Private equity market bullish on E&S brokers

By mid-November more than $500 billion in private equity transactions had occurred in 2006, $100 billion in Oct. 2006 alone, according to Andrew Rosen, a partner with private equity firm HM Capital Partners. Dallas-based HM Capital has a controlling interest in national wholesale insurance broker Swett & Crawford.

Historically, the insurance sector has not been high on the list of preferred investments for private equity markets. But since 2001, interest in insurance and reinsurance has been rising, not only with private equity firms, but also with other forms of alternative capital investments. The terrorist events of 2001, followed by New York Attorney General Eliot Spitzer’s investigations into the insurance industry, and the hurricanes of 2004 and 2005 created investment opportunities, said Rosen, a speaker at the Texas Surplus Lines Association 2006 annual meeting.

“Private equity falls into an investment class that is considered alternative assets,” Rosen said. “Within that class, private equity, at least the way we look at it, is considered controlled investing in established businesses with the use of leverage — leverage meaning debt.” Other forms of alternative investments include venture capital and hedge funds.

Rosen explained that the private equity industry has seen “tremendous growth” and matured in the past 20-plus years. After a “Wild West” ride in the 1980s, investors figured out that to use the capital wisely, they needed to be more than just financial investors.

“A lot of firms, if they survived the early ’90s period came out very strong. You started seeing a rise in the number of firms but also in the size of firms,” Rosen said. Now we have individual firms managing $15 [billion], $20 billion worth of private equity capital.”

The equity market today is at an all-time high in terms of “deal-flow” and equity capital raised. “It’s not only a few firms that have a lot of capital, there are over 100 firms that control more than $100 billion in capital,” Rosen said.

A lack of interest

There are a few reasons for the historical lack of interest in the insurance sector, he said. A highly regulated industry and trying to create change in a regulated environment can be very difficult. In addition, underwriting firms are difficult to evaluate; without knowing what the long tail costs are going to be, it’s a challenge to determine profitability. Different accounting standards and complex reserving requirements add to the confusion, and it can be a difficult business to leverage, he said.

However, there is a lot of interest, particularly in the excess and surplus insurance market, where there has been a much growth. Events of the past five to six years have generated a need for capital. “Somebody needs to fill that void,” Rosen said.

E&S is growing, he noted, and “when you see fundamentals that are positive over a growing market, that will be interesting to private equity investors.”

HM Capital, he said, has “shied away from the risk side of the business.” He said the firm likes the wholesale brokerage business because in addition to tremendous growth, the market has good fundamentals. “Overall we’re very bullish about this industry because of the role that it fills. The expertise, placing risks that are generally not suitable for the standard markets … long term growth in this business is positive. And we like the fact that it is not as cyclical. We all recognize that this is a cyclical business, the private equity business is a cyclical business, but we like the fact that it’s not as cyclical [as] the risk bearing businesses.”

Wholesale brokers, he said, have the expertise and access to markets that their retail clients need, therefore they have business value. “This is not a capital intensive business,” Rosen said. “So when you think about private equity and the fact that we do use leverage, high cash flow is important to us … high cash flow, low capital requiring businesses is a huge positive.”

Rosen said with increased specialization in the insurance industry, the knowledge and relationships wholesalers have is valuable to retailers. “We’re seeing more and more specialization by carriers and it makes it even more and more difficult for retailers to figure out how to place business. It makes the role of the wholesale broker extremely important,” he said.

“For private equity, if there’s any way that we can play the role of consolidator, that’s of tremendous value,” he added. “This industry is still relatively fragmented — the top 10 wholesale brokers still represent only about one-third of the premiums … there are just a lot of firms out in this marketplace.” Rosen predicted there will be increasing consolidation over time on the retail and wholesale front.

Buying Swett & Crawford

Rosen said HM Capital spent several years investigating opportunities in the E&S sector before it acquired Swett and Crawford from Aon. “We didn’t originally think there was anything for us in the wholesale sector. We didn’t see anything of that size, of that scale. … All of that changed because of Mr. Spitzer.” Spitzer’s investigations led big carriers, including Aon, to choose “to divest their wholesale operations, so all of the sudden you had sizeable wholesale businesses for sale,” he said.

HM Capital, he said, views the Swett relationship as a partnership. Swett is a stand alone business in which more than 20 percent of the company is owned by employees, and there are more than 160 employee shareholders. One of the first things the company did was reorganize the management structure and focus on how the company interacts with its retail partners and its carriers.

We “created practice groups and practice group leaders,” Rosen said, “so that when we actually go and address the market, or the markets need to find a way to address us, it’s very easy. … We don’t want to bring the resources of an office to solve a client’s problem we want to bring the entire resources of Swett, to have all of our offices interact together through these practice group leaders.”

Topics Agencies Excess Surplus Market