InsurTech Ledger Investing believes it will be able to offer MGAs multi-year capital support from future securitisations, as it seeks to scale up following a recent $10mn fundraise.
Ledger has now helped 15-20 MGAs transfer risk via securitisations since one of its first transactions, an auto insurance bond invested in by AlphaCat, in 2019.
Ledger is also considering launching a casualty ILS fund and believes it could deploy $100mn to $200mn over the next two to three years, the firm's founder Samir Shah told this publication.
MGA focus
Initially, Shah had expected that the firm's customers would be insurance companies, and was surprised by the interest from MGAs.
He still believes that insurers will be the next step in the chain for the InsurTech, but now thinks that a focus on MGAs is the most efficient channel for it to source risk.
The MGAs are attracted to securitisations because they face underlying uncertainty over capacity from carriers that can quickly change their program strategies, and because fronting is expensive.
For now, Ledger's deals have provided capacity on a one-year risk period, but in the future it may look to do multi-year transactions.
"That would give agencies a chance to differentiate themselves," added Ledger chief revenue officer Gary Maier.
Ultimately, by tapping into ILS capacity, MGAs can source a deeper more stable capital base, Shah said.
"It works with what we're doing to recast the value chain."
Capital change
The former AIG head of capital markets believes that splitting insurance into two broad functions – risk servicing and risk financing – the latter will ultimately become commoditised and make greater use of outsourcing.
"Risk servicing doesn't lend itself to commodification, that will continue to become more specialised," Shah suggests.
However, progress on making risk financing more efficient is being held back by the industry approaching the issue from a "risk management not a capital management perspective", he said.
At the moment, insurers are targeting risk transfer strategies that change the risk profile of their books by lowering volatility, even if that involves lower returns due to the cost of buying reinsurance or doing an ILS transaction.
From a capital management perspective, this would imply creating a portfolio where carriers are comfortable with the risk profile, then searching out the cheapest source of capital.
"Permanent capital is a big problem for the industry," Shah said, describing it as the leading factor in creating soft market conditions. "The real problem [behind soft market cycles] is you have fixed capital you have to deploy."
But in moving away from a largely retained risk model, insurers should be looking to outsource their lowest layers of risk to the capital markets and keep the highest layers, where their ratings would be an advantage, Shah believes.
This largely runs counter to the way (re)insurers have used ILS markets to date, with cat bonds taking upper-layer risk, and arguably makes this goal more distant, as collateralised retro capacity locks up and ILS firms set up their own rated carriers.
In the near term, Shah agrees that the industry has a lot of "messy paths forming", but says this shift belies a growing belief that a "hybrid" capital model is optimum.
Investor base
Shah said that the bulk of the investors in the firm's deals since then are not from the ILS world, and that they have had more uptake from crossover investors in the life insurance and credit markets.
The firm's deals are structured more like mortgage-backed securities to provide a sense of familiarity to non-insurance investors and are essentially risk transfers based on accident year loss ratios.
In the ILS space, while some investors are seeking to expand beyond catastrophe risks, others have become more reticent about taking on new risks after a run of nat cat losses, he says.
Meanwhile, ILS managers face the chicken-and-egg dilemma of finding it difficult to get specific mandates to diversify into casualty ILS business, as that market segment is not yet sufficiently developed.
Ledger's focus to date has been on auto and workers' compensation, which represent "vanilla" casualty lines of business that investors can easily understand and where plentiful data is available.
Shah argues that the nature of these lines of casualty risk – where loss ratios typically ebb and surge around the mean over time as carriers respond to emerging trends – makes them less spiky than cat risk where returns can be tranquil for many years before a major steep loss.
This makes them easier to model with statistical, non-actuarial methods, which enables expense efficiencies by avoiding any re-underwriting done in the risk transfer process, which Shah has previously argued against.
In the long term, investors should be willing to accept a net return target of 6%-8% from such deals as they represent an uncorrelated source of equity-like return, Shah believes, but initially risk-takers will demand a novelty and illiquidity premium.
After a deal closes, Ledger can provide investors with daily portfolio updates, which could lend itself to future secondary trading.
