Playing for power

It was a damp September day last year when news of Towergate Partnership’s £276m acquisition of broker technology giant Open International broke, sending shockwaves through the insurance market.

Words such as “stunning” and “gobsmacked” were bandied around by senior insurance executives for whom such hyperbole were rarely heard. “This is a major strategic move by Towergate and may well create a change in the market going forward,” commented Theo Duchen, co-chief executive of rival software house Acturis, summing up what pretty much everyone else in the insurance industry was thinking.

Towergate had done it again. In a stroke it had taken the business into a new area – broker technology – a move which it claimed would revolutionise the electronic trading of commercial lines business. Coupled with that it had bought access to the Open International’s distribution network, Countrywide, with its 700 broker members, and the 6,000 brokers that used software house Open GI. Annual premiums of over £6bn flow variously through Countrywide and Open GI, which Towergate could attempt to tap into with its own products.

That Towergate had successfully raised nearly £300m of debt financing for the deal just as the tentacles of the global credit crunch were beginning to take hold on the corporate mergers and acquisition market was further testament to the strength of the organisation.

Launched 10 years ago as an underwriting agency, Towergate’s rise has been swift and seemingly inexorable. In the space of a decade and with over 145 acquisitions under its belt, it has become the most powerful SME broker in the UK, controlling over £2bn in gross written premiums and employing more than 3,500 people across 100 offices.

It has grown to such a scale that as much as a tenth of some of the UK’s biggest insurers’ premium income comes from Towergate, giving it unparalleled leverage in the insurance market. It has attracted some of the insurance industry’s big hitters, including Patrick Snowball, former Norwich Union executive chairman, and Amanda Blanc, previously distribution and customer services director at Groupama.

Towergate’s mantra is “Make money, have fun and do good”. Its executive chairman and founder Peter Cullum claims the business is worth more than £3bn.

But as Towergate’s power and dominance grow, some ask whether its model is simply too good to be true. Is Towergate providing the good deal for its insurer partners that it claims? And, ultimately, is the model sustainable?

Insurance Times obtained exclusive and unprecedented access to some of Towergate’s top executives, including Peter Cullum.

Held to ransom

But as the investigation unfolded, it emerged that not all of Towergate’s insurer partners are happy with the level of returns they get from their relationship with the company. One senior executive at a top UK insurer admitted that his company was effectively held to ransom by Towergate, owing to its control of the broker distribution channel.

Cullum, however, insists that it has made money for insurers across the cycle and that its insurer partners have stayed with it for many years. He argues that insurers would withdraw their support if they didn’t make money.

Since its launch in 1997, Towergate has grown at a blistering pace. Cullum claims its annualised GWP is now £2.3bn. And as Towergate grows, so does the insurance industry’s fascination with the organisation.

No other company within the sector has captured the interest of the insurance community as much as Towergate has. The sector’s thirst for news of the latest turn in the Towergate saga seems unquenchable. Who is it going to buy next? Will it be sold to another company? Will it float on the stock market? How much is it worth?

Gossip and speculation is rife. It is linked to pretty much every acquisition rumour (prompting some companies to declare that they will never sell to Towergate). Towergate watching has become a hobby for some, with people keeping files on the company’s accounts, annual reports and press cuttings and poring over the business and its model.

Everyone has a view on Towergate. It is a business that polarises opinion, evoking responses that range from admiration to scepticism and dislike.

£580m refinancing

What has been remarkable is the apparent ease with which, to date, the company has raised money. It was originally backed by Royal Bank of Scotland, but in 2006 it completed a £580m refinancing, led by HBOS and Lloyds TSB and supported by a range of other banks and asset managers.

The refinancing created an acquisition war chest of £250m. It also raised additional money to finance its £276m acquisition of ‘ ‘ Open International in 2007. Towergate is now expected to refinance this year. Reports suggested that the company could be looking to raise over £1bn to consolidate its debts and provide additional funds for acquisitions.

