K2 has $500mn of dry powder for M&A as it seeks to build global QS capacity
MGA K2 will pivot to an active M&A strategy, as it seeks to double from its current $1.5bn premium base by deploying a $500mn war chest from new private equity backer Warburg Pincus, group CEO Bob Kimmel told Inside P&C.
Other growth initiatives from the top-five independent US MGA include a project to build quota-share capacity across its 24 programs, ambitions to establish a presence in wholesale and reinsurance broking, and a property cat sidecar raise.
“Right now, we’re about $1.5bn of annual written premiums, and we did that in 11 years,” Kimmel told Inside P&C. “Warburg Pincus would like to see us double in four or five years.”
In December, the private equity house – which also backs Foundation Risk Partners – struck a deal to acquire a majority stake in K2 at a valuation of ~$1.25bn, equivalent to around 16x-17x Ebitda, with prior backer Lee Equity Partners set to exit entirely.
Kimmel told Inside P&C that roughly 25% of the growth would come from organic growth, driven by increased policy count and rate, with a further 25% projected to come from the team lifts that have driven much of its growth in recent years.
But he said that a shift would be evident with the new private equity ownership after a period where the firm has transacted relatively little M&A.
“The biggest leg of the stool will be acquisitions,” he said, with this accounting for around 50% of the planned $1.5bn premium growth.
Kimmel said that Warburg had provisionally pledged resources of around $500mn for M&A, noting that this would give the firm the ability to acquire $30mn-$40mn of Ebitda – equivalent to up to half of its current $80mn Ebitda.
“We’re going to go hunting,” the former Guy Carpenter executive said, adding that these plans also included targeting a list of underwriters for lift-outs.
Kimmel explained that a combination of the priorities of its previous owners, the firm’s scale and the elevated multiples MGAs have attracted during a recent M&A boom have largely kept K2 on the sidelines.
“Historically, we haven’t done that, we have not been comfortable with big bets – mainly because in a high valuation market I’ve seen them turn upside down. And we weren’t big enough to sustain paying $100mn for a business and have it go to zero.”
Kimmel said that K2 was positioning itself to ramp up M&A as valuations fell due to the increased cost of capital.
“Given the interest rate environment, valuations are coming down,” he said. “Everyone is preaching that they’re staying where they are, or even growing – it’s fundamentally impossible.”
Kimmel said that when the increased cost of capital feeds through private equity firms’ models, “they can’t stretch as far on valuations”.
He added that a lot of competitors backed by PE have sprung up and grown very quickly in the last three to four years.
“It’s a very crowded space now,” the executive said, adding that “the only way you grow quickly in our business is cheap price – so what happens is losses will come, terminations will come, and valuations will drop”.
“At that point we’ll be here to help,” he said.
Kimmel noted that K2 will look for acquisitions in areas it does not currently operate in, but he also explained that the heads of its 24 underwriting cells had also been urged to find consolidation deals.
“We’ve empowered our underwriters and said, go find some of your competitors and you become a small K2 and start acquiring companies.”
In these instances, the construction team, for example, would be given financing by the company to buy and fold in another construction MGA.
Kimmel added that lines of business where it is currently looking to add new teams included environmental, D&O, reps and warranties, and architects’ and engineers’ professional liability.
A global quota-share to support all 24 programs
The CEO said that K2’s capacity had historically been arranged at the level of the individual underwriting cells.
However, he added that his company is currently exploring the creation of a cross-class panel of capacity to write across all 24 programs.
Kimmel said that K2 is in live discussions with multiple carriers about the creation of a “global quota-share” that would give capacity providers access to the index of the MGA’s results.
He stressed that if this capacity does join, it will not be used to displace (re)insurers that support individual programs, with the capacity instead used to support growth.
Kimmel said that the business delivered a blended combined ratio of just under 85% in 2022, and that carriers writing across K2’s programs would consistently have achieved this kind of result in recent years.
