Brown & Brown, Orchid Insurance & MGA Economics

Disclaimer: This interview is for informational purposes only and should not be relied upon as a basis for investment decisions. In Practise is an independent publisher and all opinions expressed by guests are solely their own opinions and do not reflect the opinion of In Practise.

I want to understand Brown & Brown’s MGA and MGU business specifically. We could use Orchid as a case study. I'm trying to grasp how this has evolved over the years, including the carrier-broker relationship, and the risks and opportunities. I would like to start by going back to your days at Marsh and just get a brief introduction to your role there, specifically how you were exposed to or worked with Brown & Brown.  

I actually had 10 years at Marsh on the West Coast in Los Angeles, where I was just a frontline broker placing business into the markets. Arrowhead, which is the big MGA running earthquake business, was a key client of mine. You can go back 30 plus years to the beginning of my relationship with Arrowhead. Now, remember, that was Arrowhead, not Brown & Brown.

One of the notes that I did make was that my relationship with Brown & Brown really only started in 2016. I was the property leader for all of North America for QBE. QBE was a core business partner, not just for Arrowhead as an MGA carrier partner, but also to the Brown & Brown organization in terms of casualty, motor vehicle, environmental. We were a multiline trading partner with the Brown & Brown organization. So that was my first real executive-level interaction with Brown & Brown.

But the Marsh days were in Atlanta. I was a hybrid. I had experience facing the clients and just talking to the clients about their strategies and then handing the business off to our internal placement people who then interacted with the markets. I had prior experience as a placement guy who took instructions from the client-facing people. We wanted a 500 million limit. We wanted a $200 million retention on flooding.

But Marsh, in Atlanta, when I joined, created a hybrid where I was both, and I had a team across the Southeast. With the bigger clients, like Coca-Cola, Bacardi, Home Depot, Lowe's, the state of Florida, the really high-end clients spending big money, we brought those two roles together so that I was able to talk to the client and relay to them what the market said we were able to do.

Obviously, that involved talking to them about using MGAs and the capacities coming out of MGAs, as well as the capacity coming out of Allianz, Zurich, and Munich Re.

When did MGAs first come on the scene then?

I won't be able to give you a year. But what I can tell you is that the London market looked at the US and said, the non-admitted, the E&S business segment in the US is exactly what the London market wants to write.

So London used to give certain people in the US the authority to either receive submissions and pass them on, or actually quote, bind and quote. And they were cover note holders. But they were just, you know, a little, little mom-and pop-shop like me, right? I've got two other employees in my little consulting practice, specializing in this or that. And London gives them a half million dollar binder, you know, to write small commercial, small personalized businesses. That's been around forever.

Now, when it actually grew into the point where now there's a fully fledged standalone organization, an MGA, MGU, who's got marketing, finance, claims handling, an office, you know, all this, this is now a fully fledged standalone operation that can underwrite, bind, quote, settle claims, market, take clients to lunch, pay bills, has licenses in 22 states, that's been a much more recent, certainly in the last 20 years that the strength of that has come forward.

It evolved from the standards, you know, London carriers just using standalone small brokers to like just build our proper operation?

If one carrier partner is good, then two carrier partners are better. And if two are good, then five is fantastic, and 10 is unbelievable. If you and I are both partners to Orchid, you may choose not to write golf exposures that are older than 20 years, whereas I will, provided the deductible is 5%. The more partners you have, it's not that they all do the same thing and stack; it's that one of them likes this sort of business, which is why the other one likes the same sort of business. They look similar, but one of them's gray. So, the more partners you have, the stronger and more solutions you can provide.

How does this impact the carrier then? I mean, looking back at how the carriers let these MGAs explode, how does that impact their business?

I have the best story in history on this. Seriously, you're going to have to let me go 30 seconds here. So, I joined QBE as the head of property in North America, and QBE does $7 billion with MGAs in property casualty, commercial, auto, environmental, and workers' compensation. I was at this function in Las Vegas, leaning against the railing, when this older gentleman comes up to me and asks, "Who are you?" I replied, "I'm the new property manager. Who are you?" He said, "I'm Ned Zeller." "Okay, Ned, what do you do?" He said, "I've got an MGA." I figured that because it's an MGA function. "What do you do?" I asked. He replied, "I do post offices." As a risk guy - Factory Mutual, AIG, St. Paul - I asked, "Why?" He said, "For 37 years now - some of it was as a cover note holder, but just bear with me - we've written the property, the casualty, the motor vehicle, the environmental, and the workers' compensation for 46,000 post offices across the United States. If you franchise a post office from the federal government, they will direct you to my phone number, and I will place your insurance. I don't do anything else."

So this guy knows post offices better than anybody on the planet. I said to him, "Ned, we do property for you." "Yes, you do. How can I help you?" He says, "Stay out of my way." That's the MGA. That's the theoretical. Someone has knowledge about sporting arenas and they go, "Well, we want to set up this little shop to write nothing but sporting arenas. We don't want to do hotels, shipping terminals, and grocery stores. You want to do sporting, or you want to do $4 million worth of business and do nothing but that, because we're really, really good at it." And that's how the MGA operates.

Now, the problem is, so you write $12 million with the sporting arenas and you think, "Well, we're pretty good at that." And then someone asks, "How different is such and such to a sporting arena?" Suddenly you decide, "How do we grow?" Everybody in the world has to grow. So they start to go sideways. Or they hire Will and his team, who are really good at small hotels, boutique hotels, and suddenly they do sporting arenas and boutique hotels. So the MGA is supposed to be a specialist. Orchid, for example, does nothing but two things. Homeowners within three miles of the coast and small commercial businesses on main street USA, up to a million dollars in limits. They don't do big factories. I mean, they did little dry cleaners and all that sort of. That's all they do. You show orchid a home five miles from the. From the ocean; declined.

You're really good at homeowners. No, we only handle those exposed to hurricanes, floods, and tornadoes. So, specialization is the keyword for MGA.

