The emergence of large national and regional firms and the creation of networks of brokers as industry kings are transforming the nation’s wholesale insurance marketplace but experts maintain that independent privately-held firms will still remain the backbone of the excess and surplus wholesaler segment.
According to Dick Bouhan, who heads the National Association of Professional Surplus Lines Offices, there have been a number of large national and regional wholesalers created, some through organic expansion but a lot through mergers and acquisitions.
From his vantage point, NAPSLO suddenly has “a member that pays $770 in dues, and now we have a branch office that pays $250 in dues.”
Still, overall, NAPSLO membership has remained stable over the 10 years that this has been going on because there have been some new entries into the marketplace, especially with the building of networks of national and regional firms, “which is a new phenomenon.”
“What’s happening is the wholesale business is becoming much more complex,” he said. “It’s a reflection of the way this business is becoming larger, more complex and more national. Like any industry we are starting to mature. And as the industry matures, many of its operators become national.”
On the question of continued independence, Bouhan said, “I would say of our 400-plus wholesaler members certainly 200-250 are independent. We still have a lot of independent operators. That’s still a backbone of the business.”
Bernie Heinze, executive director of the American Association of Managing General Agents, noted that there has been a merger trend of larger entities looking for established and profitable distribution networks and sources of business for the past two and a half years as the insurance market made its correction through the hardening cycle.
The industry, he said, has now reached a more stable environment and “we see interest in mergers and acquisitions continuing, and the service offerings, capabilities and sources of surplus being more expansive than they may have been in the past.”
Heinze said there has been an appreciation as the market matured among prospective acquirers of the benefits of the E&S industry and the role that boutique managing general agents play within it.
“As that information continues to develop, and they look for ways to expand their service offerings in an innovative fashion, that is what is driving the business,” Heinze said.
While many remain independent operators, those who decide to sell to national chains find themselves immersed in a different world with less control, Bouhan noted. “If you’ve run your own operation for any number of years, you’ve been your own boss and now you’re part of a national organization. It’s a whole different lifestyle and that’s something that entrepreneurs, which many of these people are, have to consider.”
There are always some M&A transactions driven by sellers who are getting along in years and figure now is a good time to cash in. But certain emerging issues are also beginning to affect merger and acquisition activity, most notably the so-called Spitzer effect and the falling of rates in the marketplace.
“We’re seeing an uptrend in the amount of activity right now due to the instability of the marketplace, what’s going on with Spitzer, softening rates, and people’s uncertainty about the future due to lack of perpetuation,” said Paul Vredenburg, an M&A insurance specialist for MarshBerry.
A lot of these agencies haven’t put themselves in a position to perpetuate internally and there are some motivated buyers in the marketplace. “The larger brokers are very active in looking at sources of revenue and the banks are continually looking at opportunities as well,” Vredenburg said.
“Our numbers show the brokers acquired more in 2004 than they did in 2003 and we see that trend continuing as far as the public brokers are concerned. The banks are actually down in the number of acquisitions they’ve done. Overall, it’s probably equivalent, if not a slight increase, in acquisition activity, mainly attributable to the brokers.”
MarshBerry did 154 insurance M&A deals between 1999 and 2004, 23 in 2004 alone. The firm reports that total acquisitions in this segment numbered 573 (44 percent of the total) among public and private brokers, 411 (31 percent) among the banks and thrifts, 229 (18 percent) among insurance companies, and 95 (7 percent) in the “other” category.
Vredenburg sees that trend continuing due to the soft market. “E&S brokers definitely have a concern about their ability to continue to grow due to the rate environment,” he said. “Obviously, the carriers’ appetites are changing–in terms of risk structure, underwriter criteria, and coming out of the E&S marketplace and going back into standard markets. They see themselves bogged down with a lot more submissions because people shop more in a soft environment and there’s the possibility the business could be moved out of the E&S marketplace. Brokers have looked to alternatives to try to mitigate some of their risk.”
Steve Wevodau, CEO of WFG Capital Advisors of Harrisburg, Penn., sees the Spitzer investigations having some effect on activity, even though overall the number of transactions may not jump dramatically. “There’s the same level of activity as the industry has seen during the past year or two as far as consolidation goes. The Eliot Spitzer investigation threw the industry a curve ball. The biggest issue is when you look at the largest players in the industry. Many of them had captive outlets for many of their E&S lines. Each of them had outlets and facilities that were in some instances within arm’s length. And there was somewhat of a shadow cast, in my opinion.”
There may have been, in many of those instances, “channeling of business and double dipping,” Wevodau said.
“When you step back and look at the major retail players in the insurance business, and what they did with their outlets, there was some level of hidden concern as to where the Spitzer investigation would wind up,” he said. “Fortunately for everyone it has been confined to criminal activity–tying and some of the other matters that have percolated to the surface. Some months ago, there was widespread speculation over how this was going to affect the overall market, particularly from a compensation standpoint.”
