How to Start an MGA: Understanding Risk, Paper and Capacity Providers

Introduction 

For founders, underwriters, or anyone in the early stages of building an MGA, the learning curve can be steep. Industry jargon can be confusing, and some concepts hard to grasp. And yet, now’s the time. In 2023, the U.S. MGA market surpassed $102 billion in direct premiums written—a 13% jump from the year before. This trend underscores the expanding role of MGAs in the insurance industry, making it an ideal time to enter the space. 

This is where MGA 101: a series of discussions between industry experts Chris Lowell (Managing Director, InnSure) and Somil Jain (Principal & Sr. Consulting Actuary, Lewis and Ellis), comes in. Having spent years launching, scaling, and advising MGA programs, they simplify key concepts surrounding Risk Capacity—offering real, practical insights on not just entering the MGA space, but thriving in it. 

What Is a Managing General Agent (MGA)?

A Managing General Agent (MGA) acts like a mini-insurer, building and selling products without needing to raise millions in risk capital. They capitalize on market gaps that regular carriers may not cover, focusing on niche markets and creating specialized products.

The Big Questions: How do MGAs operate Without Risk Capital - and How to Start One?

Here’s how it works.

MGAs rely on insurers or reinsurers to back their risk capital, either in full or in part. It can be spread across multiple partners, depending on each party’s appetite and how the deal is set up.

Let’s understand this in detail, starting with risk’s place in insurance.

Understanding Risk Capacity in Insurance: Why It’s Central to MGAs

Insurance, as a business, earns by putting a price on risk and betting that not every claim will come in at once. What the insured purchases isn’t a product or service with a defined cost; it’s a promise, priced based on past data of what might happen. Insurers don’t know exactly how much an individual would cost them, which is what makes Insurance work. By pooling risks together, an insurance company can better estimate how much a risk should be priced at, on average. Risk capacity refers to an entity’s ability to take on and manage financial risk. It is the money that will cover claims and losses arising from the policies an Insurer or an MGA underwrites.

Since it’s meant to cover a large pool of people, risk capacity has to be substantial. According to Investopedia, most states ask insurers to maintain around 8 to 12 per cent of projected claims in reserve. To put this into perspective, one could, on paper, start an insurer for an amount as low as $50,000, just in risk capital. In reality, no state would authorize the operation of an insurance company for that little (yes, little) money.

If securing this level of risk capital were easy, MGAs would probably be having very different conversations. This Insurance model is designed in such a way that the funding, or financial responsibility of covering claims is separate from the building and distribution of products. While insurers or reinsurers provide financial backing for claim obligations, MGAs focus on day-to-day operations such as pricing and underwriting. This is done using operational capital, often funded by the founders themselves or early investors.

Once founders have shortlisted their MGA idea, the next step is to pitch it to capacity providers and insurers with Paper.

What “Paper” Means in Insurance and Why MGAs Need It to Operate

Paper refers to the license that allows an MGA to underwrite policies and provide insurance services within a given state, not as an agent, but as a risk carrier. Since MGAs don’t hold this license themselves, a licensed insurer provides this paper. This lends credibility to the MGA’s ability to repay its claims — or in this case reinforces the capacity provider’s obligation to do so. In return, MGAs pay insurers for this access to paper, along with compensation for returns the insurer could’ve made, had the capital been used elsewhere.

It’s important to note that there are cases where the insurer provides only paper, requiring risk capital to be sourced from other partners.

Understanding the Role of Fronting and Hybrid Carriers in MGA Models

• Fronting Carriers: Also known as Pure fronts, these are insurers that allow MGAs to use only their license.
• Hybrid Carriers: These entities allow MGAs to take on some percentage of the risk in addition to granting paper.

Now let’s say an insurer takes on 15% of the risk. What about the remaining 85% risk capacity? MGAs can approach other insurers or even a reinsurer.

What Reinsurers Do and Why Even Insurers Need Insurance

A reinsurer provides insurance to insurers. Why? Because even Insurers need protection. Consider this: If a tornado were to hit City A, where every Client of Carrier A resides, the resulting claims would be immense. While that sounds improbable today, back in the day, risk was generally shared among those who lived in the same region. This meant carriers were especially vulnerable to localized disasters.

Reinsurers help mitigate this issue by taking on risk from multiple insurers, making up for the lack of geographic diversification. By spreading risk across different regions and insurers, they provide a critical layer of financial stability to the insurance ecosystem. Therefore, while MGAs focus on building and distributing tailored products, reinsurers provide the financial support needed in the form of risk capital.

Your Next Steps in the MGA Space

Each insurer and reinsurer come with their own goals and risk appetites, which means founders need to approach each one differently. But where do MGAs actually find these partners? What makes one a better fit than another?

We cover these questions and more in the next video in this series. While this conversation clarifies some foundational concepts, the next one dives deeper into the questions above and more. Stay tuned for what comes next.