By Dale A. Myer, senior vice president, Gilland Roeser Holdings, Inc.

Merger and acquisition activity began heatingup in the managing general agency (MGA) andmanaging general underwriting (MGU) sector during2010. The continuing soft market, the long and steady decline ininsurance rates plus the effects of the recent recession have ledto reduced exposures, smaller books of business and loweringpremium prices for many property and casualty insurers. Thecombination of these factors is forcing insurance companyexecutives to explore new ways to improve top-line growth, whilemaintaining underwriting discipline, generating adequate profits,and putting underutilized surplus to work effectively andefficiently. MGAs and MGUs are increasingly being viewed as targetsfor mergers and acquisitions because of their perception as"virtual insurance companies" and their ability to generateunderwriting profits.

Today, many insurance companies are sitting on balance sheetsthat carry extremely low underwriting leverage(premiums/surplus) and relatively low levels ofROE (return on earnings). To compensate, insurers arekeeping higher net retention levels at the primary level.Reinsurance pricing continues to be weak and the current lowpremium/surplus ratios are forcing reinsurance markets around theworld to aggressively price their products and services to deploytheir capacity. Even in light of minimal catastrophe losses in theU.S., reserve takedowns have in all probability run their course.Going forward, it's doubtful that reserve takedowns will continueto be a viable tool to enhance bottom-line performance. Finally,with extremely anemic investment returns, the asset side of aninsurance company's balance sheet is not able to offset poorunderwriting results.

Read related: "Haveyou updated your agency valuation?"

In acquiring MGAs and MGUs, insurers see a way to retain (fordefensive purposes) or purchase (for offensive reasons)gross written premium dollars. The ability toevaluate the MGA/MGU business model and perform detailed actuarialdue diligence on underwriting results eliminates many of the realor perceived risk factors when looking at the acquisition of an MGAor MGU. Some of these deals also add specialized underwriting teamsand even capture technology efficiencies that many MGAs and MGUshave developed or refined over time. It is not all uncommon to seeMGAs and MGUs posting operating margins as measured by pro formaearnings before interest, taxes, depreciation and amortization(EBITDA) of 20 to 40 percent of grossrevenues.

As for MGAs and MGUs, they have generally gotten stronger overthe past 10 years. Many focused on being a good underwritingpartner with their issuing carrier and its reinsurers. Some haveeven established profit and risk-sharing structures that alignedthe interests of all parties on building long-term appointmentswith stable markets. The most successful MGAs and MGUs havereinvested their capital back into operations, making them moreefficient and profitable. This investment included embracingtechnology to enhance operating margins and EBITDA.

Read related: "Deals in the balance."

There are other factors that make the valuation of an MGA or MGUeven more compelling for an insurance company versus other buyerssuch as another MGA or MGU or a private equity firm. These includethe addition of underwriting profits and investment income to theacquiring insurance company.
When these two value sources are added to the underlying EBITDA ofthe MGA or MGU, the resulting purchase price can be significantlyenhanced. The firms generating interest produced annual grosswritten premiums as low as $10 million to well over $200million. Many of these entities consistently posted verydesirable underwriting results. In addition, the technologyenhancements and various profit sharing arrangements in place withthese MGAs/MGUs increasingly makes them look attractive toinsurance company executives.

Read related: "Dealsor no deals."

When all of the factors outlined in the preceding paragraphs aretaken into consideration, the owner of an MGA or MGU in today'smarket may be sitting on an asset with higher potential value thanhe/she might have otherwise recognized. As we see it, the demandfor MGAs and MGUs is strong and will even increase, while thesupply of well- run MGAs and MGUs is finite. This market imbalanceshould lead to an intersection of the supply and demand lines at ahigher point, equating to higher valuations for MGAs and MGUs.

If an MGA or MGU owner wants a change in his/her ownershipposition, there is a good reason to be hopeful for a positiveoutcome and a substantial financial reward for years of toil andsacrifice.

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Dale A. Myer is senior vice president at Gill and Roeser Holdings, Inc, a member of FINRA. He has extensive experiencein insurance M&A, banking, and structuring M&A transaction.He holds Series 7 and 63 licenses. Gill and Roeser Holdings workswith its sister company, Gill and Roeser, Inc, a reinsuranceintermediary. Dale can be reached at 212-972-4880 [email protected].