Wevodau said there’s been a recent lull. Will the Spitzer probe bring a “revolutionary change” in the industry’s compensation structure and in its distribution channels?
“I don’t think so,” he said. “What it did, especially during the fourth quarter of 2004, is it forced a lot of industry professionals to step back and ask, ‘where are we heading?’ We’re in a much better place than we were 120 days ago. It seems like the dust has settled somewhat.”
The activity in mergers and acquisitions in terms of who is buying is in flux, Wevodau said. “It’s shifting away from the banks and financial institutions. Two years or so ago a lot of the regional and national banks were looking to supplement their services by acquiring platforms and expanding their distribution systems overall in pursuing the theory of the cross sale and the synergy related to the cross sell.
“What we’ve seen lately is the emergence of the larger first and second-tier publicly-traded broker firms, the traditional firms. The emergence as well of private equity groups, whether they’re going vertical on their own and building insurance distribution platforms, or whether they’re getting behind large privately-held players as their initial platform to spearhead with their money on the backside and go out to insurance distribution systems.”
Wevodau sees the banks retrenching. “I attribute that to their conservatism,” he said. “With product rate stabilization and softening in some lines, banks are taking the opportunity to sit back and retrench. Maybe 18 months from now, if there’s some correction in the cycle or some firming in certain segments, some of them will get back into it.”
When activity is looked at on a national basis, the brokers and the private equity firms “are the ones that are charging pretty hard,” according to the WFG Capital executive, who adds that publicly-held firms are the ones that are really feeling the ills of no organizational growth due to the softening market conditions. “They’re stuck between that Spitzer situation and shareholder demand, so they’re the ones who are going to be more acquisitive,” he said.
Market conditions right now are working heavily against privately-held firms that don’t have the capitalization to wait out market cycles. “I think that’s what’s prompting a number of them to look at acquisition as an opportunity.”
Heading into 2005, Wevodau expects that the overall announced transactions among publicly-held firms will increase over 2004, which was higher than 2003. But even if the pace accelerates, Wevodau agrees with NAPSLO’s Bouhan that independent firms will still outnumber the publicly-held. “Rumors of the demise and continued viability of privately-held firms have been greatly exaggerated,” Wevodau said.
Slow organic growth
Steve DeCarlo, president and CEO of American Wholesale Insurance Group of Charlotte, N.C., echoes much of Wevodau’s analysis. “There’s a lot of activity still from the retailers, but it’s slowed down from the banks’ perspective,” he said. “The banks are still active, but the smaller retailers (that’s a relative term) the non-Marshes, non-Aons–the Brown & Browns, the HRHs, the Gallaghers are still out acquiring wholesale brokers and managing general agents.”
He said “there is a lot of activity” in that organic growth has slowed down as the market changes. “People look for growth opportunities through mergers and acquisitions.”
In addition to the slow organic growth, DeCarlo thinks the Spitzer effect will be felt. “I think transparency is causing people to look at a lot of different issues when it comes to wholesalers and MGAs.”
DeCarlo thinks regulations requiring disclosure of all fees and commissions for all affiliates would have ramifications for the E&S side of the industry. “I think they will be relatively cautious right now,” he said. “If you’re a mega-retailer and own wholesalers that ‘and affiliates’ clause may be problematic.”
As for DeCarlo, his firm’s motto is Independence Matters. “We want to be able to say to our retail clients that we’re here to service you as an independent organization, not supported by another retail broker,” he said. Firms have to be careful, he added, when they create distribution channels or multi-distribution channels and they own the retailer, the wholesaler, the reinsurance intermediary, the Lloyd’s broker, and the insurance company. “There’s got to be some transparency around all those fees and commissions being earned.”
Joel Cavaness, president of Risk Placement Services of Itasca, Ill., agrees that the merger and acquisitions arena is still pretty active in the wholesale segment. “We’re looking at as many as we have in the past three or four years,” he said. Cavaness foresees “no big change in what’s going on out there.”
Going forward, AAMGA’s Heinze says, companies will continue to look for specialization, not only in the insurance field, but also in other aspects of the current corporate culture. “There appear to be continued new opportunities where companies look to outsource various specialties or qualifications that they may not have in house to those that have established a reputation for creating a positive return on investment in various select areas,” Heinze said.
“It is a market that is still in a dynamic flux and will continue to be so for quite some time as customers, whether they are policyholders or retailers, continue to look for the best possible insurance products at the best possible competitive price,” the AAMGA leader maintains.
“Remember,” Heinze added. “This is still a relationship business. We’re binding business at the click of a mouse of millions of dollars at a time. Submissions are being transported over the ocean to London companies or to the Bermuda insurance captives, but it’s still a business built upon relationships. And the principals’ desire in terms of longevity and what they want to do with their business will decide whether they seek business partnerships or perhaps to acquire.”