But how and why did the carriers allow the MGAs to accrue the data and the edge to let that post office guy be the post office guy?

Let's turn this around. You're the property manager for QBE in North America, and I'm this guy who went to a conference and met someone who does post offices. They do $47 million a year in post office business. How about QBE gets into the post office business? You ask, "What's the loss ratio?" 17%. They're printing money. That's a good idea. Do you know anything about post offices, Bob? No. John do you know anything about post offices? No. Well, let's go and find some people, hire them, pay them a salary, and grow a book from zero, hoping we can steal some of Ned Zeller's business. Or let's partner with Ned and say, "Ned, you got it. You're currently giving 30% to Zurich, 30% to AIG, and 30% to Brit. We want to help you grow and share the business." That's because they have expertise. You plug in through a contract, ride their expertise, and your startup costs are nothing. A year later, you'll have a quarter of his business. Just like that.

And the carrier's returns are obviously healthy for them, right? If they don't spend anything on distribution.

History will show, and this is data that is available, that the results, the underwriting loss ratios for the MGAs are better than for the companies. Believe it or not, even the big players like Arrowhead, AmRisc, and Orchid of the world, they do actually focus on a niche. It may grow over time, but they're not in any way all things to all people.

But at some point, the carriers have allowed this Ned Zeller guy to accrue all of the proprietary data in managing post offices? Because they benefited and they didn't want to pay the distribution. But if you project this forward 20 years, when there are all MGAs, what does that industry look like?

I'll tell you how it looks. The MGA unit at Canopius in London, the MGA unit at Brit, the MGA unit at Chaucer, they do hundreds of millions of dollars of business. Do you know how many people are in the unit at Chaucer? Eight. Not 80, not 18, but eight. They're all senior people, getting monthly reports, watching what Ned, Orchid, or Arrowhead did, and then they're getting on the phone and saying, "Hey, Bill, how are you? It's time for our monthly call. I see South Carolina was really good to you this month." Eight people are managing $400 million of business at Chaucer.

Look at the economics on this thing. If you pick the right MGA partner, you're printing money. Your entry costs are minimal. If you felt the workers' comp market or the commercial auto market was hot right now, what do you do? Go around, hire some people, set up some offices, set up a website, set up a marketing program, introduce yourself to Will and his team at the local agency, or go to Orchid, who has 7,000 agents on register. It's an existing distribution network, existing flow of business licenses, the whole deal. It's plug and play.

But doesn't that commoditize the carrier though?

Certainly, companies like Orchid and Brown & Brown, among others, strive to transcend commoditization. They express a desire to meet with us regularly and establish a partnership. One of Orchid's strengths is that they truly partner with us. They don't just focus on transactions; they engage in discussions about numbers, future strategies, expansion to the West Coast, and adding liability. They ask questions like, "Do you want to do this? Can we grow faster in the Northeast?" It's a genuine partnership. One party brings expertise and context, while the other provides capacity and oversight. However, if you keep the two separate, it becomes commoditized. You're absolutely right. When I was at Orchid as the Chief Risk Officer, I served as the link between Orchid and the markets, managing relationships with carriers. Yes, it involves commoditization, but it also brings efficiency.

They're happy because it's easier for them to grow, increase premiums, and achieve better loss ratios. But I assume all carriers want to find Ned Zeller and might underprice to enter Ned Zeller's business.

So then you wonder, why choose carrier one over carrier two?

Yes.

When I joined Orchid, they had seven carrier partners. Four and a half to five years later, they had 12. I told them I didn't want to commoditize this. I wanted to choose partners who say, "We want to meet with you. We want to visit you in Vero Beach. We want you to come to London. We require a quarterly stewardship report, transparency of data, numbers, ratios, expenses, etc." Some might just fly into Florida once a year during the London winter, play some golf, have lunch, and ask, "How's it going?" That's a lazy partnership. When problems arise, those are the last people you can rely on. However, partners who know your team personally, who have spent time in your office, they'll reassure you during tough times. Orchid has had a 19-year run of profitable results, even with major hurricanes impacting the Gulf. Those are the partners you want, the ones who understand efficiency but also want to engage deeply.

For them, if the expense ratio is very low, the return on equity and the return on assets on their balance sheet is still very attractive for acquiring an MGA.

One of my secrets, which I introduced at QBE, is typical compensation where the insurer, the carrier partner like Canopius in London, will pay 23 to 24 points on gross premium.

Out of that, Orchid has to pay the agent, which is about seven or 10 points, to the retailer. They also need to run their business and make some money for themselves. When I was at QBE, as the carrier, I told them one of the reasons they should choose us was because we wouldn't pay 23%, we would only pay 20%. Everyone appreciated that. I added that we would pay an additional 7% for a total of 27% if the loss ratio was less than 40%. In other words, if you make money for us, we will give something back to you.

After joining Orchid, Brad, knowing that QBE was a partner of Orchid and was a trading product, told me a couple of years ago to go to London to our six partners and ask for more. So, I did, and at the end of the story, I asked if they would give us 28% compensation because we had been so profitable over 19 years. They all refused. Then, I proposed 20% plus an additional eight if the loss ratio was 35%, and they agreed immediately. Now, does 20 plus eight equal 28?

Why is that then?

Because you only get the additional eight as a profit commission if your numbers are fantastic. It's a sliding scale. If you make them a lot of money, they're happy to give it back to you. If you have a bad year, not only do you not get your bonus, but you also get 20% instead of 23%. In other words, the MGA is putting its cooking on the table, saying we believe in our own cooking and are willing to take a financial share of the results. We'll take a hit if we mess it up and get a reward if we don't. This differentiates MGAs who are not just looking to skim commission.

They're underwriters effectively, right? They're taking a share of the underwriting profit.

