Will the credit crunch effect hit brokers?

If you believe what you read, the credit crunch is king, and everyone is subject to him.

While banks haemorrhage profits and tighten up their lending facilities, and the latest estimates suggest that the subprime crisis could lead to up to $6bn in D&O related claims, it seems almost impossible to overstate the impact that recent global financial events could have on the insurance sector.

Indeed, it is all too tempting to see a natural carryover from one domain to the other.

The question that has yet to be answered is to what extent the effects of the credit crunch will trickle down into the broker market.

Despite reports suggesting that the perceived economic downturn could result in widespread redundancies in the broker community, the consensus – at least at this point – seems to be “not much”.

Insurance is famous for bucking trends in the other financial markets. By its very nature, when the rest are down, insurance is generally up.

But insurance and its protagonists are increasingly diverse. One group in particular is being frequently cited as potential victims of the credit squeeze. The consolidators.

And with ever increasing levels of borrowings it is easy to see why.

A senior source explains: “The long term business models for the consolidators have been constructed on a high leverage basis, which will have been hit by the twin blows of a credit squeeze and the recent capital gains changes, which will have raised the expected cost of capital.”

However, though banks and private equity houses have reportedly retrenched somewhat from their positions as financiers, it does not appear to have had an adverse effect, as yet, on consolidators.

Two of the largest, Towergate and Oval, have emphatically bucked the trend.

Towergate secured a cool quarter of a billion from principal backer HBOS to fund its acquisition of Open International in September, while Oval, having already increased its loan from Barclays and Lloyds by almost a third to £70m, has said it would be borrowing a further £50m to bankroll further acquisitions next year.

More curious is the case of Gresham-backed Giles. Recently, it fell short of £100m war chest target – by £50m in fact – in part because it was reluctant to grant Gresham a larger equity stake in the business (it currently owns 41% of Giles’ shares). Sources meanwhile have said that the credit crunch was a contributing factor.

But even if the banks are less willing to part with their cash, insurers are showing no short of interest of investing in brokers. Allianz’s 10% stake in Oval is being used to fund acquisitions, while Norwich Union plans to invest hundreds of millions of pounds in smaller brokers.

Though it seems clear that this is largely a defensive response to the consolidators, there could be a credit crunch implication, too.

Indeed, the question of broker solvency has been raised by senior industry figures, with a chief executive at a major insurer revealing it is carrying out heightened credit check on its broker partners.

Yet the majority of commentators point out that the way that brokers conduct their business makes them less vulnerable to peaks and troughs in the global economy.

After all, it seems that any broker with cashflow problems can simply look to sell and receive a good price – and quickly too. Other sources suggest that banks will not generally lend to brokers who are not acquiring in any case, because there are few assets to lend against.

Damian Keeling, managing director at Kendall-based Peart insurance brokers puts it simply: “Why would any credit squeeze affect your average broker, who probably is not highly borrowed in any case?”

Presumably, that’s where Norwich Union comes in. But is its timing significant?

Whatever the case may be, there can be no doubt that the credit crunch will continue to stoke fears among insurers, consolidators and smaller brokers alike.

In the meantime, as Keeling concludes, there are much more pressing financial matters. He says: “The time to worry about broker solvency – excluding consolidators – would be if general broker profitability were very low.

"This is not, and has not been the case, for some time.”