As money began to flow into InsurTechs back in 2014 and 2015, these companies essentially fell into two categories: You were either a provider of technology to insurance companies or a distributor of an insurance product to an end customer.
Executive SummaryRecently IPOed Metromile was one of the earliest InsurTechs to convert from the MGA to the full-stack carrier model, and more recently companies like Buckle, Hippo, , Next Insurance, States Title and Porch have made moves toward joining the big three P/C InsurTechs—Metromile, Root and Lemonade—in embracing the carrier model. What’s the attraction? And why are InsurTechs pitching VC firms today talking about MGA-to-carrier aspirations for their businesses?
Here, Matthew Jones, the principal of fintech venture firm Anthemis and author of CM’s VC Viewpoint series, cites an awareness of “dependency risk” as one of the drivers that’s putting the insurance carrier model back in vogue. He also provides some factors for InsurTechs to consider in determining whether making the transition from MGA to carrier is really the right move.
If you were a distributor of insurance, the model was obvious: You structured yourself as an MGA. It was genius. You get to be active in the insurance market, but without the need for an unwieldy balance sheet and the regulation that came with it. MGAs weren’t new—the industry itself knew that—but “capital light” was the name of the game in venture capital, and so began a boom of virtual insurance companies.
Vast quantities of money have continued to flow to MGA propositions, and not many people expect this to change any time soon. However, from the front lines of insurance venture capital, one thing has become very clear over the last 12 months in particular: Once rejected as old-fashioned and even impossible, the insurance carrier is back in fashion.
But why, and why now? (Article continues below)
Why would anyone choose to become a carrier?
Perhaps unsurprisingly, the attractiveness of the full-stack strategy is largely driven by the shortfalls of the MGA approach, rather than entrepreneurs’ irrational lifelong ambitions to take the helm of an insurance carrier. Specifically, entrepreneurs running an MGA simply don’t have full control over the entire value chain. That’s largely the point, of course—you get to be in market without the obligations that come with being a carrier. Entrepreneurs get to call themselves “nimble.”
However, while MGAs own the customer relationship and take on the very tough task of trying to convince someone to buy insurance, they also run one of the biggest risks of all: dependency risk. If the carrier decides to stop writing a particular kind of business tomorrow, that’s it. You’re out of the market. If you want to launch a new product, that’s a collaborative process with your insurer partner, likely over several months. Many entrepreneurs joke of their scars and war stories from attempting to build MGAs, but can an MGA really label itself nimble, given those operational complexities?
Smart entrepreneurs have figured out that the best way to mitigate this risk in the short to medium term is by working with a number of insurers. The idea is to generate a sense of competition among that group, encouraging them to move quickly and be pragmatic. However, for a young startup initially generating very small volumes, this can be understandably hard for a carrier partner to accept. Resources invested in developing new partnerships—diligencing the team, the product—are not costless. The numbers need to work for the insurer partner.
The numbers need to work for investors, too. Venture capital firms have been the primary backers of these new companies over the last few years. Recall, investors make their money from exits, which are liquidity events in the form of an IPO or an acquisition by a larger company. One of the most hotly debated topics in insurance venture capital circles (we don’t get out much, you know) is whether an MGA can ever achieve a “venture scale exit.” In other words, is it possible for an MGA to grow to a valuation of $1 billion or higher?
Recent IPOs have proven that InsurTech businesses can IPO and they can clearly deliver excellent returns to their early investors. However, SaaS businesses aside (a different model to be discussed another time) these have all been full-stack carrier propositions. With one or two exceptions, insurers and reinsurers have not yet proven to have the appetite for large, transformative tech MGA acquisitions. A new wave of MGAs going public would be a game-changer in how venture investors approach their insurance investments.
Faced with a lack of total control, dependency risk and an uncertain exit landscape, entrepreneurs are turning to becoming an insurer themselves more than ever. But why now?
Why is this happening now?