Right. Now, every one of the 12 carriers on the Orchid panel is on the profit commission. Some of them have a slightly different formula, but that's just life in the fast lane. Every single one of them bought into the story and loved it. That's a differentiator. Now, a carrier partner in London or New York might say they want to get into the West Coast because of wildfires as an opportunity, or into Florida and the southeast because the rates have never been this high. Who do they partner with? We would say, we'll go along for the ride with you. In a bad year, we'll get penalized; in a good year, we'll get rewarded. They loved it. It's just simple.

How do you see the economics evolving over the next 10 years in terms of that 23% and then a share of the commission? How does that change for MGA?

Yes, more and more people will go that way. It's just a reality. It's not reasonable, given that the results of the last five years have not been profitable. When someone like Orchid says, "We'll share your pain and take reduced compensation," they immediately stand out. That's another three points in our Canopius pocket. It has to go that way because it's a very competitive market. There are a lot of companies and private equity wanting to invest in the MGA itself and many insurance companies and carrier partners wanting to enter this segment of the market. There's quite a lot to pick and choose from. At the same time, the results have not been great in the property segment, whether it be from wildfires or storms. So, my short answer is, that's the future. That's the way it's going to be.

You really have to be, as always, quite good and have proprietary data, better modeling, and better underwriting.

Right. I personally think the days of a guy and his brother operating out of the backseat of their car or out of their living room and doing $12 million worth of business are gone. I'm only one person, but I'm talking about MGAs, not covenant holders. Someone at Lloyd's may still give those two guys some capacity. But as you said, you have to have data, access to data, exposure data, not loss data. Questions like how old are your buildings, how far from the beach are they, what deductibles are they carrying, etc., are crucial. Secondly, you've got to be able to model your results. You've got to be able to say, "We've made this change and because of it, our modeling shows this will decrease in the problem area and increase in the good area." So, you've got to be more sophisticated than just two guys operating out of someone's living room.

What do you mean by differences between exposure and loss data?

It's one thing to show what your loss numbers are. It's another thing to understand why we are having water damage claims in the Northeast. For instance, the roofs are older than 25 years, the buildings are all near the coast, they don't have basements, they're all on slabs at finished floor elevation, and the roofs are older. Oh, by the way, they're carrying really small deductibles. So, knowing you're having losses is one thing, but overlaying the losses on top of what type of buildings you're in, how your newer buildings with 2% deductibles that are a couple of steps above the ground are doing on water damage, is another.

It's not a northeast problem. Don't stop writing business in the northeast. Stop writing business on older buildings that are on a slab, that are two inches above ground level. And by the way, if the roof is 28 years old, it probably leaks when it rains. So, what are you doing here? Overlaying claims experience with location tells you what type of location is giving you the losses.

Let's move to Orchid now. Can you explain the advantages of having an MGA, MGU with a wholesale brokerage under one roof?

It's about control, efficiency, and timeliness; all the things we discussed. Let's change the scenario and make you the agent. Now, you come to Orchid because Orchid represents 12 insurance companies. As an agent, you don't need to make 12 phone calls; you just call Orchid. Suppose you have a risk in Palm Beach, Florida. Melissa Austin immediately identifies which insurers are not interested and narrows it down to five options. She then asks if you prefer a low deductible and a high premium, or vice versa. So, Orchid offers one-stop shopping as the first advantage. The MGA handles everything for you.

Secondly, having all functionalities under one roof means that if you call me back at 4:30PM in the afternoon and said, you won't believe it, the client changed his mind. He does want the high deductible option, the MGAs, MGUs have underwriting authority so they can make that switch without having to send an email to London overnight to get an answer back the next morning. So there's an efficiency and flexibility service to the customer issue here.

One of your questions was about authority versus brokerage. Orchid, like other MGAs I've worked with, has the authority to bind and quote business, set prices, deductibles, and limits for each of the 12 insurance companies it represents. For instance, Canopius has specific rules, such as not liking business in Texas. So, nothing is written for Canopius in Texas. However, in favorable areas, if the roof is less than 18 years old, the deductible is more than 2%, and the property value does not exceed two million, Canopius trusts Orchid to set the price and deductible.

The alternative is dealing with someone who uses you merely as a distribution source. You would need to prepare the package, send it to the underwriter in New York or London, and wait for their response, which might include questions or issues with the terms. You end up waiting to hear back about companies like Lexington or Brit.

So, it's more of a pure distributor then?

Yes, pure distributor. He probably has an exclusive arrangement with Brit or Lexington in that part of the country. They're smart enough not to have 20 representatives stepping on each other's toes. But you still have a single underwriter in Boston at Lexington trying to manage all incoming queries as quickly as possible, while also being interrupted by her boss. Meanwhile, you and I are waiting. Whereas at Orchid, Melissa Austin can immediately say whether something is possible or not, like not going lower than 3%. She offers the deal right then and there. This flexibility comes from representing multiple insurance companies, but also from having the authority to quote and accept business on the spot.

Why don't all carriers just fully transition to the MGA business model?

That is a conversation you need to have a drink in hand for because it's a really good question. About 20 minutes ago, I mentioned that the data shows the MGA-written business is significant. For instance, QBE, which had a personal lines homeowners division that Jim Hagerty wrote, and which ultimately reported to me. They wrote homes directly on QBE paper, where the agent calls a QBE underwriter. They've got a whole floor of underwriters. Additionally, I had four or five MGAs, including Orchid, Eclipse, and Arrowhead. My five MGAs consistently outperformed the QBE direct business unit, not just by a point or two but by a significant margin. In my last year there, we shut that business down, concluding it was a waste of time and energy, and decided to allocate all the capacity to the MGA.

You mean the loss ratios were much better?

Yes, over a year or two? Fine. But over a five-year, 10-year period, the MGA sector has outperformed the direct market in nearly every line of business

So why do you think that is? Obviously, we spoke about the postman guy, right? He has the edge, but that's it. Better data?

It's not complicated, and it's really easy to argue for that. Ned Zeller knows post offices better than anybody, and I'll put my money on Ned in any argument you want to have with him. The MGAs find people, or small teams of people, who have worked in some of the specialty areas, like sports stadiums, for example.