Bill Cooper, managing director of financial institutions Lloyds TSB Corporate Markets, says: “It is a profitable business that has been able to reinvent itself.”

This reinvention has been particularly noticeable in recent years. It has acquired mortgage general insurance specialist Paymentshield, moved into the financial service sector, acquired a software specialist in Open International and created a networks division through acquisition of the Broker Network.

Towergate’s claims to have rewritten the rule book on how insurance products are distributed to clients. In essence, the model is based on underwriting and distribution.

On the underwriting side, the business has grown, through acquisition, into a £500m plus virtual insurer or managed general agency (MGA), focusing on specialist schemes, such as cover for armed forces, golf clubs and classic cars.

The company claims to provide the widest range of products available of any single insurance group in the UK. Approximately 50% of Towergate’s business comes from underwriting.

On the broking side, Towergate’s retail business has grown through 113 acquisitions into a broking business placing over £500m in annual premiums into the insurance market.

The combination of good underwriting returns and a powerful distribution network enables Towergate to leverage a greater share of the overall returns, whether through enhanced commissions or profit share agreements. In Cullum’s words: “a recalibration of the overall gain share,” or to put it more simply, taking “a larger share of the cake”.

Cullum says: “Our scale is significant leverage, we have £2.3bn in premiums.”

“On one particular deal we were paid 42 points but the average commission pay-away is 32 points, so we are existing on a very slim margin.

But he says the model is not just about obtaining enhanced commissions. “Our underwriting side is about producing good underwriting results with profit shares that are potentially very significant.

“We get a bit of flak from brokers who don’t really understand our model. One insurer chief executive said he had been asked by brokers for the same deal as Towergate. His response was that if they provided the same underwriting returns as Towergate they would get the same deal.”

Cullum is at pains to play down the large commissions that Towergate is rumoured to achieve. “45%-50% commissions are a gross exaggeration,” he says. “It is one dimensional to look at commission. Commission varies by class of business. If you look at the MGA side we get paid extra because we do the work, such as claims and administration.”

He also argues that on wholesale business where gross commission levels may be high, Towergate exists on a relatively small margin given the commissions that it pays out to sub-brokers.

“On one particular deal we were paid 42 points but the average commission pay-away is 32 points, so we are existing on a very slim margin. Insurers could not exist on a 10 point margin, we do and we make a profit. We like to do it for profit and not just for fun.

“There is a misconception that we are greedy and take large commissions. We take larger commissions than may be the norm because we do the flipping work. That is often lost in translation,” says Cullum with some apparent agitation.

Some, such as Hiscox director of mergers and acquisitions Charles Dupplin, argue that Towergate is not achieving the commission increases that it should be. Dupplin also argues that Towergate has not achieved efficiencies from integrating its acquired businesses (see box).

Enhanced commissions

But Cullum insists Towergate is getting enhanced commissions from acquisitions. He says that its 2007 accounts will show like-for-like growth in profit of over 20% and over 10% in turnover.

“That was in a very, very hostile market place. I don’t think you will find many brokers in the UK showing significant growth in their 2006/2007 numbers given the soft market,” he says. “We are an organisation that earns significantly from profit shares and 2007 was not a great year. We come under the cosh as much as everyone else.”

In terms of integrating acquisitions, Cullum admits that this has not been done. “We haven’t been possessed with cost reduction programmes. We pride ourselves in buying good quality businesses not turnaround businesses, so autonomy is very important. We don’t want to engulf the businesses in bureaucracy and squeeze the life blood out of the organisation.”

So how does Towergate get value out of its acquisitions? “If I told you the formula I’d have to shoot you,” retorts Cullum but, when pressed, lists areas such as enhanced deal structures with insurers, cross-selling new products, better deals on premium finance and other add-ons.

“With most of our acquisitions we can consistently show an uplift in virtually all cases. If we don’t feel we can add value and significantly improve the bottom line we don’t buy.”

