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Entire contents copyright © 2015 Crain Communications Inc. All rights reserved.
BROKER GROWTH STRATEGIES BUSINESS INSURANCE WHITE PAPER
Business Insurance’s white papers are copyrighted products of Crain Communications Inc. All rights reserved. Contents may not be copied, shared, resold, redistributed,sublicensed or publicly displayed on a website without the permission of Business Insurance. To obtain information on reprints,
contact [email protected].
INTRODUCTION
An old adage warns that if you are not moving forward, you are falling behind.
But for commercial insurance brokerages, moving forward in revenue growth
has become increasingly tough as various property/casualty insurance
market segments have softened, pinching producers’ commissions.
For at least the rest of 2015, brokers anticipate that rates will remain soft or
deteriorate as insurers attempt to deploy their abundant capital. If the average
brokerage does nothing different this year in terms of organic growth, it can
expect to grow at a slower rate than a year ago.
But the marketplace comprises more than average brokers. The growth
strategies for above-average firms result in year-over-year revenue gains that are
several times greater than those of the average brokerage, according to
management consultants.
Can the average brokerage keep up? If so, how?
There are a couple approaches it can take. But neither is as simple as it sounds.
The strategy producing the most robust revenue gain is acquiring another
brokerage. Publicly traded brokerages, the industry’s largest firms, as well as
many smaller but still-substantial private companies backed by acquisition-
hungry private-equity financing have long used this strategy. And metrics indicate
that it’s growing in popularity.
Smaller brokerages can adopt this strategy as well, according to consultants.
But they stress that it involves much more than opening the company coffers or
lining up the necessary financing for mergers and acquisitions. Buyers need
several attributes to make their deals work, including the management and
resources to ensure a successful post-acquisition integration of the operations.
Buyers also need an acquisition strategy that is more sophisticated than merely
deciding to jump into the M&A playing field.
Organic growth is the other strategy. There are a variety of tactics that promote
above-average organic growth, but, typically, only a small percentage of
brokerages use them. Unlike acquisitions, however, those tactics are suitable for
any brokerage. Even buyers should apply them, according to consultants. As one
expert observed, buyers do not want to see the business they just acquired shrink.
Whether a brokerage adopts an M&A or organic growth strategy or
combination, experts caution that some common missteps threaten a transaction
and prevent organic growth from taking root.
In this Business Insurance white paper, we will examine both strategies — how
they have evolved, what they entail and where the pitfalls are.
CHAPTER 1
The metrics
of brokerage growthPAGE 3
CHAPTER 2
Growing through mergersand acquisitionsPAGE 6
CHAPTER 3
Dooming an acquisitiongrowth strategy PAGE 9
CHAPTER 4
Investing in organicgrowthPAGE 11
CHAPTER 5
Specialization could spurorganic growthPAGE 14
CONCLUSION
PAGE 15
2015, values had jumped to a guaranteed 7.5 times
EBITDA with an earn-out opportunity of 10.5 times
EBITDA. Valuations for larger firms typically are
about 2 points higher, according to the consultant.
But Kevin Stipe, president of Reagan Consulting,
notes an oddity about today’s high brokerage
valuations in relation to earlier increases. The
shares of public brokerages — whose values are
used as a benchmark for determining multiples —
currently are trading at “an unusually high average
of 12.1 times EBITDA,” Mr. Stipe reports in his
Organic Growth & Profitability Survey for the first
quarter of 2015.
That figure is well above the historical norm of 9
to 10 times EBITDA for publicly traded brokerages,
according to Mr. Stipe. Indeed, over the past 25
years, those firms’ multiples were that high only
once: during the 2001-2002 hard market. But,
unlike then, many segments of the current
property/casualty insurance market are softening,
which pinches brokerages’ revenue.
Despite that peculiarity, Mr. Stipe does not
foresee these high valuations receding soon unless
there’s a major stock market correction. He said he
believes that today’s valuations give buyers a
strategic benefit: “an arbitrage play.” They benefit
from the lift that an acquisition’s lower EBITDA
experiences when it is pooled with the buyer’s
higher EBITDA. Even at today’s high valuations,
that arbitrage opportunity is “too lucrative” for
buyers to ignore, according to Mr. Stipe.
Organic growth
Not all firms have the financial fortitude to grow
through mergers and acquisitions. But all
brokerages — even very active buyers — want to
grow organically, consultants observe.
As segments of the insurance market soften,
however, material organic growth has become
increasingly difficult for all but the largest firms,
according to consultants.
In 2014, organic growth averaged 7.3%, according
to Marsh, Berry & Co. Inc.
Reagan Consulting, however, reports a lower
growth rate of 6.2%.
For the first quarter of 2015, results were even
weaker, according to Reagan Consulting’s figures.
Overall, organic growth was 5.8% on average,
compared with 6.2% in the first quarter of 2014,
Mr. Stipe reports in his first-quarter survey.
Property/casualty business led the way at 6.6%,
down from 8.4% a year earlier. Group benefits grew
4.3%, down from 5% in the first quarter of 2014.
And personal lines business inched up 1.3%, less
than half of its 2.8% increase a year earlier.
Softening property/casualty market conditions
explain the slide in organic growth, according to
Mr. Stipe. Prices in the first quarter of 2015 fell
2.3%, the sharpest drop since 2010, he noted,
citing the CIAB’s Commercial P/C Market Index
Survey. If that pricing trend continues, organic
growth rates likely will slow more, he noted.
The spread in organic growth rates between the
best-performing brokerages and the rest of the
field, however, is dramatic, according to
MarshBerry. In 2014, the top-performing
brokerages reported 17.5% of organic growth, or 2.4
times the average, it reported.