You mean insurers?

Yes. Suddenly, they have a self-contained business unit that can write $10 million or $20 million of sports stadiums for us. It fits our profile perfectly and the liability and the comp. This could be a $20 million, $30 million business unit for us. The entry cost for us is just lunch and a couple of conversations. Right? Expertise. You nailed it.

There was an interesting conversation Brown & Brown had when an MGA program became very competitive and actually moved out of it, which was for architects and engineers. They were providing insurance for workers comp, general liability, and all that kind of stuff. So when does it go bad? When does it become too competitive?

Well, that's true, isn't it? It's not all rosy. There are MGAs that have failed, and I have canceled MGAs both as the leader at QBE and as the leader at ACE. There are two answers to that. The simple one is what you mentioned, the market gets too competitive and people won't let go. Let's not kid ourselves here. The MGA's compensation starts with gross written premium. If you walk away from all this business and you've got 23 staff, I mean, it's challenging. Orchid had 176 staff and $700 million of gross written premium. But if you walk away from 20% of the business because the price is too cheap, you can do the math. They're wondering, "How many people do we fire?" It's a traditional underwriting puzzle; when do you walk?

The other side of it is sticking to what you know. We're really good at post offices. But then you think, "Libraries are a lot like post offices. Let's do libraries." You see what I'm saying? I mentioned earlier, I hate that the American economy is obsessed with growth. You can't just sit there making an ROE of 22 every year because it's not considered good enough. And I'm thinking, "It's a 22 ROE, what more do you want?" Well, the turnover is only 26 million. If you don't want the money, give it back to us and we'll keep it. Thank you.

That's the temptation, right? Or the third reason is that they can't keep up with technology. So they think reporting their numbers once a year to Canopius in London or to Lexington in Boston is sufficient. Whereas other MGAs are now getting on the data bandwagon, using web sourcing and mapping functionalities, and are now able to crunch data and map their exposures on a quarterly basis. I instituted that at Orchid and said, "Forget this once-a-year stuff, the next time you see me in June, I'm going to have the previous quarter's numbers and maps in front of me." And they were surprised. Now, a couple of years later, Orchid can do it daily.

You can come in in the morning, and I could press a button and look at my business in the Northeast or in Texas or wherever, and see how it has moved and how old it is. So not keeping up with the market is a big ball for the MGA state. Ned Zeller. been out there 37 years, printing money with post offices. I know half of the owners by first name. What do I need technology for? What do I need real-time data for? Well, the market is getting used to it and is starting to demand it. So not keeping up with technology is a big issue.

Just very simply, at a high level, what's the difference between an MGA and an MGU?

An MGU is only different because the last letter is a 'U'. They're just underwriters; they don't handle claims processing. At Orchid, we handle the claims on behalf of our carrier partners, pay the claims out of our account, and have a monthly reconciliation. We have marketing authority, underwriting authority, and claims handling authority. We're a fully enclosed operation, whereas an MGU is just involved in quoting and binding.

What's the advantage of having the claims?

Again, you are a fully self-contained operation in London and you want to penetrate the US market. Who are you going to use to handle your claims? You can go to a TPA, a third-party adjuster, who can manage all that for you. However, he will be using terminology and referring to locations that are unfamiliar to you. For instance, he might mention that a risk was in Duval County and another in St. John's. If you don't know what that means, it can be confusing. These are adjacent counties, just a couple of miles apart. So, being an MGU simplifies things. It eliminates any chance of corruption and misdealing.

What is the commission you get as an MGU, compared to the 23% as an MGA?

Obviously, it's less; it won't be more than 20%. But a claims operation shouldn't cost you more than one and a half to two and a half points. I knew Orchid for 11 years in total. In those 11 years, I saw their numbers, and they never paid more than two and a half points out of the total for claims handling. Some of that is related to hurricane scenarios, which can get a bit crazy because everyone needs a loss adjuster and a new roof. However, it's not just about the efficiency of handling the claims; it's all under one roof. You manage the data better. It's not just that we had a water damage claim; we need to know the location because we need to inform Canopius in London that the older roofs are causing issues with water damage. Orchid took a view that it wanted to be able to tell the whole story, not just bits and pieces. Owning the data, both on the claims and underwriting sides, was the only way to achieve that.

Let's walk through a typical policy then. What was the most common line that Orchid wrote?

Orchid wrote two lines of business, all property. They wrote personal lines, primarily homeowners, with homes valued between half a million and $5 million, which constituted 90% of their business. Then they wrote a commercial book of business, which typically involved a dry cleaner on Main Street, USA, or a little village in the UK. We covered property, liability, and marine cargo for these dry cleaners. What set Orchid apart was that both of these streams of business were located within a band three miles from the ocean, so they were all heavily exposed to hurricanes, floods, and wind.

So, for a million-dollar property on the coast within two miles in Florida, let's say, you would have a retail broker source that insured risk and then come to you. How would that work?

Yes, it's all done electronically. Submissions come into our portal. Once it's cleared, the first thing we want to ensure is that you, assuming you're the agent, and another agent down the street haven't both been approached by Mr. and Mrs. Homeowner. You can't quote the same property twice. So, it goes into the portal and it quickly clears based on the address. We don't care about the name of the insured, but if we already have 1149 Garrison in the system and there's only one house at that address, we've got a problem. It gets cleared, immediately pops into the underwriting system, which geocodes it, pulls the valuation data from the submission, and throws it against the model. Before Melissa Austin, one of my better underwriters, even sees it, it's been cleared, modeled, mapped, and the loss numbers in the submission have been fed into a computer that calculates, for example, if the premium's $10,000, what the five-year loss ratio would be. When it gets to her screen, she knows where it is and what it is.

What do you mean she knows what it is? How much data does she get? How does she get data like the roof type?