“So that’s where I would want to be if I was a risk bearer,” he said.
Some other MGAs – including Dual – have been able to negotiate some capacity on this kind of cross-class basis, but carriers tend to be reluctant to provide support on this basis – backing their ability to stock pick over the benefits of spread.
Kimmel stressed that delivering an underwriting profit to carriers was central to the firm’s approach.
“If you ask any one of our 24 leaders about their priorities, the first words out of their mouths are ‘we’ve got to make a profit for the carrier.’”
He continued: “No matter what kind of Ferrari you build, without the gap of the carrier capacity, you’ve got nothing. We’ve had it where we’ve lost paper, and the value of that business goes to zero.”
In soft market conditions – as with workers’ comp in recent years – “we just kind of backed off”.
“We’re not going to grow in a soft market environment because that will lead to a zero-program outcome down the road,” he added.
Property cat sidecar discussions “ongoing”
Questioned about the breadth of areas suitable for an MGA, Kimmel observed that specialization was crucial.
“When the big national commodity players want something, we have to get out of it.”
He added that the corollary of this is operating in markets where other carriers, including the large admitted plays, are running away.
“So, dislocation’s rule number one – we want to be in dislocated markets.”
Right now, he said that areas that made the most sense include property cat reinsurance, wildfire insurance and wind insurance.
Kimmel acknowledged that several MGAs were seeing pressure around capacity in these areas, inhibiting their ability to take advantage, and noted that it had lost some of its capacity in cat treaty last year when Peak Re pulled.
“Of course, in heavy dislocation, those that win are those that find capacity, convince people it’s a great time to do it. And that’s where great MGAs thrive in dislocation.”
Following the loss of that capacity, K2 has been working with investment bank Stonybrook to raise a $250mn-$400mn sidecar to support its cat underwriting.
Questioned about the progress of the work, which has been underway for several months, Kimmel said the project is “ongoing”.
He continued: “We’re having a few very good conversations with very large capital providers who are talking about $100mn to $250mn investments.”
The executive emphasized that K2 still has cat treaty capacity but noted it had been forced to retrench due to reduced support.
Kimmel expressed confidence in the raise, noting that capital would ultimately come into the space and that it made sense for it to “plug into” the MGA’s data and underwriting rather than looking to build a company or syndicate from scratch.
Spreading across the value chain to wholesale and reinsurance broking
Kimmel said that the business will never again go near retail broking after an ill-fated foray but emphasized that it was keen to operate across more of the value chain – pointing to its efforts to build out in the TPA space.
He also flagged two further opportunities.
First, he noted that K2 currently declines 70% of the submissions it receives. Kimmel argued that this creates an opportunity for the firm to create an automated wholesaling capability that would allow it to offer capacity to retailers for business that was outside its appetite.
“We’ll probably purchase a wholesaler and use it really as a captive wholesaler for our business we decline,” he said, noting that this could be done with the commission then split with the retailer.
There has been a trend for brokers to spread out and try to own more of the value chain. Major wholesale brokers like Ryan Specialty and Amwins own multi-billion premium MGA and binding operations, with large retailers like Hub, Alliant and Risk Strategies all highly active in the MGA space.
We have four execs who were executives in reinsurance. Why aren’t we a reinsurance intermediary?
The same has been evident in reinsurance broking, with the likes of Lockton, Howden and BMS building out organically or through acquisitions.
Kimmel – previously an executive at John B Collins and then Guy Carpenter – said K2 is also eyeing reinsurance broking.
“We have four execs who were executives in reinsurance. Why aren’t we a reinsurance intermediary?”
The CEO said that the lines have become blurred in distribution, and that K2 could also take advantage of that development.
Questioned about the long build to profitability of some other challenger reinsurance brokers, Kimmel concluded: “We don’t need to have $200mn of revenue. We could survive on $10mn of revenue.”
This story has been updated to clarify that Lee Equity will not roll equity in K2.