Over the next decade, all of these factors will
lead to some significant changes in the makeup of
the insurance distribution field, according to
Reagan Consulting. It projects that the number of
brokerages generating $100 million of revenue
could more than double to 74 in 2024 from 32 in
2014 but more likely will net out at 50 because of
consolidation among private-equity-backed firms.
The number of firms generating $5 million to $10
million of revenue will grow by about 10.3% to
1,018, while those generating $1.25 million to $5
million of revenue will grow by 19% to 4,284.
But the population of mom-and-pop agencies —
those generating less than $1.25 million of revenue
— will fall by 37.5% to 20,000, Reagan Consulting
predicts.
5
Entire contents copyright © 2015 Crain Communications Inc. All rights reserved.
BROKER GROWTH STRATEGIES BUSINESS INSURANCE WHITE PAPER
ORGANIC GROWTH TREND AMONG LARGE AGENTSAND BROKERS*
*Survey of insurance agents and brokers with median 2014 revenue of more than $17 million.
Source: Reagan Consulting Inc.
2008
(1.3%)
10.6%
2009
(3.5%)
4.5%
2010
0
4.4%
2011
3.3%
7.1%
2012
7.6%
4.8%
2013
8.2%
5.0%
2014
7.0%
5.7%
n Commercial lines
n Broker organic growth
Commercial P/C pricing
n Employee benefits
2014 ORGANICGROWTH RATES
ORGANIC GROWTHVS. COMMERCIALP/C PRICING
All agency average
7.3%
High growth agencies
Source: Marsh, Berry & Co. Inc.
Source: Marsh, Berry & Co. Inc.
17.5%
2011
2.7%
3.7%
2012
5.0%
6.2%
2013
2.1%
6.2%
2014
(0.7%)
6.2%
2015Q1
(2.3%)
5.8%
8
Entire contents copyright © 2015 Crain Communications Inc. All rights reserved.
BROKER GROWTH STRATEGIES BUSINESS INSURANCE WHITE PAPER
which gives buyers greater flexibility in structuring
a deal, consultants note.
This is one reason private equity often prefers to
back acquisition-minded brokerages rather than
insurers, noted public brokerage analyst Jay Cohen,
a New York-based managing director at Bank of
America Corp./Merrill Lynch, Pierce, Fenner &
Smith Inc.
When a broker acquisition target has good cash
flow, a buyer can leverage the acquisition much
more than it could if it were pursuing a similarly
situated insurer, Mr. Cohen said. That’s because,
unlike a brokerage, an insurer assumes and carries
risk. Insurance regulations, therefore, limit the
amount of debt a buyer may assume.
Many brokerage M&A deals involve a 4:1 or 5:1
debt to equity ratio, said Mr. Cunningham of Optis.
Interest rates are so low that the cost to service
the debt is not significant, he said. So if a buyer
can lock in today at a pretty low interest rate, “that
gives you a pretty nice window to operate in.”
n Do not have staff redundancies.
n Are well-positioned technologically.
For example, an agency system that requires the
firm to “backfill” various customer data fields, such
as contact information, “could be a problem” for a
buyer, Mr. Cunningham said.
n Do not have a history of errors and omissions
claims.
Some potentially worthwhile acquisition targets,
however, may resemble “an ugly duckling,”
according to Mr. Wicher. Those are “basically good
firms” that need new leadership or a resource that
current management cannot provide but a buyer
could, he said.
Stick to your knitting?
A company may do best what it knows best, but
is sticking to one’s expertise when identifying
acquisition targets the best growth strategy?
“It depends; it’s not monolithic,” Mr. Cunningham
said.
If a target would bring “a certain level of quality
and profit margins,” then big, active buyers “will
buy anything,” he said. A target might offer
“something unique” that the buyer wants, such as
a premier aviation broker.
But some smaller firms need to do a better job of
identifying their goals before developing an
acquisition strategy to accomplish them, Mr.
Cunningham said. Some smaller buyers “get deal
fever” but have no acquisition strategy, he said.
“You have to define your strategy. From that comes
your business plan.”
M&A deals involving firms with complementary
experts generally represent a lower risk to the
buyer because its management knows the
business, Mr. Wicher said.
“Moving into a new line of business has greater
risk at the front end. But if it works, your revenue
stream realizes greater diversification, which is
positive,” he said. “One hint if moving into a new
line of business: Start small, learn what you don’t
know, then bite off something larger” later.
Except, consultants agreed, with the health care
sector.
With health care, “you just can’t dip your toe in
anymore,” said Phil Trem, a Cleveland-based senior
vice president at Marsh, Berry & Co. Inc. “If you’re
going to go in, you have to go all in just to be
competitive” with other firms that have that
practice.
Mr. Trem added that if a buyer has a strong
commercial property/casualty presence, its
producers would not “want to jeopardize their
accounts (by cross-selling) if they’re not sure
you’re committed to that benefits business.”
Deciding later that the benefits business was a
mistake and withdrawing from it could irritate
property/casualty clients and prompt them to
move their business, he said.
Strategically, large public brokers’ acquisitions of
employee benefits firms now is “well within their
expertise,” Mr. Cohen said. Indeed, their “well-
developed” benefits business is growing faster for
them than their property/casualty side is, he said.
ATTRACTIVEACQUISITIONTARGETS
An M&A target might fulfill one ofnumerous possible strategies for abuyer, but most targets have a fewcommon traits. They boast:
n Profitability
n Diversified revenue streams
n Little or no debt
n Timely collection of receivables
n No staff redundancies
n No checkered history of E&Oclaims
PUBLIC BROKER VALUATIONS AT PEAK LEVELS
Average year-end public broker EBITDA multiples
Source: Reagan Consulting Inc.
2008 9.1x
2009 8.3x
2010 9.6x
2011 9.7x
2012 9.9x
2013 11.7x
2014 12.1x
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