He cites the acquisition of Paymentshield, which Towergate acquired in 2006. “We paid £180m for it. The adjusted EBITDA [earnings before interest, tax, depreciation and amortisation] was £13m – so that’s a pretty sexy [acquisition price] multiple. In the space of over a year we have more than doubled its profitability in a market place that is pretty dull.”

Talking to some of Towergate’s key insurer partners, Insurance Times discovered a range of views about Towergate’s model, with one senior executive privately expressing concern about the leverage that Towergate has. There were also warnings that Towergate could find it difficult securing extra commission this year given the tough times faced by insurers.

Key insurer partners

Towergate’s key insurer partners include Norwich Union (NU), AXA, Allianz and RSA. Towergate business accounts for approximately 10% of AXA’s general insurance book in the UK and is thought to account for around 5% of Allianz’s and NU’s general insurance premiums.

Chris Hanks, general manager of Allianz Commercial, says Towergate provides good access to market given its scale, but adds: “The business model is difficult to make optimum returns from.”

AXA distribution director Mark Cliff says the insurer would like to improve the profits it makes from Towergate. He says: “Is it always the easiest relationship? No. We’d like to get better returns and Towergate knows that. We are actively trying to get that.”

The insurer has supported Towergate for eight years and they have a joint profitability review group. “Some schemes work extremely well and have a superior loss ratio, but there are others that don’t. We have parted company on some schemes business that we could not make money out of.”

Cliff says it is difficult to quantify the typical commission uplift that Towergate achieves. “It aims to increase commissions, but Towergate is not an homogeneous business, so it is difficult to put a figure on it. It bought one broker and the commissions went down,” he says.

Does AXA get a good deal from Towergate business? “Are they providing a level of service? Yes. Would I like to make more money? Yes. Are we working to achieve that? Yes.”

John Kitson, sales and market director at Norwich Union Insurance, says Towergate has produced good results for NU. “Towergate has been very good for us. It is one of our top five partners. Over the last five to 10 years we have had good returns over the cycle.”

Kitson says NU will be looking for Towergate to support it on achieving rate increases. “How can it support us on rate increases? Everyone knows 2007 was difficult for everyone and we need the support of our major partners to increase rates.”

Privately, some insurers say Towergate’s model extracts too much value in terms of commission and profit shares. One senior insurance source says: “The model doesn’t work for us, as we can’t get the returns on capital.”

Continued support

The source said his company continued to support Towergate because of the scale of its distribution. “The vast majority of our business comes through brokers. Towergate has access to the market and it keeps buying brokers. It has the power and, as long as other insurers support it, it will keep that power.

“There is a misconception that we are greedy and take large commissions. We take larger commissions than may be the norm because we do the flipping work.

He added: “We have conversations with Peter Cullum and [Towergate chief executive] Andy Homer along these lines. It does us a deal, because it would prefer us to be in rather than out. At the end of the day, if I could find another distribution channel that made such returns I would move.”

Cullum insists that Towergate has produced good underwriting returns for its insurer partners and does not force insurers to accept uneconomic deals. He says. “It is ‘ ‘ always an intelligent and mostly unemotional conversation with insurers. They are tough traders, they are not pussy cats. They have targets – if we put a deal before them that is not going to hit targets then we are shown the door, particularly at the moment, insurers are bleeding.

He insists insurers would walk away from a bad deal. “I have experienced it. There is a tipping point between a deal that makes sense and one they would walk away from. We have been very loyal to a number of carriers. We don’t knee jerk, we don’t switch loyalty unless for a specific reason.

“Our track record is not just about brokerage, but underwriting triangulation. We are fiercely interested in underwriting results. We don’t think there should be an adversarial relationship. We have a joined up sustainable relationship with our carriers where both parties are making a half decent return on capital.”

