Buying an MGA - market trends and top risks

There has been sustained interest by private equity backed MGA and trade consolidators looking to acquire or start MGAs to create scale and more balanced underwriting portfolios. Increasingly, MGAs have also become an area of interest for insurance brokers looking to broaden and diversify their product offerings and operations.

A number of factors have led to there being an increase in MGAs as well as the number of M&A transactions involving MGAs:

  • There has been a number of entrepreneurial and agile underwriters with specialist skills looking to gain independence and create value;

  • The sustained soft market provides an incentive for insurers to shift fixed costs to a variable commission model;

  • There has been an increase in the number of MGA incubators which are able to make business plans of entrepreneurial underwriters a reality; and

  • MGAs are attractive to financial buyers and are perceived to provide a value added service, benefitting from higher valuation multiples.

Current market trends

There are a number of factors and current trends which, in the future, could impact both the strategy of those buying MGAs as well the attractiveness of MGAs:

  • The recent Lloyd’s ‘Decile-10’ performance review and business plan approval process has led to syndicates being challenged on underwriting performance. This has led to changes to business plans of capacity providers and has created difficulty for certain MGAs in securing capacity. MGAs could be incentivised towards consolidation to gain greater negotiating power with capacity providers.

  • Brexit has led to uncertainty for MGAs that write business in the EU as well as on a more macro level for UK based insurance businesses. Corporate reorganisations as a result of Brexit will be more costly to operate and may provide a further incentive for MGAs to gain scale through M&A.

  • The efficiency of doing business with MGAs and the value added to the insurance value chain is under scrutiny and MGAs need to differentiate in terms of: risk selection, underwriting pricing, underwriting discipline and the use of technology. This may lead to capacity providers revisiting how MGAs are remunerated and underwriting agreements being renegotiated to provide a greater alignment of economic interest.

Top risks

When looking at the purchase of an MGA, buyers should be considering a wide range of financial and commercial risks which could impact the success or failure of a transaction:

  • Underwriting profitability and whether the MGA’s  book of business is sustainable in the long term. This will determine the prospects of a long-term relationship with capacity providers and whether earnings are maintainable. For start-up MGAs there is often a tension between writing business to generate commission to cover overheads and writing business profitably.

  • Whether there are contingency plans for the replacement of capacity in the event that key providers withdraw from underwriting agreements. This could be a particular risk for MGAs which operate in one, or closely related, lines of business.

  • The distribution of products and relationships with producing brokers and introducers is a key area that provides comfort in securing long term partnerships.

  • Revenue recognition and the recognition of profit commission is a key area to understand to ensure that there is a firm basis for understanding the performance of the business. Many acquirers are also having  to consider and evaluate the impact of IFRS 15 on revenue recognition. This can be challenging, particularly when the target business does not already report under IFRS.

  • A key balance sheet risk is the accounting for insurer cash and liabilities, particularly when an MGA may be holding money on risk transfer for an insurer. There may be risks that commission withdrawals and insurer liabilities have not been correctly accounted for and that there could be significant undetected liabilities.

How BDO can help

Our dedicated insurance sector experts provide advice to underwriters, Lloyd’s syndicates, P&I clubs and other mutuals, outsourcers, and multinational insurers and brokers. Our specialist team helps clients stay abreast of the latest opportunities, as well as any potential pitfalls.

This article provides a brief guide to the key issues, but specific advice should always be sought. For further information, please contact Tom Barford or your usual BDO contact.