There are two ways to do that, and Orchid use both. We respect that agents try really hard, but we don't trust the agent's information completely. So, we take an address and there are multiple third-party websites in the US, whether they be aerial photos, building code data, or state tax data, from which you can pull information like value, year built, number of stories, square footage, and when the roof was last permitted for repair. Before Melissa starts, she's not keying in any data manually. This is where Orchid was much better. She's not typing errors; she's sitting there and all this information just comes in on eight screens on one big monitor.

So that's like proprietary software, I guess you built.

Absolutely. Now we know where it is and what it is. Melissa then takes that risk and says, "Well, I know I've got other business in Palm Beach, Florida. Let me lay that on top of this." Then the computer looks at it and says, "Well, this one sits in the 52% band for value, but is in the 20% band for roof because the roof is new." And he built the house up on some steps, so the house is four feet above finished ground. In other words, all these positives start popping up for her.

And that's nice, but that's pulled from third-party data. You're getting those new data sources, right?

Yes, we also, and I'll come back to this, but just remember, we would also do an inspection if we wrote the proprietary information. But this is all third-party data that Orchid has to pay for.

Would you go and visit the house?

I'll get to that in a second. We believed that data was king. The more you knew about a risk, the stronger you were. I also instructed our underwriters to look at what else we had written in that area. I told our technology team that underwriters must be able to see this information. I emphasized not making hasty decisions on a Thursday afternoon, like approving something that is 20% cheaper than everything else in Palm Beach.

Now, she has it all. She pulls it onto her personalized screen, inputs a few details, presses a button, and an indication goes to the producer. Within about half an hour, not from when it hits our system but from when it appears on her screen, it becomes just a queue. We guaranteed a same-day response. If you submit it in the morning, by after lunch, Melissa is sending you an indication saying, "We're going to have a 3% deductible, a 44% rate, a $4 million limit, full replacement cost, including this and that. Here's the premium. Are you interested? Yes or no?" I can do it with Brit from London on an A+7 paper, or with Lexington, which is an AIG company, on an A+15 paper. They're both ENS, they're both on the Orchid form. Which would you prefer?

What do you mean by A+15?

The financial strength is measured by Standard & Poor's or AM Best. They're both top-line companies.

You would know what Lexington or Brit would want then, in terms of whether they would only offer that deductible or that limit in Palm Beach, you'd better give that quote out immediately.

That was my puzzle when I got there. Remember, I had been a partner of Orchid for six years when I was with QBE. Then Orchid hired me out of QBE.

You were the producer, you were the carrier.

I was a QBE carrier partner. Then I left and moved down to Orchid. So think about it, Melissa has 12 carriers, right?

Yes, that's a lot.

They've all got a traditional hardback binder with all their rules. When I enter the building, I see Melissa, who has her workstation wallpapered with the basic fundamentals of each of the 12 companies. And I love her. She's a superstar. So I digitized those guidelines. So when you say, I'm going to use Brit on this house in Palm, you've got a quoting platform that you choose your carrier. Well, now Brit has got built in, you type in four million in the sum insured field. It goes, no; we don't do more than three million in that part of the country. So those little slips that would drive people nuts, we fixed them by digitizing. So now either Melissa or her assistant can quickly say, we think this fits Brit, but she's literally sitting there going, Canopius will like this better than Lexington because these underwriters, they are something, you know.

But does the carrier determine or require a certain loss ratio?

Yes, the carriers tell us, "In the Palm Beach area of Florida, we prefer the higher valued properties, from two to five million. But we also want them to be newer and come with a deductible." So, if you show us something that's higher valued and not newer, we don't want it. You've got 12 carrier partners on this.

Because that's the risk they want, basically. That's what they want, right?

They want this, not that. Yes, they prefer the ones with the little stuff on the side. That's the game. It's very important in personal lines. Each carrier, each insurance company for Orchid writes your home 100%. So, there's only one insurance company. That's just the way personal lines work. In commercial lines, it's different. You wouldn't believe it, but for that little dry cleaner on Main Street USA, there's a million dollars limit. We would split that between three insurance companies because they say, 'I don't want to be picked and chosen against. I just want to share everything you write, provided it's not a dynamite factory or something like that. If it's in my appetite, I want to share it.' So when Orchid has a loss ratio on commercial business of 27%, I want to look at it and say, mine's 27% also because I just had a third of all your business.

The problem on the personal line side is, Melissa gives the house we talked about in Palm to Canopius. Then, two hours later, she quotes another one three miles from there and gives it to Brit. Guess what? The one for Brit burns to the ground and the one Canopius doesn't. Brit's all upset going, 'Well, our loss ratio is 59 and theirs is 16.' And you go, 'Yes, that's true actually.' But there's no way around it. Part of her job is also to say, 'Well, I can't just keep giving Canopius, Canopius; I've got to spread my business.' That's why the thing I did with overlaying your home with the homes that we already write in that area was important because we eventually got them color-coded. You could say, 'Well, I have a lot of red houses in this area, and red is Canopius. Maybe I need to look at someone else.' It's a very detailed, on-the-fly process. We used to say to them, 'Every time you quote one, Melissa, stand up, walk around the floor, talk to Susan, come back.' In other words, take a little break.

Do you commit to a loss ratio for those? How does that work then? If I'm the carrier and I come to you, you've got your MGA. What are you selling to me?

If you caught the previous conversation, of course, we're committing to a loss ratio because we're saying we want an additional six points of profit commission at a 37% loss ratio.

But you actually give a loss ratio?

There's a bit of negotiation involved because Brit might say, "37 is too high. I want 35." But after 22 years, like Orchid, you get a very good handle on what's out there. You know what renewal business is coming at you every month. Orchid declined nine out of 10 new business opportunities. It was strategic, selecting only the most lucrative options, like finding the best house in Palm Beach and focusing on that, without the pressure to grow but to make a profit. All the underwriters received bonuses at the end of the year based on the profit commission that Orchid received from the carriers. So, this was not about production. That's the key.

