Despite Woes, Big Insurance Brokers Still Make the Grade, Says Fitch

By | January 16, 2008

Taken as a group, the nation’s largest public insurance brokers did better in 2007 than 2006, although the continuing soft market will make it harder for them to improve a lot on the 2007 performance in 2008, according to ratings analysts at Fitch.

Fitch rates the outlook of the insurance broker industry for 2007-2008 as stable.

“While industry profitability and operating margins will not return to levels reported in the early 2000s, broker operating performance in 2007 will be modestly better than 2006, largely due to the larger brokers adapting to the elimination of contingent commissions,” said James B. Auden, head of the property/casualty sector for Fitch.

Leaner and more transparent as a result of their expense cuts and restructurings following the erosion of contingent commission income, these brokers are “better equipped to deal with the challenges of deteriorating insurance market conditions and intense competition,” he said.

The largest brokers forfeited considerable income from contingent commissions beginning in 2004 when the New York attorney general began attacking them.

In terms of reported revenue growth for year-to-date 2007, Fitch reported the average growth of the top six brokers to be 13 percent, with Marsh & McLennan (MMC) at 3 percent, Aon and Willis both at 7 percent. Both Willis and Aon have done better (4 percent) in organic growth than Marsh, with 0 percent.

For the first nine months of 2007, the top six publicly traded brokers reported consolidated operating income up by an average of 14 percent, according to Fitch. All, except MMC, have reported improvement in 2007.

Average pretax operating margins for the insurance brokerage business through Sept. 30, 2007, were 21 percent, which is roughly equivalent to the year-ago period. For Marsh this average is 11 percent; for Aon, 17 percent and for Willis, 24 percent.

2008 outlook
For 2008, Auden said Fitch expects overall industry profitability for these brokers “to be flat to modestly improved.”

He said “the accelerating pace of insurance rate decreases will challenge brokers to grow organically, and make it difficult for brokers to improve margins, especially since several of the larger brokers have already gone through several rounds of expense reductions over the past several years.”

Despite the challenges they have faced and will face, overall the larger brokers “continue to possess qualities that are consistent with investment-grade ratings,” according Auden.

For its overall stability and outlook ratings, Fitch reviewed the 10 largest insurance brokers as ranked by 2006 brokerage revenues: Marsh & McLennan ($10.5 billion); Aon ($6.7 billion); Willis Group Holdings ($2.3 billion); Arthur J. Gallagher ($1.4 billion); Wells Fargo ($1.0 billion); Brown & Brown ($900 million); Jardine Lloyd Thompson ($800 million); BB&T Insurance Services ($800 million); Hilb Rogal & Hobbs ($700 million) and Lockton Companies ($700 million).

Fitch estimates that, based on 2006 revenues, the top five global brokers control about 70 percent to 75 percent of the overall insurance brokerage market and that the top 10 have about 86 percent market share. Marsh leads with 35 percent of the total market, followed by Aon with 22 percent and Willis with 8 percent.

Top three
The top three — MMC, Aon and Willis — each received solid debt ratings along with stable outlook ratings from Fitch. Fitch’s senior debt and outlook ratings for the biggest three brokers are: Aon- BBB+ and Stable ; MMC- BBB and Stable; and Willis- BBB and Stable.

But there are different stories behind the ratings.

Of the three, Aon is rated the highest, reflecting Fitch’s view of the company’s “progress in developing a new business model that is less reliant on contingent commission income,” said Gretchen K. Roetzer, Fitch’s analyst for Aon.

“Aon continues to demonstrate its ability to retain clients and grow new business while improving profitability,” she said.

Gregory W. Dickerson focused on Willis and MMC in his report.

In the case of Willis, Fitch is impressed with “the company’s superior operating performance, excellent operating margins relative to peers, strong cash flow, established market position, and management experience,” Dickerson said.

“Fitch believes that Willis’ insurance brokerage operations have outperformed those of its closest competitors for several years and that it will continue to do so in the near term,” he said.

The positives at Willis are somewhat offset by concerns related to debts of $600 million in March and then another $1 billion in November, much of which was used to repurchase common shares. “As a result, Fitch believes that Willis’ key credit fundamentals will continue to worsen in the near to medium term,” said Dickerson, although he added that this should not be a problem as long as the company continues to demonstrate an operating performance similar to current levels.

MMC’s rating of stable — a rating Fitch raised from negative in June — is less certain than the others due to “continuing instability in its insurance brokerage operations,” according to Dickerson.

Of the biggest brokers, MMC has made the least progress in overcoming the loss of contingent commission income and franchise value that followed the 2004 investigations by the New York attorney general, Dickerson said. He said Fitch remains concerned that MMC’s insurance segment performance “continues to lag that of its closest peers.”

MMC posted a 40 percent drop in profits for the third quarter and has experienced significant turnover within the ranks of senior management as a result of its disappointing performance.

Positively, Dickerson noted that MMC has roughly $2.5 billion from its sale of Putnam Investments it can use to pay down debt, “thereby maintaining current financial leverage and interest coverage ratios near current levels, which are sufficient to support MMC’s existing ratings as long as the company’s operating performance does not further deteriorate from current levels.”

In a teleconference to discuss the outlook, Dickerson also said MMC remains a “very competitive” and valuable enterprise given its strong and diversified group of businesses. Its divisions include insurance broker Marsh; reinsurance intermediary Guy Carpenter; and consultants Kroll and Mercer.

Dickerson expressed caution in response to suggestions that MMC should break up its businesses. “If they could increase profitability by spinning off, it could be a positive, but they would lose the diversity and strength they currently enjoy,” said Dickerson.

The Fitch analyst suggested that the worst could be over for MMC. “Most of the bad news has come out … but we’re watching very carefully,” he said.

The largest brokers, including Marsh, continue to explore new fees and other incremental revenue sources to compensate for the lack of contingent commissions, according to the Fitch report.

Within the universe of the largest insurance brokers, Fitch sees smaller or regional brokers, many of which still accept contingent commissions, in good shape.

“Regional brokers are doing better than the large national brokers and will continue to post higher margins,” Auden said in the teleconference.

Fitch’s report shows fourth-ranked Arthur J. Gallagher with revenue growth for the first nine months of 2007 up 10 percent compared with Brown & Brown’s 12 percent increase and Hilb Rogal & Hobbs’ 38 percent. The operating margins thus far in 2007 are 15 percent for Gallagher; 35 percent for Brown & Brown and 24 percent for Hilb Rogal Hobbs, the Fitch analysis shows.

Fitch noted that two formerly publicly traded brokers, HUB International Limited and USI Holdings Corp., were both acquired by private equity investors during 2007 and that MMC has also been widely rumored as a potential target to be taken private. Auden said Fitch will be watching to see if the remaining public brokers are tempted by private equity firms.

Source: Fitch

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