With Next Insurance making a decision convert from a digital managing general agency for small and medium-sized businesses to a licensed insurance carrier in May, there isn’t much to report from the carrier’s statutory financial statements as of yet.

The filing prompted Carrier Management to ask about the benefits of being a carrier compared to an MGA, the valuations of both types of entities and the likelihood of more changes in status going forward.

First, we summarize some of the reasons to be one or the other from the InsurTech executives.

(Editor’s Note: The comments from Guy Goldstein were sent to Carrier Management in May; comments from the other executives were delivered at the S&P Global Market Intelligence 8th Annual Insurance M&A Symposium in October 2017.)

Guy Goldstein, CEO and Co-Founder, Next: “As a carrier [instead of an MGA], we want to be able to take some of the risk of insurance upon ourselves and to be able to offer fully tailored products to entrepreneurs. This will allow us to better control the holistic experience and to continue to innovate faster.

“Small business insurance was stagnant for many years. We are rebuilding it from the ground up with new, fresh and innovative thinking. As a carrier, we are developing the insurance product, claims management process, customer experience and more. This step is key in achieving our mission of delivering simple, affordable and tailored insurance for every entrepreneur…

“The benefits for our customers are greater than the costs to us as a company. Offering a high-quality product to the market and making sure our customers have the coverage they need is our main goal, and we see becoming a carrier as a way for us to deliver more value to them. There are certainly challenges to being licensed in all 50 states, but our belief is that challenges and opportunities are two sides of the same coin. State regulators are very open to innovation and are looking for better ways to serve small businesses in their states, so the relationship with us is a natural fit.”

Alex Timm, CEO and Co-Founder, Root Insurance Company: “It’s obviously a very difficult thing to do to start an insurance carrier. I think a lot of people, in general, look at the regulation and they shy away from it. But we really thought, in order to disrupt insurance, we had to jump right in the middle of it. We really didn’t think sitting right next to an insurance carrier and partnering with them was really the right strategy…

“And we came from insurance backgrounds. I worked at Nationwide for four years, and so the other thing that we knew very early on was that as we [thought about] partnering with these carriers, [it] was really just adding layers and layers of cost. We knew it was going to be very difficult in order to actually move as quickly as we needed to because now we’re dealing both with the bureaucratic systems but we’re also dealing with IT systems that are 30-plus years old. It’s actually easier just to throw it all away and start brand new and say we’re going to build a policy management system from the ground up…

“I have not talked to an insurance company that’s not spending tens of millions of dollars every year just for a new back-end system. And so we thought maybe we just won’t do that. We’ll just kind of reinvent it from the ground up. That way we control our product, we control our pricing, and we have full control of the user experience. We don’t have to get permission from somebody else to go do something. We’re really in control of our own destiny. So, that was really why we said we need to be an insurance carrier…

“We went down the route of purchasing a shell as opposed to just doing one de novo…The shell vs. just starting right off [new] I don’t think was the big decision. I think the big decision was if we wanted to disrupt this massive industry, we have to jump in with both feet and really start to rebuild the stack from the ground up because we knew so much of it was broken.”

Mike Rudoy, Co-Founder and CEO, Jetty: “We chose to be an MGA, although we have very specific requirements in terms of our carrier partners. No. 1, we wanted to manage technology. It was important for us to manage our PAS, own the claims experience. Basically, all we were looking for was capital. And there are a lot of carriers out there that had requirements around giving us their insurance back end, which we were not willing to take. They wanted to own more of the product experience. Clearly, that wasn’t in the cards for us…

“So, we ended up finding a great partner who effectively allowed us to own that end-to-end experience, own all the pieces of the value chain that we were interested in—primarily distribution, clearly marketing, technology—and they effectively just become the capital.

“The other thing that was important for us was to find a single partner. We’re a young company. We didn’t want to be dealing with multiple companies at this stage, and so we needed someone who wanted to take on our entire portfolio of products—today, which includes three, but over time, which we see as many.” (Editor’s Note: At the time Rudoy made these comments last October, the company was selling renters insurance, security deposit replacement and lease guarantor replacement.)