When looking at MGAs, you need to determine whether they are driven by growth and production or by loss ratio. That's a significant message of mine. You might say to a carrier, I need help in the Palm Beach area, so I'm pretty sure I can give you 10 million in the first year. Or, I have a lot of support in Palm Beach; I don't really need much help there. I'll give you a couple of million, I'm sure. But my needs are in the northeast and on the west coast. Are you interested in supporting us elsewhere? So, there's this game, this ongoing conversation about how we can help each other.

What happens if you price it wrong? What type of relationship are these? Like, are the contracts with the carriers annual, or what?

Yes, they are contracts and some of them are annual, with specific dates for reporting and notice periods. These are fully fledged operating contracts. Most of them are annual, but they're more about an anniversary date than a renewal date. They're more like three-year commitments, but technically, you have the option to exit every four months if you wish. But we commit to giving you, over a three-year period, $30 million of business that looks like this, because that's what you told us you want.

You're committing to that?

Yes, and we've also informed you that we need to give you 2% to 5% of business that looks like this, and you agreed. If we turn up three years from now and have given you the business as we said we would, we expect you to continue the relationship. What you heard from me at the beginning was that I shifted those meetings from annual to monthly, so there were no surprises. We were in lockstep together. They loved us because we were transparent. We wouldn't write a report; we would take a screen dump of the monthly data, press the share button, and send it directly. It wasn't analyzed, cleaned up, or formatted. It was just the raw monthly data report, unfiltered. Here it is.

And so, how do you work with the reinsurers, if at all?

Well, the short answer is, we don't. I mean, we leave that to Canopius and Lexington. When I was at Orchid, I set up a captive, which was one of the reasons they hired me. Orchid owned its own little insurance company. So now, we've got what you call a segregated cell in Bermuda. It is a risk-holding entity in Bermuda that now has to buy reinsurance. Now we're in the reinsurance market. But that was done for two reasons. The management of the organization, including myself, said we're making really good loss ratios. We're making great ROEs for our trading partners. At that point in time, we were private equity-owned. So, we went to the private equity people and said, we can make more money for you. You'll need to give us five to seven million in capital to fund a risk cell in Bermuda and so on. And they said, where do we sign? But generally speaking, the short answer is no.

Now, we were a little different in that we would invite the Brit and Canopius people to bring their reinsurers with them. The Londoners would visit us in February when it was a little gray and rainy, and it was glorious and sunny on the beach. We would make it a bit of a social occasion, but it was also an effort of transparency. We said, come on down. We want to be open with you. We'll share. We were proud of our results, and we've had a tough year two years ago, but we fixed it and we want you to come down. We'll answer your questions.

Just briefly. So, you mentioned the ROEs. How did you measure that? What was earning for your carriers? And did you go that far and say, look, you're earning this much out of that or how did that work?

Well, you know, it's not rocket science. I write $100 million for Canopius one year. We see the claims because we're handling them. And we produced the monthly claims report. So, this is not an exercise in nuclear physics. We know.

Yes. This is what it is.

We know what we're paying. We know what they're paying us and we know what they're paying in claims. X plus minus Y minus Z equals this. And we divided by 100 million. And there's your number.

But they're earning crazy ROEs then.

Think about a year when a hurricane doesn't hit the book of business. We're making ROEs in the fifties plus.

Yes, 60. I was going to say 60. Yes. You can have a 20% to 30% loss ratio?

We're hiding money. That's probably not the technical legal term to use, but we're being very liberal with IBNRs and IBNERs, and we're putting some money away for the following year, which might have a rainy day. But in a non-cat year, the money is kind of obscene, for want of a better word. But everybody goes, well, that's obscene. And I say, yes, but the previous two years, we lost money.

Over a 10-year period, what does the average ROE look like?

Around 19 or so.

For you or for the carrier?

For Orchid. What we did was the same mathematics. Add up all the premiums, take out all the commissions, add up all the expenses.

They haven't got many expenses, right?

No. So it was 19 gross to them. As I said, they've got four or five people managing 20 MGAs. There's another half a point or something, but gross to the insurer, it was 19. It was a market-leading number. I've had people in London and Bermuda tell me they don't believe my numbers. I say, okay then, call me a liar. It's a great start to our conversation. But remember, you could have a bad year, and then a good year with a 60 ROE. What does the three-year number look like? Pretty bloody good.

That carrier is getting a similar ROE as you on that, even though they have no expenses. I don't really understand it. So, if I'm the carrier, I give you my balance sheet, you deal with the expenses, and I just pay you 23%?

Or 20% plus 6%.

But what would my return on equity be then, if I'm giving you that?

Let's look at the non-cat year. Expenses plus loss. We ran a non-cat loss ratio between 11 and 15. Add that to the 23. So that's our loss ratio at 23 points for the carrier, who pays us a gross commission of 23. 15 plus 23 is 38. So they wrote $100 million with a gross expense ratio of 38. They've got to pay some people in London. And don't forget, they have to buy some reinsurance. So they've got a reinsurance expense that Orchid doesn't have. But the gross ROE is in the sixties.

They will still be earning 40% ROE on a non-cat year, then potentially.

Right. And then, of course, it becomes very smart, but also very easy to say if you support us over a long period of time, our 22-year track record shows. Pick any five-year period and you'll make money with us. You may have one year that gets a little exciting, but pick any five-year period and the fact of the matter is you'll make money. We are just that good. Every year is not a heavy hurricane year.

But then Orchid will say, don't just write the business in Miami Dade where the rates are through the roof and the deductibles are 10% and 15%. Write some business up in the Northeast because a hurricane that hits Miami will not hit Boston. Write some business in western Texas or deconcentrate yourself geographically. You may only have eight million in premium up here and 90 million in premium down here, but that 90 million is exposed to the hurricane. That eight million is not. So you can isolate that and say, I made a 60 ROE on the business up in Boston even though I had a tough year down here. So think about the moving pieces and how they join up. And the carriers would love the fact that we would say, we'll give you some of this low, low exposure, low hazard to support some of this little higher hazard.