Five or six years ago, the regulation, compliance and risk management functions operated by an insurer were seen as an insurmountable barrier to becoming a fully fledged insurance company, or even entering the industry at all. As the MGA model has matured and as more of these businesses have been funded, tech entrepreneurs—and, by extension, their investors—have become a lot more comfortable with what it takes to build and maintain such capabilities.
This comfort has largely been driven by two things. First, we continue to see a flow of experienced professionals that are moving from the traditional side of the industry to new tech startups. It’s now clear that tech startups can attract this kind of talent. Second, when thinking about those core insurer functions, in particular, we are beginning to see that technology can (in some ways, at least) be used to do a better job than some incumbents were doing in the first place. This is not unique to insurance; similar stories have played out in parts of fintech and other regulated industries.
In one sense, the fact that carriers are back in fashion now is partly driven by where we are in this current wave of technology-driven innovation. Some MGAs have now been in business for a few years and have successfully used their technology to profitably sell and underwrite business. These companies feel that they have a genuine underwriting advantage and wish to move even further toward introducing new data sources and other novel underwriting approaches. A solid track record is a good way to open the conversation with a prospective regulator, and building this just takes time.
Of course, it’s not just regulators that are impressed by a track record. Investors are, too. As readers well know, carriers can take a lot of capital to stand up and then again to support new business as the book grows. Capital is no longer the constraint it was once thought to be. In 2020, $300 billion of private capital poured into technology startups globally; only $7 billion went to insurance, yet that number is up 20-times since 2012. As early-stage investment funds get bigger, and later-stage investment funds move earlier to capture more gains, there appears to be more appetite than ever to back disruptive insurance propositions with established business models like being a full-stack insurer. The funding question is far less of a concern today than it was a few years ago.
Finally, a key part of any S-1 filing (the document filed to explain an initial public offering of securities) is a discussion of the company’s reinsurance arrangements. Almost all of the major reinsurers have played a vital role in enabling new carriers to be established. In one obvious way, this is a different form of dependency risk outlined earlier, but the reinsurance industry has largely proved itself to be commercially savvy, quick to support and patient for profits.
Should all MGAs become carriers?
Most InsurTech entrepreneurs pitching us today tend to present a two-stage plan: Start business as an MGA, then move toward being a carrier. CEOs argue that they shouldn’t be handing all these dollars over to an insurer partner in the long term when they could keep them and pay claims themselves.
Should every MGA transition to a carrier? The answer is surely “absolutely not.” There are already thousands of licensed insurers across the United States. The industry arguably does not need more “me too” carriers doing the same as everyone else.
From a venture investor’s perspective, there are some things that are non-negotiable: Your business must be underpinned by modern, scalable technology. You must be a first-rate team with technology and industry experience.
Beyond those basics, to have a compelling case to be a carrier you should be differentiated. Do you have something that customers seek out? Do you have the ability to sell at a manageable cost? Insurance is a totally different game to many other industries targeted by venture capital; you must understand the need for good underwriting from the very beginning. It must be hard—but not necessarily impossible—for others in the market to figure out (or worse, copy) what you are doing. Finally, you need to have line of sight on significant premium volumes. A sub-scale carrier can be a regulator’s worst nightmare—and by extension, yours, too.
Absent both of these key parts of the puzzle, remaining an MGA is likely to be the best strategy to pursue. (See related sidebar, “Solving the InsurTech Dilemma: Should I Stay an MGA or Become a Carrier?” for a step-by-step evaluation)
MGAs have driven innovation in product and distribution over the last few decades. There is a big place for MGAs in the insurance industry. In considering the journey toward becoming a carrier, the entrepreneur needs to carefully consider several aspects of the business. It isn’t always the right option, and there’s plenty to be said for partnering with established experts in order to bring a new product to market. To assume control over the entire value chain comes with benefits, sure, but a significant level of responsibility, too. Carriers are back in fashion, but let’s see for how long. Tastes do change, after all.