Tony Cornell looks at the benefits and downsides of brokers growing by acquisition....

Most brokers in the UK are buyers or sellers, as the economics of broking and the consolidation of insurers force them to consider their strategies for the future. Size is becoming increasingly important for brokers to survive and prosper.

The critical mass for brokers is now probably £1m commission income or about £5m to £6m of premiums under their control. The rationale for this is:

  • Access to markets – Consolidation means that the large insurers are increasingly focusing their attention on the larger broker players. Smaller brokers are likely to only have an influence with half the insurers, yet to provide a real service and market coverage to their customers they need many more
  • Technology – There is a constant need to upgrade systems, but the costs of a meaningful presence in the emerging technology markets, such as internet, are likely to be high. Smaller players will increasingly find it difficult to produce the profits to compete
  • Marketing – To create a brand or franchise in a local market or specialist niche is costly but crucial, if brokers are to retain market share against attacks by more powerful competitors
  • Staff – The resources to recruit, train and develop good quality staff can only be put in place in larger companies
  • Specialisms – Specialisms in trade sectors and niche markets are becoming more important. Smaller generalist brokers have difficulty in committing resources to developing expertise in these areas

    Organic growth is becoming more difficult in a stable economy with low inflation. From 10% to 15% organic growth is probably at the top end for most established brokers, and in these cases achieving a critical mass will take too long. In many cases, acquisition is the only solution.

    70% of brokers will go in the next ten years
    In the future there will be no shortage of companies wishing to sell. There are some 7,000 brokers in the UK who have commission income under £150,000. A recent survey suggested some 50% of these will need to exit the market in the next five years and 70% in the next ten. This is purely because of the age of the principal and lack of successors. Others may have to go because of the impact of GISC, and market and financial pressures.

    The price for the winners is some £3bn of premium income and an extra £450m in commission. The downside is that capital approaching a similar amount is required in an industry, which has few fixed assets and is not on the banks favoured list for acquisition finance. At least GISC has taken a more pragmatic view of solvency margins than IBRC and included goodwill as an asset.

    The profit and loss accounts and balance sheet of a broker who is acquisitive, takes a real hammering, as goodwill has to be written off against profits over five to seven years, and the interest and capital on loans have to be paid off. Borrowings become high and are charged against an intangible asset which is discounted by banks and credit rating agencies. However, with careful selection and planning, the enhanced profit from an acquisition can easily fund all the costs.

    The most profitable acquisitions are bolt-on ones, where the business can be easily absorbed into an existing structure. Costs can be reduced dramatically by savings in staff and fixed costs, and earnings enhanced by using the additional volume to negotiate better deals with insurers.

    Remote acquisitions, where offices and staff remain in place are more difficult. Savings are harder to achieve and management resources to manage the integration are high. It is often difficult to impose a culture on an office some way away. It is also important to assess the impact on customers if the new business methods are different.

    Other issues to consider include:

  • The shape of the business – the fit of the businesses is crucial. A commercially dominated broker needs to think carefully before taking over a personal lines one. A broker whose strategy is to grow in the mid-market by high quality service doesn't want a broker specialising in small business
  • Age of customers – should the principal be exiting because of age, his clients may be in a similar position. The book could quickly disappear as these leave their businesses as well.

    A lot of work needs to be done before acquisition day. A template needs to be put into place, new deals negotiated and the financials measured regularly.

    Sometimes brokers only buy the customers of a business and not the business itself. This presents problems under the Data Protection Act and there may be a residual liability to employees under TUPE.

    Unless it is a small additional business, it is likely that an acquisition will affect companies' organic growth plans in the following 12 months. This needs to be recognised in any planning process.

    A successful broker needs to make sure that his book of business is profitable for underwriters. A poor block of business may affect brokers' reputations and will certainly hit profit share arrangements.

    Finance needs to be put into place to make the acquisition and this can be obtained from banks, insurers or third parties. Each has their own merit, the broker does need to understand the impact on this finance on the business.

    Pre- and post-acquisitions need to be drawn up, together with cashflow forecasts and the effect on the balance sheet measured. A full integration plan with regular monitoring helps to ensure the identified benefits are realised.

    It is important to keep all stakeholders informed. The most important of these are staff, who will feel threatened by any acquisition. Other stakeholders will include banks, major insurer partners and important customers.

    Mergers
    Don't merge. Buying is fun but merging is hell (so speaks an ex-CU man). The consolidation of brokers is the biggest single market issue over the next few years. To some, it means a guaranteed and successful future in business, to others a secure and happy retirement and to a few a lot of heartache and worries. Buying and selling is a big decision for everyone and careful planning is vital if it is to be a success for all parties.
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  • Tony Cornell is an independent consultant and can be contacted at tony.cornell@ talk21.com