the harsh reality of a property cat reinsurance crunch that dominated discussions at CIAB earlier this month as an existing demand-supply imbalance was exacerbated by Hurricane Ian.

Sources at reinsurance brokers, MGAs and fronting carriers involve in programs with any kind of cat exposure were visibly concerned at the prospects for renewing or securing new cat capacity from reinsurers – at least at a price that maintains the viability of deal economics.

Buyers of cat reinsurance anticipate a brutal market at 1.1 and beyond – and with many deals renewing in the first half of the year there are naturally concerns over availability of capacity after reinsurers deploy to major nationwide and global carriers and what that will mean for business plans and budget projections in 2023.

There are thought to be a number of capital raising initiatives out in the market (including those involving PE) looking to target cat.

It was suggested that up to 10 business plans are being worked on at various stages of development. But none of them are likely to be above the $500mn mark, which means in the aggregate they are unlikely to make a major dent in the estimated $20bn of new demand for cat limit in the US when supply has been heavily depleted.

This publication revealed earlier this week that K2 is working with Stonybrook Capital in fundraising for a potential $250mn reinsurance vehicle to bring capacity to its K2 International platform

Meanwhile, a number of participatory fronting carriers with cat exposure are undertaking portfolio optimization exercises as they face the reality that PML will have to be trimmed, with knock-on impacts on the programs they provide their paper to.

In line with those CIAB discussions, concerns are also beginning to emerge about reinsurance capacity in other lines of business, with an expectation that placements will be tougher in casualty and other areas too.

Constrained reinsurance capacity is even leading to suggestions that some players in the fronting space could come under pressure, precipitating consolidation of the swollen ranks of carriers that now number in the mid-20s. It was also noted that the MSI-Transverse might not be the last involving trade buyers outside the US looking to acquire fronting platforms.

5. Flight to quality

In this environment, there is greater discussion about a flight to quality across the P&C sector when it comes to reinsurance capacity, and the MGA and programs sector is no exception.

Multiple sources talked about winners and losers – particularly post-Ian – as those MGAs and carriers that can demonstrate to reinsurers that they outperformed the market on their share of industry losses are likely to be favored when it comes to deploying capacity on renewals.

The issue extends beyond property cat, however. In a market where reinsurance capacity looks to be more limited across the board, reinsurers will inevitably be much more selective in their deployment. While there is no indication that there will be a widespread retrenchment from the sector by reinsurers, those programs that can demonstrate a strong track record of results and provide transparency into the performance of the business and their underwriting will be in a better position to secure the capacity they need.

6. Strategic capacity partnerships

An emerging theme among aggregators in the MGA space is of a desire to develop strategy partnerships with capacity providers – insurers and reinsurers – across their portfolios of programs.

Recent examples include the Aspen deal with Ryan Specialty earlier this year where the Bermudian committed capacity to a greater number of the wholesaler and underwriting platform’s MGUs, bringing its insurance, reinsurance and alternative capital arms into the mix.

There is plenty of anecdotal evidence of similar initiatives at other MGU and MGA platforms in what looks to be a more syndicated approach to underwriting capital.

Sources talked about a range of approaches, including a buffet, or bouquet as an alternative to more of an index play for a slice of the action across a portfolio.

For the MGUs the strategy can provide cornerstone capacity and more meaningful and easier-to-manage relationships with fewer insurers and reinsurers in an echo of the consolidation of wholesale broking appointments by retail brokers that took place over the last decade.

In a time of capacity constraints, that strategy relationship can prove highly beneficial.

For capacity providers, the arrangement can provide a way of building a selective but diversified portfolio.

Sources also noted that carrier participation would always come with some level of “dietary restrictions”, however.

7. Built to ride stagflation fears?

Macroeconomic challenges were also talked about with regulatory at the event – in terms of their direct impact on (re)insurer capital and the availability of capacity, the implications for loss cost trends of inflation, and demand for product from clients if growing fears of a recession in the next 12-18 months materialize.

The prospect of inflation and recession combining remains a very real threat. While there are concerns about the impact of inflation on current and prior-year loss picks – an impact which is likely to lead to greater underwriting resolve at carriers – there is a widely held view that, on balance, the MGA and programs sector is built to navigate the macroeconomic challenges.

Inflation tends to drive growth at distribution businesses as exposure bases rise to push up premium volume. And although there are some classes of business or segments where demand falls in a recessionary environment, many areas of insurance are either mandatory or importance buys for clients as long as their businesses remain functioning.

So while it may be a stretch to describe the MGA and programs space as recession proof, it is largely seen as a recession hedge.

8. Shifting M&A landscape

That recession hedge may be a factor in MGA sector’s favor as M&A conditions in the broader distribution space come under mounting pressure.

A major theme of CIAB was the dramatic shift in the debt market as a result of rising interest rates which is already having an impact on the volume of transactions in the retail brokerage space.

The pulling of the Relation recap process last month was seen as an indicator of issues that will resonate more broadly, with the firm’s lack of a portable debt facility and changes to financing terms at the 11th hour by the PE bidding frontrunners stymying a deal as economics shifted along with views on valuation.

There is an expectation in that sector that there will be a significant impact on the volume of deals over the next 12 to 18 months, and that seller expectations will begin to adjust, with a meaningful reset of Ebitda multiples after time after the upwards march to record levels of recent years.

However, an M&A panel at Target Markets said that in the MGA space, the rise of specialization, scarcity of assets, and stronger underwriting performance are all likely to help sustain the recent boom in valuations for the long-term, even if there is some moderate shift in pricing.

Sources added that private equity remains attracted to the fundamentals of the business such as strong margins and repeatable recessions – and its relative resilience to recessionary pressures.

9. Focus on organic growth

Nevertheless, in line with messaging from brokers at CIAB, there was a clear focus of MGA platforms spoken to by this publication on organic growth, amid dwindling sizable MGA acquisition opportunities.

The continued E&S boom will help that organic growth, as will the continued creation of de novo programs to meet the needs of clients.

With many nascent MGUs and programs launched over the last year or two now gaining critical mass, the engine of organic growth is expected to remain strong, with the necessary caveat around capacity availability.

10. The fight for long-term relevance

And in a typically energetic keynote address on Monday, David Howden made it clear that growth ambitions in the sector should look beyond the current product set to expand offerings to meet demand for solutions that is currently not being met by the P&C industry.

The founder and CEO of the Howden Group said that the MGA and programs sector has a responsibility to deliver a “proper” return to capital providers in order to remain relevant and position itself to address significant opportunities presented by the shifting risk landscape, including climate change.

Howden said it is critical for the prospects of the wider insurance industry for it to refocus its efforts on serving the needs of clients by partnering with entrepreneurs to help them build their businesses and take risks off their balance sheets, rather than assessing its own risks and “internalizing it”.

“If we’re not actually taking risk off their balance sheet, because we haven’t got enough capital in our business or our pricing is wrong, we won’t be relevant in the future.

“I want to close the relevance gap, and I believe that GAs, MGAs and program administrators are really capable of doing that,” he said.

The firm has, of course, wed its fortunes to the sector with the acquisition of Align Financial by its Dual platform, and the deal to merge TigerRisk with Howden Re – along with the creation of SabRE, dedicated to MGA business.

That demonstrates a good deal of faith and optimism in its prospects – an optimism that remains widespread in the sector, even in the face of growing challenges.

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