Insurance M&A:  The Pressure Is On

FactSet FlashWire Weekly
March 28, 2005

The insurance industry will see continued consolidation in 2005 despite downward price pressure and the slowing of acquisitions by banks, predicted top officials at WFG Capital Advisors in a March 22 webcast to insurance agents.

During the presentation, “Perpetuation & Succession - An Insurance Mergers & Acquisitions Summit,” WFG founder and President Robert J Lieblein and Managing Principal Steven S Wevodau outlined trends driving what they characterized as record M&A activity in 2004 and highlighted factors they expect to affect the market in 2005.

Moderator Bruce Hillman of event sponsor National Underwriter Co said there were 224 agency transactions in 2004, valued collectively at “hundreds of millions of dollars.”

“This is a major topic of discussion in the industry, and it’s important to understand the ’04 dynamics since they will drive the ’05 trends,” he said.

The consolidation is part of a long and dramatic process whereby the approximately 50,000 insurance agencies of five or ten years ago have dwindled to 30,000 today and are expected to continue consolidating to a level of 10,000 to 15,000 over the next decade, Wevodau said. WFG Capital Advisors expects the current consolidation surge to begin slowing in 12 to 36 months.

Among the pressures affecting revenues of the leading insurance brokers are a downward trend in rate renewal increases -- forcing agencies to work harder just to maintain current revenue levels – and a regulatory environment in which state attorneys general, particularly Eliot Spitzer of New York, have questioned commission structures, including contingent commissions paid to insurance brokers, Lieblein and Wevodau said during the presentation.

The flat prices impede organic growth, forcing companies to look at M&A as an alternative way to fuel growth, while the regulatory questions raise concerns that the revenues from contingent commissions may dwindle or disappear, Wevodau said. Both factors have the potential to squeeze profit margins.

“Our firm belief is that for the next 12 to 24 months we’ll continue to see rate stabilization - potentially reduction - which we believe will continue to exacerbate the results, particularly among the leading brokerage segment,” Lieblein said. He expressed less confidence in the outcome of the contingent commission question, noting that predictions ranged from a full return to fixed commissions to less drastic reform of the commission system.

Other key issues in insurance industry consolidation, Wevodau said, are “acquisition of the acquirer;” new entrants into the market, such as niche markets and private equity groups; and a shift in product focus toward employee benefits and long-term care.

In a breakdown of 2004’s insurance transactions by specialty, the presenters found that 39% of targets were full-service agencies, 29% were commercial property & casualty operations, and 15% were for employee benefits and consulting. However, they noted that employee benefits and consulting accounted for 33 transactions in 2004, up from 26 in 2003.

“We clearly expect in 2005 and going forward that employee benefit firms may not have the largest number of transactions, but in terms of increasing from a baseline, will definitely be jumping up considerably,” Lieblein said.

Insurance brokers continue to be the most prolific acquirers of insurance agencies, according to WFG’s data, which ranked Brown & Brown Inc, with 22 transactions; Arthur J Gallagher & Co, with 17; and The First American Corp, with 11, as the top acquirers in 2004.

For the first time in years, however, banks have had fewer insurance agency acquisitions in 2004 than private insurance company buyers, though there is still considerable overlap between the top 40 banks and top 100 insurance brokers, and banks continue to be a significant player in insurance M&A.  

The presenters said prices declined in the second half of 2004 and into 2005, despite a perception within the industry that sales are bringing very high multiples. “When we speak with many people in the industry, people are beginning to think that multiples should be 8 times or 7 ½ times, and that’s just not the case. It has to be a very unique situation – right buyer, right seller at the right time – to be able to drive values such as those,” Lieblein said, noting that bank buyers in particular tend to be the subject of unrealistic expectations. “I think there’s a great misnomer that if a bank is buying an insurance agency, they’re going to pay a higher price than a public broker. That is not true, particularly if that bank has already acquired a foundation agency and they’re doing a second-tier acquisition.”

About 45% of 2004 transactions had multiples between 6x and 7x, while most private transactions have multiples of 5x to 6x, according to WFG calculations, which were based in part on Mergerstat data.

In addition to lower multiples, a breakdown in pricing elements points to an increase in the percentage of a sale price that is at risk, to an average of 30% in 2004 from 25% in 2003.

Despite WFG’s sobering statistics, however, insurance professionals who tuned in to the webcast expressed optimism about the future of their own businesses in an interactive poll, with 59.3% of participants indicating they expect a slight increase in agency profits, and close to 70% saying they expect to acquire another agency in the next three years.