Market turmoil and longer-term industry trends may have encouraged many investors to look elsewhere.
“We still believe that MGA investment is going to continue to be strong, but, right now, I think, it’s suffering from a broader pullback, given the economic conditions, headwinds and some consolidation in the market around investment,” said Chris Raimondo (pictured top), EY’s Americas insurance technology leader.
Some investors say that they’re not surprised investment in MGAs would decline. After all, investment in insurtechs and technology in general has plunged in recent months over questions about their long-term viability. MGAs are part of that mix. Other insiders assert that MGAs are not drawing VC attention due to everything from a hardening reinsurance market to questions about their business model.
MGAs aren’t tracked on their own as investment vehicles, though it is clear that insurtech investment has plunged in 2022. Insurtech funding dropped 56% in Q2 2022 quarter over quarter and stayed flat in the 2022 second quarter, according to the CB Insights State of Insurtech Q2 2022 report. Insurtech deals in Q2 also declined 16% quarter over quarter, the lowest level since the 2020 fourth quarter, the report noted.
Similarly, PitchBook data through the 2022 second quarter shows a number of downward trends for the fintech space, of which insurtechs, and MGA startups are a subset.
VC deal activity in the fintech space reached $53.5 billion as of mid-year 2022, compared to $121.8 billion in all of 2021. That number covered more than 2,500 deals through June 30, 2022, compared to almost 5,600 deals in 2021, the PitchBook data reveals.
The value of venture capital exits has dropped precipitously, pointed to likely investment losses as investors cashed out.
VC exits hit $21 billion through June 30, 2022, compared to nearly $370 billion in 2021 and just under $38 billion in 2020, according to the PitchBook data. Broken down further, there were $14.5 billion in VC exits through the first six months of 2022 where startups hit the public market, versus $344.2 billion in 2021. Acquisition-related VC exits were worth $7.5 billion through Q2 2021, versus $22.2 billion in all of 2021. PitchBook valued buyout exits at just under $1 billion for the first half of 2022, compared to $3.3 billion in 2021.
Sandeep Bhadra (pictured immediately below), general partner at the investment firm Vertex Ventures US, said some investors didn’t and still don’t fully understand the risks behind MGA insurtech startups.
“Many investors valued MGAs just as they would value SaaS [software as a service] companies without appreciating the risk profile of some of these MGA businesses,” Bhadra, a sometime MGA investor, observed. “As a result of that, some of the MGAs have suffered.”
In the public markets, that has amounted to falling stock prices as part of a broader technology sell-off. Full-stack MGAs that shoulder greater risk have been particularly vulnerable, he said.
“It has affected some of these full-stack MGA businesses more than software companies, and has brought in a certain amount of caution,” he said.
In some cases, Bhadra said, that has meant keeping some MGA investments and not making others.
“Late-stage investors … many of them are still holding MGA investments on their books. At today’s market, multiples and valuations will reflect a loss on their books and so they are not keen to add more MGA exposure to their investment portfolios,” Bhadra said.
Reinsurance and disappointments
Adrian Jones (pictured immediately below) is a partner at HSCM Ventures, which invests in insurance and insurance technology.
He observed that insurtech funding has dropped considerably in 2022, which leaves less money for MGA startups by default. At the same time, MGAs are still earning “very robust [investment] multiples,” he added, though he said investors may be backing off to some degree because of the hardening reinsurance market.
“As reinsurance becomes harder to find, the MGA business model can have its economics crimped a little bit, so that may be the first thing,” Jones added.
Also, Jones said, the earlier class of MGAs – many of which became fledgling carriers – likely disappointed investors seeking greater returns.
“Some of the most-highest-profile known MGAs and young carriers have not lived up to expectations,” Jones observed. “In some cases, that was because they didn’t appreciate the insurance fundamentals in the way that they needed to.”
Those companies include Trov, which started out life as an MGA and never made money. Travelers eventually acquired its technology assets which included a platform enabling the embedding of insurance products. There’s also Metromile, which was initially an MGA, which got snatched up by Lemonade, a relatively promising digital insurer that remains unprofitable.
“It’s the companies that went public perhaps a little bit soon with high valuations,” Jones said. In that case, he added, if the loss ratios are too high and there’s a lot of dependence on reinsurance the financial vulnerabilities become apparent.
