Behind the asset-light revolution
Conning’s William Pitt examines the rise of asset-light insurance vehicles.
Around the world, insurers are discovering the benefits of travelling light. Asset-light vehicles such as MGAs, fronting companies and reciprocal exchanges are burgeoning in the US, and increasingly taking root elsewhere. The solutions they are offering, often buttressed by innovative data models, are changing the face of insurance.
Ahead of this year’s Monte Carlo Rendez-Vous, Conning has been working with Howden Tiger and other Howden Group companies to investigate the causes of the asset-light revolution in P&C insurance (we do not believe “revolution” is too strong a word) and to identify the effects it will have on insureds, brokers and capacity providers. Our report, Travelling Light, is published today.
These entities have been multiplying at a dizzying pace, particularly in the US market. They have varied roles, but often fit together as parts of a broader ecosystem. MGAs have been drawing increasingly heavily on fronting companies to help them address their capacity needs in what is now a very hard market for many lines of business. But some have been turning to reciprocal exchanges to supply more durable capacity.
Reciprocal exchanges are perhaps the worst-understood asset-light entities. They comprise two parts: an unincorporated association of subscribers, who are also the policyholders insured by the exchange, and an attorney-in-fact (AIF) that runs the day-to-day operations of the exchange. The balance sheet component of the structure will typically be capitalised by contributions from policyholders, reinsurers and surplus notes investors – normally specialist private equity funds or ILS funds.
Reciprocal exchanges are not asset-light structures in their entirety – Howden calculates that they account for an estimated 7 percent of the total surplus of the US P&C market and 9 percent of the market’s net premium volume, with major insurance groups such as Farmers, USAA and Erie Insurance having operated this model for decades. But the AIF, a fee-based business, is indeed asset-light – and recent history has shown that it can generate significant value for founders and other investors.
AIFs have had particular appeal to investors from outside the insurance industry, particularly technology investors (assuming the reciprocal’s business is supported by innovative technology). As Sean Harper, the founder of Kin, one such tech-enabled reciprocal exchange, describes it: “The economics of an AIF are close to those of a software company or very high-margin services business.”
Evidence of the value that can be built by AIFs operating within a reciprocal exchange structure emerged in 2019 when Tokio Marine agreed to buy Privilege Underwriters Inc, the AIF for Privilege Underwriters Reciprocal Exchange, for $3.1bn – a price-to-earnings multiple of 33x based on the company’s expected post-tax profits in 2020.
An MGA that closely partners with the AIF of one or more reciprocals is in an enviable position at a time when long-term underwriting capacity can be difficult and expensive to secure. This is the case for SageSure, one of the fastest-growing property-focused MGUs in recent years, which now insures more than 400,000 homes and businesses in 14 coastal states.
Founded in 2009, SageSure now has more than $1.2bn in in-force premium, backed by a combination of AM Best A- rated insurance companies and two reciprocal exchanges (rated A by Demotech). The exchanges’ catastrophe exposures are protected by a mix of traditional reinsurance, SageSure’s own affiliated reinsurance captive and $780mn worth of protection from ILS investors raised through five cat bond issuances.
As SageSure’s business model illustrates, the assumption of risk, especially catastrophe-exposed risk, remains a heavy lift, necessitating a strong balance sheet. For every new asset-light entity, there will typically be a range of capacity providers committed to assuming most or all of the risk underwritten. But it is through partnership between asset-light and traditional balance sheet vehicles that an increasing volume of risk is originated, priced and insured in today’s market.
Why is this happening? We have identified three reasons:
Attractions to talent
The growth of asset-light businesses reflects increasing dependence of large sections of the market on technology skills that have not historically played a large role in insurance. Traditional carriers have often found it hard to recruit talented individuals in fields such as software development and data science, whereas these individuals are often attracted to the entrepreneurial opportunities presented by MGAs.
Attractions to capital
Where the talent has led, significant investment has followed, with an influx of non-insurance investors into the insurance market to support tech-enabled asset-light businesses, particularly MGAs and, in the US, reciprocal exchanges. These investors are often willing to make large upfront investments, but are seeking far less volatile returns over time than those associated with balance sheet insurance businesses.
In addition, a more volatile risk landscape for many classes of insurance is helping to drive the popularity of asset-light vehicles among investors. Recent, elevated catastrophe loss experience in the property market – sometimes too readily ascribed to climate change – is contributing to this. But it is not the only market affected.
Attractions to insurance buyers and to brokers
In volatile market conditions, an insurance market dominated by large and relatively inflexible insurance companies is in danger of underperforming for insurance buyers. Today’s environment instead requires a diverse range of risk management and risk transfer options, enabling buyers to secure appropriate insurance coverage while allowing investors to find opportunities tailored to their risk appetite.
Asset-light insurance businesses are rising to this challenge. Assuming little or no underwriting risk, these businesses have proved more attractive to many investors than balance sheet carriers. Supported by data and technology, they have partnered effectively with traditional insurers to identify profitable opportunities and meet buyers’ needs in a challenging market.
William Pitt is director, insurance research at Conning
Travelling Light is a joint report produced by Conning and Howden, published this weekend. In addition to focusing on MGAs, fronting companies and reciprocal exchanges, the report explores the popularity of consortia in the Lloyd’s market.
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