In the first of a new monthly series, consultant Tony Cornell says that half of the broking industry may disappear over the next few years - and asks where the money will come from to fund this massive consolidation?
Brokers will face renewed pressure in the 21st century
The insurance industry was dominated in the late 90's by insurer mergers and acquisitions and the consolidation of the international broker sector. The first few years of the 21st century will be dominated by the growth of e-commerce and the consolidation of the independent intermediary sector.
£2bn of capital required
The pressures on the sector will be intense. The succession timebomb would in normal circumstances have caused the shake out. But this is exacerbated by the expected renewed pressure on broker-held personal lines business and the impact of self regulation on non-registered intermediaries. The latter could well be the last straw for thousands of intermediaries who have already been left shell shocked by insurer consolidation and the soft market.
If the numbers in broking sector halves, as expected, then those who survive will need capital in excess of £2bn to acquire those who wish or have to exit the industry.
This money will be required by a relatively few brokers, probably in their hundreds. Critical mass will be even more crucial for a broker to be successful as the decade unfolds.
The question is from where will the money come? Traditionally there have been four forms of capital for the sector:
- Brokers have accessed capital through their banks, venture capital companies, insurers or private finance from major clients, friends or wealthy directors.
Banks have, unfortunately, failed to satisfy the appetite of the industry as, in general, they do not seem to understand the economics of the sector.
The major asset for brokers is usually goodwill and this is often discounted by banks, making the resultant balance sheet unsuitable for a lending proposition.
- Access to venture capitalists is only for the very large, brave and ambitious. There is usually a price to pay in terms of control of strategic direction and monitoring performance. The investor normally wants an exit route, probably by a floatation or sell-off and this could mean reduction in control. Size is therefore critical and this route is only open to the larger broker.
- Private capital is now less readily available with companies sticking to their core business, returns in the broking sector being at a low level and the stigma of Lloyd's in peoples minds.
- This leaves insurers. Often this option seems an easy, low-cost, convenient route for brokers who look for acquisition funding on a deal by deal basis. However, what are the pitfalls for independent brokers obtaining funding from one of their suppliers?
Brokers need to examine their IFA position with insurer loans
For insurers, there are undoubted attractions. It enables them to forge a strong relation with the borrower, work jointly to develop the business and above all make it a condition of any loan that they can cherry pick any business as a result of the acquisition. There is also a strong possibility that the existence of a loan would be taken as an opportunity to depress commission.
For the broker, however, it does threaten his independence and may cost more than it seems.
When FIMBRA and LAUTRO drafted their rules, they were well aware of the affect of the soft loans by insurers to brokers. The rules were very tight and even extend to general insurance players where there is any hint of life business involvement. The FSA will no doubt take the same route. Brokers need to fully understand the implications where they have common directorships with the regulated IFA.
Beware of general insurance regulation
The draft EU intermediary regulation for general insurance called for hard disclosure of loans or anything else which influences a broker in this choice of insurer. It remains to be seen what GISC will say or what will be the final EU regulations.
In other industries, suppliers do finance their distributors, brewers finance social clubs, building societies estate agents, motor manufacturers dealers, but these are all on a tied or exclusivity basis. Even these deals are often under review by the OFT and with the added teeth of The Competition Act, there must be fears about any large financing of independent brokers by their suppliers.
Check the hidden cost of finance
Finally, there is the hidden cost of insurer finance. Interest fee, deferred capital payments, even capital write-offs can be part of these deals. They can seem attractive but they have to be paid for. There is often overlooked commission sacrifice. If a £100,000 loan means two per cent less commission on £500,000 of business, the notional interest rate is ten per cent. Sometimes, the customer may pay a high premium by not having his business broked in the open market.
The way forward
Brokers who have a long term access to finance will have huge opportunities over the next five years. This needs to be put into place now.
For most, a close relationship with their bank is vital and should be worked upon above all else. Banks are the natural financiers of business development. They need to be educated on broker economics and buy into the brokers' long-term plans.
This arrangement can be supplemented by tactical short-term loans from insurers where available. However brokers need to ensure that such loans:
- Do not threaten their independence
- Have no impact on an associated IFA
- Have no hidden cost
- Do not prejudice customers
Remember, he who sups with the Devil...
Tony Cornell can be contacted on firstname.lastname@example.org