As the soft market continues, what is the impact on the commercial broking sector? Can M&A bring the growth so badly needed?
The insurance broking industry has faced a number of significant challenges since 2008. Yet, despite the consequent pressure on revenue, the sector has remained profitable, albeit on a reduced basis.
For brokers, the global recession has acted to suppress product prices, reduce the demand for ancillary products and has led to increased lapse rates amongst clients. The resultant stagnant rates for many classes of business have made it difficult for brokers to deliver organic growth and without a strong focus on client retention, in many cases, revenues will have been reducing.
Add to this a collapse in investment income and the resultant loss of a key insurance broking revenue stream and it is clear that in the absence of other changes, profits will have been under stress. Put simply, insurance brokers have had to work harder to retain their clients and remain profitable.
The industry is seeing rapid technological advances and, in particular, the introduction of e-trading for commercial business has the potential to significantly reduce brokers’ costs. But only the larger brokers have the balance sheets to invest in e-trading at this early stage in its development and thereby transform their business models. In the absence of this, for most brokers there has been only limited scope for cost reductions.
Despite all of this, since the onset of the global financial crisis, broker M&A volumes have held up well. Valuations have fallen, however. Nonetheless, there remain compelling drivers for insurance broking M&A.
Without a doubt, we have seen fewer landmark deals like the Marsh acquisition of HSBC’s broking interests. This has in part been due to the lack of availability of debt to finance acquisitions. At its peak, debt multiples were available to the consolidators of five to six times profits but these disappeared almost overnight in the second quarter of 2008. Even though debt markets are now open again, the multiples for new lends are closer to three times profits now.
The lack of landmark deals has also in part been due to the temporary withdrawal of the consolidators from the large-scale acquisition arena. Smaller-scale brokers continue to be acquired, albeit at lower valuations.
It is fair to say that private equity is also still attracted to the broking sector and that the buy-and-build business model fundamentals remain strong.
The reduced profitability and prospects for growth amongst brokers has negatively impacted sector valuations, which have fallen considerably from their peak in the first quarter of 2008. The drivers of M&A, however, are as powerful as ever and M&A remains an option to deliver the growth that the broking sector is missing.
Be it consolidation amongst brokers, international brokers seeking a UK presence, insurers seeking to gain control of distribution, or the continuing hub-and-spoke activities of the consolidators, the prospects for broking M&A remains strong and the next 18 months are likely to see a return to increased M&A activity by the larger players in the UK broking sector.
Ian Clark is a partner in Deloitte’s corporate finance insurance practice