Cullum adds: “Over the cycle over five years we made exceptional results for insurers. We did not do it in 2007 on property because of floods. We don’t panic. We produce combined operating ratios in the early 90s across the cycle.”

How stable is the Towergate model? To what extent is it at risk from high interest rates, given its level of debt, and softening rates, which will have an impact on its commissions and profit shares?

Resistance from insurers

One senior insurance source says that Towergate could face resistance from its insurer partners if the soft market continues. “Insurers are finding it difficult to get returns. If Towergate doesn’t get the commissions then it is at risk. It is not in imminent danger, but it is not as robust as Oval or Jelf. If interest rates go up 3%-4% and the soft market persists, then Towergate would struggle,” says the insurer source.

Another top executive at a major UK insurer says Towergate, and other consolidators, will find it difficult to negotiate extra commissions in 2008 given the financial pressures on insurers. “It is coming to the point where we, the insurers, say enough is enough. In 2008 we will be there. We will say look at our numbers.”

Norwich Union’s Kitson says Towergate’s model is robust but suggests that integrating the businesses will be a key challenge. “How can it make the whole greater than the sum of the parts?” he says, adding that Towergate also needs to address the issue of achieving organic growth as well as just growth from acquisition.

He adds: “It needs to keep [Towergate] moving. It needs to be fed with acquisitions and keep the acquired brokers happy. It is buying brokers led by people with big personalities. Cullum is a charismatic leader and has been able to do that so far,” says Kitson.

AXA’s Cliff says: “Is it a robust model? Look at Peter Cullum’s success in the City in terms of raising money in difficult economic times.”

He also raises the issue of integration: “It has been a successful vehicle, but it needs to integrate.”

A number of people also questioned whether Towergate would continue to run successfully when Cullum and Homer step aside, probably within the next few years. “The health of the business depends on Peter Cullum,” said one senior source.

Cullum says he has already begun to consider Towergate’s future leaders. “They are already with us,” he says.

In terms of the risks to Towergate’s business, Cullum says: “The risks are huge. If it were easy everyone would do it. There are lots of challenges, but we are not complacent. The soft market challenges us.”

How precarious is Towergate’s business? “We have to mitigate risk, we can’t do it completely, but we have to mitigate risks.”

In terms of the threat of rising interest rates, Cullum says Towergate has hedged against rises, so is protected.

What if premium rates continued to fall? “I’d fear more for insurers as our balance sheet is never at risk,” he says. What about the impact on commissions? “Our return on income is well north of 30% – it stands very well against our peer group, so we have a lot of headroom if the market goes further south. I hope it doesn’t.”

Finally, what is the future for Towergate? Cullum says that a float in the next two to three years is a possibility “provided there is an appetite from the [financial] markets for it and institutional support is available”.

“We have advisers that tell us an IPO [initial public offering] would be a smart move. It is not an end game, but a source of less expensive money and would provide us with a war chest [for acquisitions].”

Step aside

It seems likely that a public listing, if it were to take place, would be Cullum’s finale with Towergate. “I need to step aside within the next two to three years,” he says.

What about a sale to private equity? Towergate is reported to be considering selling 25% of the business to private equity firm Candover for over £800m, potentially as a means of raising additional capital prior to a float.

Cullum will not comment specifically on the Candover speculation, but says: “We have been approached by private equity. So never say never [to a sale]. This is a difficult time to be talking to banks.”

In relation to Towergate’s refinancing, Cullum says: “We don’t have to refinance. We have some interesting deal opportunities over the next three to six months and it will require additional funding. It is dependent on what is available.”

Towergate is for the first time exploring acquisitions of underwriting agencies in the US. And as Insurance Times went to press, there were reports that Towergate was looking to acquire an insurance company, possibly Sterling Insurance whose portfolio mirrors that of Towergate – although Towergate would not comment on the speculation.

Cullum says: “I have always said we have to reinvent ourselves every three years. If you are standing still you are going backwards.”