What's the biggest risk to a company like Orchid?

I thought that was a great question. And I actually had to think about that. So there's a couple of things. Let me just run down the list very quickly. There are only four or five points here. Number one is just the loss of capacity, but frankly, they're insulated from that. They've got 12 carrier partners and now they have a captive. So one or two of them have a bad year or have a change of philosophy or whatever. But again, Orchid's chosen carriers who are in the property cat exposed space, you know, they're not choosing car insurance, like Safeco or something like that. You know, Safeco doesn't do houses. So the people that they're partnering with have been in this space for a long time and probably will continue to be.

Number two is just, ERM, enterprise risk management. You know, do you get hacked? Do your core offices in Tampa, Vero, and Dallas get hit by a hurricane and you've got some short disruption to operational stability and staffing and all that? It's 100% remote, 100% duplication of servers, data, systems, backup and running tomorrow. I'm not saying there won't be a disruption, but it won't be lethal to the company. We've got a backup server sitting in Des Moines, Iowa. We've got another one sitting in Europe somewhere.

Loss of license now. Some sort of a fiduciary situation where someone does something with money that they shouldn't do and we lose a license in Florida or in Massachusetts or in Texas or whatever. This company is set up in such a way that underwriting claims, financial, etc are separate towers. And I can't get to the claims. I can see the data as the chief risk officer, but I can't manipulate a claims file, even though I was on the board of the company. I can't have a login to get into the claim system. Simple as that. I also don't have a login to the accounting department to get myself a cash advance for a trip to a baseball game. So there's structure and walls there, preventing someone from doing something that's inappropriate.

And then I guess the last one, you'd have to say something like, key man exposure, but very, very minimal. A very flat organization with lots of experienced underwriters. Melissa Austin is probably a VP, but, you know, she works in a workstation. She's not in a fancy corner office. She's a rank and file underwriter. She's really good at it. She's well compensated, she loves her job, the agents love her, and we got an army of them.

So what's the typical underwriter salary look like? So they got a base salary and how else are they incentivized?

Results. I was the lucky man because underwriting reported to me. We used to pay our bonuses in March, and I suggested to the CEO that it was unwise. We know the numbers by mid-December because we cut the year off then for tax purposes. I proposed that I walk around my floor on Christmas Eve and hand out bonus checks. Culture is important here as well.

Let's say, with Melissa, for example? Does she have a target or an underwriting profit loss ratio?

Her target is simply a loss ratio, not a production number. I had a situation where I would hand bonus checks to Melissa and Kathy, who sat next to her, and then move on to the next person who didn't receive one. Now that's tough.

Yes, it's hard. But I was just wondering, I'd write just one policy. Is there a certain minimum you have to do?

You've reasonably got to renew at least 75% of your expiring business. There are some fundamentals, like getting feedback from your top five agents. We used to bring brokers and producers in all the time for a chat and a bit of fun, and we'd ask, "How's Melissa doing?" It's a bit of a matrix, but yes, there are thresholds she has to meet, but it's not a production operation. I will fight to the end of the day on that subject. Handing out bonuses on Christmas Eve made people cry, but also drew attention to those who didn't get them. I didn't apologize; I said, "I didn't get one last year either. Hello. I know what this is like. We have a bad year, I feel it too." But it's a very incentivized operation, and I think that connects everyone with the same message.

Why do they sell to Brown & Brown?

Why do they sell? Great question. I was there when they sold from the first private equity company. I had been there for only two weeks, and the process was already ongoing. They were in private equity, looking to go to someone in the business. For instance, Lexington owns MGAs, Marsh & McLennan owns MGAs.

Internally, there were about six people coming to talk to us about why we should sell ourselves to them. The thought was to go to Marsh. Marsh has a big MGA unit called Victor. However, Towerbrook, the private equity firm, came in offering twice the money, and it was over just like that. So now we're owned by private equity. We were in the room asking, "What's the mantra here? Do you leave us alone? Sit in on the meetings and ask questions, or do you put more people in management positions?" They said they would leave us alone. Well, three and a half years later, we're saying, "Okay, we're sick of this. You're not leaving us alone, and we want to sell again."

What do they want then?

They always had someone in every meeting. It wasn't that he had another solution or a better option; he had questions. "Okay, so why are you guys doing this?" Well, because, you know, it's underwriting 101. This guy's a finance guy, not an underwriter.

He doesn't understand it.

Melissa was sitting there thinking, "Give me a break." But his job was to oversee a $500 million investment and ensure it was error-free. So we said, "We're sick of this." Interestingly enough, they thought it was a good time to sell. So, Brad Emmons and I, the CFO, called Brown & Brown and said, "We're about to go on the market, and we want you to buy us." Brown & Brown is an insurance entity, a huge financial powerhouse with multiple MGAs under their ownership, just like Marsh. Why not Marsh? I'm not sure.

It's a long story. Just before I joined, we tried to buy another MGA on the West Coast, similar to us, but Marsh bought them by offering twice the price. We kept in touch with the ICAT people, and over three or four years, we heard things weren't as rosy as they could be. We would have still sold to Marsh, and in fact, Marsh did bid on us. But Brown & Brown had multiple high-level relationships. We just thought they were a much better fit. Once the process started, it was too easy for words. It's a long answer to your question, but there it is.

And the price they all bid was roughly the same?

Yes, Marsh and Brown & Brown's bids were similar. Brown & Brown hooked us with a three-year earnout. There were some projections we put in, feeling that the market was losing steam and needed to harden. We made projections based on prices going up, which is the definition of hardening. They were a bit optimistic. So, Brown & Brown said, "We'll pay 82% on this number and we'll wait three years." But then, of course, the market just went crazy and we exceeded expectations.

So why didn't Towerbrook buy more MGAs when they owned you? Why couldn't you acquire this from yourself?

