Cash rich consolidators are playing for high stakes, but insurers could spoil the party. Michael Faulkner explains why.
The broker landscape is changing. The sector is consolidating at a previously unheard of pace as buyers, awash with cash, pick off their smaller cousins. A new breed of super consolidator is emerging. With Towergate as the archetype, the likes of Venture Preference, Jelf Group and Giles Insurance Brokers are racing ahead of their competitors, carving up the regional broker market between them. Well-financed, these super regional brokers have a seemingly insatiable appetite for deal making, and are calling the tune in the regional market.
But the inexorable rise of these consolidating big beasts poses something of a quandary for their insurer partners. While they provide handsome volumes of business, it comes at the cost of high commissions. And insurers, with their eyes firmly on their expenses, are increasingly feeling the pinch from this.
Recent weeks have seen private equity cash pour into brokers’ coffers, helping to fuel the buying spree.
In March, Giles Insurance Brokers raised £500m for acquisition funds through the sale of a majority stake to private equity firm Charterhouse. Earlier in the year, private equity giant 3i took a minority share in Jelf Group, giving the broker access to hundreds of millions of pounds to top up its war chest. Meanwhile, Oval is believed to be in the process of refinancing, and AXA-owned Venture Preference has the deep pockets of its parent to support future acquisitions.
Now the super-consolidators are poised to race ahead of the competition in terms of size and consequently power as their acquisition drives continue.
But as the clear blue water between the likes of Giles, Jelf and Oval and the rest of the regional brokers grows, what challenges do the consolidators themselves face?
At a basic level the consolidators’ financial model is as simple as it is compelling. It is predicated on using scale to leverage greater commissions and other forms of remuneration from insurers. The consolidator acquires a broker and makes money from the uplift in commissions it is able to achieve. And with plenty of money available, the consolidators can continue buying and enjoying the benefits.
“It is a very attractive financial proposition,” says Ian Clark, insurance partner at Deloitte. He says that the consolidators’ model is changing with the development of managing general agent (MGA) businesses and broker networks. Giles already has an underwriting business, Ink; while Jelf and Venture Preference have network propositions.
Clark also says that the coming years will see the consolidators begin to buy each other. “I expect to see two go in the next two years. The question is which will be the winners,” he says.
Chris Giles has been quite vocal in suggesting a merger of Giles Insurance with Jelf or Oval in order to take on AXA’s Venture Preference and the mighty Towergate – a suggestion which Oval and Jelf dismissed immediately.
Over the coming months there is likely to be some fighting between the consolidators over acquisitions. John Kitson, Norwich Union (NU) sales and marketing director notes: “All the consolidators have a shopping list and some crossover.”
Kitson also suggests that uber-consolidator Towergate, which is considerably larger than its rivals, will be keeping a close watch on the following pack. “Towergate will look to grow faster as the outsiders come up,” he says.
Despite abandoning its refinancing owing to hostile market conditions, Towergate claims to have well over £100m available for acquisitions.
One of the challenges for the consolidators is growing their businesses without relying on acquisitions.
Kitson says: “The consolidators should focus on getting organic growth rather than just acquisitions. They need to draw breath and maximise on what they’ve got. Organic growth is hard.”
He picks out Jelf as being capable of achieving good organic growth.
Venture Preference is pausing to assess its run of acquisitions and begin integrating them. Newly-crowned chief executive Stuart Reid is currently visiting Venture Preference’s acquired businesses and has the significant challenge of bringing them together.
Bruce Carnegie-Brown, managing partner of 3i’s quoted private equity business, says Jelf’s ability to grow organically was one of the reasons the company was an attractive investment. He agrees that the consolidators cannot rely on just getting extra commissions. “They need to cross-sell [products]. The question is: how smart can they be at this? There are challenges in doing this, but there are real opportunities,” says Carnegie-Brown.
Both Oval and Jelf offer services beyond just general insurance, such as financial services.
Carnegie-Brown also says that the consolidators have clear opportunities to become more efficient and cut costs.
The growing strength of the consolidators is also a challenge for insurers. “It is not something they are comfortable with,” says Deloitte’s Clark. The bargaining power and growing size of the consolidators is seeing insurers paying out more in commissions overall, which in a soft market poses a challenge for them.
Clark says insurers are increasingly looking to support smaller brokers using soft loans and other investment mechanisms, such as minority stakes. By providing support to smaller brokers it might discourage some from selling.
Kitson is quite open about NU’s interest in smaller brokers. “We like smaller brokers more than we ever have done,” he says.
Last year, NU launched its Club 110 for brokers placing between £800,000 and £5m in annual premiums with the company. Benefits include exclusive access to a wide range of services such as new schemes, an extranet offering marketing and HR, and compliance advice.
Kitson says the relentless rise in brokers’ commissions must end. “Consolidators’ commission increases have got to stop. We have gone up a gear in respect of [assessing the profitability of] commissions and profit shares. It has to add up.”
NU is not the only insurer that has publicly questioned the high level of broker commissions. Former AXA insurance chief executive Peter Hubbard has described commission levels as being unsustainable. Recent reports have suggested that AXA is already taking steps to review broker remuneration.
Clark says: “Commission arrangements won’t change. The question for consolidators is getting volume through their current arrangements. The market will harden and profitability will improve. Insurers will be looking for brokers that can deliver profitability and volume.”
Another challenge for the consolidators is how their models will withstand the credit crisis that is dogging the UK. With credit conditions tightening across the economy and finance becoming more expensive, the consolidators will be facing pressure on two fronts – borrowing costs and commissions.
On one side they could see their borrowing costs rise, while on the other they could find it harder to achieve the commissions on which their acquisition models rely.
With tougher times ahead for the super-consolidators, achieving organic growth and cost efficiencies is likely to be vital.
The consolidators in brief
The giant of the consolidators, Towergate put its refinancing plans on hold
owing to tough financial market conditions.
Giles Insurance Brokers
The broker has ambitious plans to grow to 1bn pounds GWP in size after raising 500m pounds from the sale of a stake to private equity firm Charterhouse.
Jelf, which recently sold a minority stake to private equity giant 3i, is highly rated by insurers for its ability to achieve organic growth.
The Yorkshire broker is quietly pursuing its acquisition strategy, but has yet to refinance. It says it is considering its requirements for next years acquisitions.
New chief executive Stuart Reid has the tough job of integrating VPs string of acquired businesses; its buying spree has slowed while this happens.