Ted Devine, CEO, Insureon (former McKinsey consultant and Aon executive): “I might be the dinosaur in the room, but there’s no way on God’s green earth that I was smarter than [Chubb CEO] Evan Greenberg or [Chubb Vice Chair] John Lupica or [The Hartford President] Doug Elliot—or all the guys that make the product for us. So, we partner with Hartford and CNA and Chubb, and we’ll build two MGAs for Evan and John. They know insurance more than I will ever know.

“I want to control the front end. We have $300 million of premium. We have 300,000 clients. We’ve got B2B partners like Willis and Progressive and Hiscox and Marsh, and I want them to make the product. I want to deliver the product in a new and innovative way that they can’t do, and as long as I’ve got their capital behind me—and I’ve also done all the math at McKinsey on the ROE of a carrier versus the ROE of a distributor. There’s a reason that Aon and players like that trade at multiples of 23-25, and the carriers trade at multiples of 11 and 12.

“So, we’re just a humble small business online platform, and we hate the word disrupter…We’re not that. We’re trying to make a better user experience, leveraging our partners’ influential capital, and [we’re] true partners with them.”

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Former Bain Consultants Carbone and Jones note that relative values of MGAs and carriers may not be so clear cut.

Noting that Root achieved unicorn status with the last $100 million round of funding, they suggest that “Root’s $1 billion valuation should cause companies in low-margin commodity lines like home/renters and auto who are operating as MGAs to consider becoming a carrier.”

“One of the strongest arguments for being an MGA, not a carrier, is that MGAs are more highly valued because they trade on a multiple of earnings rather than book value. For the time being, the most valuable recent startups in insurance underwriting appear to be carriers, not MGAs,” they note, also pointing out that Chinese startup carrier Zhong An has a $7 billion valuation despite a 124 percent combined ratio in the first half.

In general, Carbone believes that structure does impact the valuation of an insurance enterprise. “If you do something as big as an insurance company, you can have huge value. If you are a tech firm that is selling something to insurance companies, you can have a huge value. But if you are only an intermediary, it is probably more difficult to have a high valuation in the long term,” he said. “Difficult, not impossible. There are fewer examples you can leverage,” he explained, looking ahead to the prospect of the company wanting to do a big exit for an IPO. The ability to look to traditional KPIs and multiples becomes more difficult, he said.

On the other hand, starting an MGA “can be cheaper and quicker compared to an insurer. You do not need regulatory capital,” he said.

Jones noted that there are a lot of successful MGAs in specialty lines, niche lines, E&S lines and other non-commoditized portions of the business. “If you’re in standard small commercial, auto, homeowners or renters, where you’re dealing with thin margins, it may make sense to start as an MGA. At some point, however, the fee that you’re paying for fronting and the inflexibility that getting 50-state coverage entails may cause the balance to tip toward being a carrier.”

“And indeed, the most valuable companies in InsurTech right now actually appear to be carriers,” he said.

As for customer-related advantages of carriers vs. MGAs, Carbone said the formal structure of the company does not matter to insurance buyers. What is more important, he said, is being a brand that customers can trust. “The mass market is not likely to buy insurance from an entity it doesn’t know…So, become trusted, become someone that an insured can give money to be sure that if there is going to be a claim,” he advised.

Jones noted that some MGAs take pride “in saying we’re backed by one of the most powerful reinsurers on the planet. I think customers understand that. However, if you want to say that you’re offering insurance directly, which is a selling point among certain customers, then you have to actually be organized as an insurance company—not an agent or a broker.”

Looking ahead, Carbone said that carriers like Root will need to continue to grow premium at a very aggressive pace in advance of future exit dates for their investors, who will likely evaluate them with traditional KPIs. He noted that Bain Capital recently offered to buy the U.K. P/C insurer Esure (mainly motor) for $1.6 billion. A sizable company, Esure wrote roughly $1.1 billion of premium (annualized from first-half 2018)—a 1.4-times price-to-sales ratio. For a $1 billion value, the implied sales figure based on this example is $700 million—a big leap for Root, Lemonade and Metromile, which have all written less than $50 million in the first half of 2018.