Hippo, which began as a home insurance MGA, is among insurtechs that went public and has struggled to improve its finances and balance sheet, in part through the purchase of carrier Spinnaker Insurance Company in 2020. Its stock had dropped below the minimum trading requirement of $1 per share despite balance sheet progress, but it recently enacted a 1-for-25 reverse stock split that boosted its stock price close to the $20 per share range, with some fluctuation continuing.
Hippo president and CEO Rick McCathron (pictured immediately below) insists that MGAs remain a strong investment but admits that investor interest is down. He predicts valuation multiples for early-stage MGAs commonly seen in 2020 and 2021 won’t happen for a while.
Reinsurance market pressure, he agreed, has been a big factor.
“If you have a hardening reinsurance market, that means startup MGAs are going to struggle to get reinsurance capacity, which means you have to take more risk, which means you have to raise more capital, exacerbated by the fact that the capital markets are tightening as it relates to MGAs,” McCathron said. “Those that have ample cash to see it through … are at a proportional advantage versus those that need to go out and raise money. If money is available, dilution will likely be significant.”
While there are differences as to why MGAs have fallen out of vogue with investors, there seems to be a general consensus that long-term interest will be there.
“One of the reasons why we feel MGAs will continue to be a strong area of the market is we think distribution is going to continue to be an overall investment theme,” EY’s Raimondo said, for startups in the space that “enable differentiated distribution, particularly as it relates to new products around embedded insurance and commercial lines.”
He added that that the growing protection gap in commercial lines makes MGAs a value proposition for carriers, giving them access to distribution and markets.
HSCM’s Jones also sees MGAs surviving any downturn in investor interest.
“I don’t know that there is a pullback so much as a desire by investors to see some of their existing bets mature,” Jones said. “If investors already have multiple investments in multiple MGAs, they may prefer to continue funding those existing investments rather than funding new investments particularly when MGAs are trying to be formed in areas where there are already young tech-enabled competitors.”
With that in mind, Jones said, MGAs remain a solid draw for investors.
“MGAs are still very much on the up right now. Despite a hard market for reinsurance, it is a viable business model for producing certain types of risk [cover] in certain circumstances,” Jones said.
Still, he added, it is important to remember MGAs have not always “been the right way to organize an insurer or insurance startups.”
Another element Jones argued: MGAs have learned from past mistakes.
“They’re realizing they need to hire the old grey hairs and have some insurance expertise around the table,” Jones said. “They’re becoming much more sophisticated in the way they think about how to capitalize their business … [and] the trade-offs between growth, profitability and operational excellence.”
Bhadra, at Vertex Ventures, said MGAs that develop new ways to price and offer risk are still coming through the pipeline and drawing investor interest. MGAs, he said, generating buzz right now if they are focused in specialty areas.
“There are aspects of specialty [cover] where there continues to be a lot of industrial demand in new products,” Bhadra said, particularly for something such as cyber insurance MGAs.
A standout idea will always drive investor interest, he said.
“If the product is unique and it has really good unit economics, you will find that investors are interested,” Bhadra said. “If the product is fairly commoditized in the sense that there’s a lot of incoming offerings in the market, and the MGA was just sort of a clever way of distributing the product using the internet, I think that investors have cooled off.”
Survival of the fittest
MGAs will most definitely bounce back, though it is hard to predict when, said Hippo’s McCathron.
“MGAs are a strong investment and will bounce back but the question is what companies will survive,” McCathron said. “Insurtech MGAs are starting to recognize that you need to have an insurance pedigree and you need to create a product that produces a positive underwriting result, so I sense that discipline is getting there.”
He predicts market capital will start to fall back into the reinsurance market, which will help support the capital structure for MGAs.
McCathron wonders when, however, because current economic trends are so volatile.
“We’re in a dark time with macroeconomic trends, with investments tightening up, with the reinsurance market hardening,” McCathron said.
This could last for a year or two, he predicted, which might put MGA startups in a quandary for the foreseeable future.
“Most startups don’t raise money to last them two or three years. They raise money for the next year,” he said. “They’re not all sitting on large capital bases, and that’s going to be a problem.”