That was interesting too, and a disappointment for us. When Towerbrook came to us in 2017, we had a stated intention of buying an MGA west of the Mississippi because Orchid had nothing in the West. I was in the room when we said to Towerbrook, "If we're successful together, you will help us buy an MGA." But four and a half years later, nothing happened.

They just didn't want to. What was the reason?

I don't know if they had other priorities or better offers. They're all looking at their private equity, thinking, "Can I make 26% here versus 22% there?"

Sure.

Yes. Whereas Arrowhead already had an existing personal lines homeowners operation on the West Coast, which focused on earthquake coverage. That was just too easy for words. So, that helped us.

And how did they change that then? When they acquired Orchid, how did they integrate the operations with their existing business? How did they approach the business post-acquisition?

They left it alone.

Even though they had another MGA in the West?

There was internal collaboration, of course, such as sharing data and results. However, in terms of market identity, Orchid continued to trade under the name Orchid. Responsibilities for lines and management remained unchanged. It was just a plug-in.

But Orchid wouldn't then move to the West because Arrowhead was already there. So, was it kind of like an unwritten rule about territories?

But you'll be surprised how many people with homes in Palm Beach are actually living in New York and have a home down in Florida, but also a home in Colorado or business in Colorado. Arrowhead had the synergies of liability and other lines of business that Orchid didn't have, so we could offer more to our customers. But in terms of reporting lines and identity, nothing changed.

But are there any synergies or margin improvements or revenue synergies when you become part of Brown & Brown, or is it still just a standalone operation?

We were overdue for a policy administration system, a PAS. They had one that was three or four years old that they'd spent 10 million on and they just extended it out. That was a great synergy. You made a great point about data. Now, there was more data available. And don't forget, Brown & Brown, through its many MGAs, had relationships with carriers that we did not necessarily have.

So we were able to be introduced to them and, since I left Orchid, two of them have actually come on and supported East Coast business for Orchid as well as West Coast business.

So you got more capacity.

Yes.

How did it work with Wright - the flood specialists - if at all, the captive operation Brown & Brown have?

It didn't because they were kept separate. Orchid has maintained its captive and it's domiciled in Bermuda. So is Wright. But there was no thought of cross-pollination. Now, that's a heavy commercial. It turns out that I set up the captive for Arrowhead as well, which is another story. But Arrowhead is a very heavy commercial operation, a bit on both coasts. And that business is what Wright is writing.

How do you think these brokers like Brown & Brown will evolve in the captive business like Wright? And in 10 years' time, what does it actually look like?

Yes, I think it looks bigger and better. I can't disclose numbers here because they're probably a little confidential, but let me just say that the Brown & Brown captive has exceeded its profitability goals by a significant margin.

The Wright business? Yes, that's what I'm saying. If you're achieving these loss ratios, then why not just take more of the risk on your balance sheet and become more of a captive writer?

AmRisc is probably an MGA. You've heard of them; they're a big commercial property MGA in Texas. They're setting up their second captive as we speak. How do I know that? Because I'm helping them build it. It's not confidential information, but they've basically exhausted what they wanted to do with the first one and want to do something slightly different with the second one. But the answer to your question is the bigger MGA is the financial powerhouses, and why not start off slow, reinsure it in a reasonable manner, but have a strategy that you're going to keep feeding the baby until it grows.

Because Brown & Brown was not pulling profits out of their captive for the last three years. They were just reinvesting them back into the account, and all of a sudden, the account is sitting there with all this money in it. And frankly, they said, why would our retention still be five million when we've got this much sitting in net dollars? Retention of 25 million would still be fine. So, it's a long way of saying, you're right, this is a trend. It gives control and lets them keep their money. And we never want to actually say that it gives them a hedge against the rest of the carrier partners losing their minds because you don't want to create an image that the board is telling the captive what to write. But the reality is the board is telling the captive what to write. Now, you can kill the goose that laid the golden egg pretty quickly if you start writing poor-quality business.

Yes, exactly.

It's a hedge against if they pull their capacity.

But do you think there's a world in which companies like Brown & Brown, seeing these MGAs with such great loss ratios, would have a much bigger captive business taking risk on balance sheet in the next 10 to 20 years?

Yes, Brown & Brown is a classic example of someone who's grown by acquisition, by buying these MGAs. Now, they may then tweak them and put them on a better platform but they find these small MGAs, these medium-sized MGAs, these very large MGAs, and they buy them. Brown & Brown, as an organization, has 32 MGAs under management in property casualty, marine, workers' comp, and cyber.

Who do you think is the best MGA business out there, like a large, publicly listed one that owns MGAs?

Brown & Brown will be hard to beat, won't they? I mean, I have to actually think about who has that many. Because don't forget, diversity across multiple lines of business is a hedge against one line going bad.

RT Specialty?

Yes, I mean, RT is going to be up there. I am not as familiar with RT. I felt that MGAs were more brokerage than MGA, MGU, if you understand. Whereas the Arrowheads are true MGAs, full service shop, full underwriting authority, full claims. I probably have to come back to you on that. That would have been a great question for me to talk to some people about.

I'm obviously studying Brown & Brown. Is there any other company, you think really, that insurer or that broker, the listed companies, or private, that I should be looking at? 

Well, what are you looking out of this study? So tell me what you find, and I'll tell you what you should look at.

The most attractive investment opportunity for the next 20 years in insurance brokerage.

Well, let's not go 20 years, because that's pretty tough. Next five to 10. I mean, Brown & Brown, you have to consider. They'd have to be in your top three.

Who else? Who else would you put your money with?

AmRisc is a property-only MGA. You know, it's owned by Truist, you know, the big bank, but it's significant. It's going to be two billion. Now, I'm not saying the smaller ones can't get it done for you, but just the sheer numbers that some of the big ones will get your attention, in my opinion. Now, do you want to analyze, you know, all 32? You want to have to analyze 10 or 15 MGAs? Do you want to analyze two or three? You know, that's because you won't write across all their business. You'll support them on this or on that or something else. Then over time, your relationship will grow. In my opinion.