Mergers and Acquisitions play an important role in how the country’s insurance industry functions. As well as helping organizations pursue their strategic aims, M&A enables ambitious firms to increase efficiency, enter new markets and push up profits.
Last year set a new record for M&A activity in the insurance industry. Much of the activity came under the cross-border umbrella and was driven by the need for insurers to improve operational efficiencies, enhance service capabilities and adhere to changes in regulation, including the DOL and CFPB rules on retirement asset management, inversion regulations and capital requirements.
The increased activity also has been linked to widespread economic factors, including competitive pricing, low interest rates, new technology and fresh entrants into the space. And the growth in activity has not slowed down in 2016.
“The volume as it relates to total number of deals this year should be in a similar range to 2015,” says Phil Trem, senior vice president at MarshBerry. “We are not quite on pace for where we were last year, when there were 456 announced transactions in the US. We are trending to a point where we think it’ll be between 425 and 450 this year.”
A perfect match
The attraction of private equity to the industry has been a key driver in M&A activity. As a result, demand has increased, and valuations have been raised – it is, without doubt, a seller’s market.
“Private equity likes the fact that insurance is highly fragmented, has a recurring revenue model, and that the model continues to provide strong returns over a three- to seven-year period,” Trem says. “In a low-interest-rate environment, where leverage is easy to find, interest continues to rise. As the world looks to find return on capital, the insurance distribution space Source: SNL Financial seems to be a safe play.”
Trem is quick to point out that ‘safe’ is, of course, a relative term, but when the average agency has 90% of its revenue return every year on a renewal basis, and those that cannot grow organically typically acquire their way to growth, it’s easy to see why this is an attractive market for private equity to deploy capital.
“This is not fad,” Trem says. “Private equity has found a real liking for the space, and we think they will be a long-stay part of the industry for years and years to come.” For a mid-sized broker, the current M&A climate does present some interesting and important opportunities. Most people within the industry recognize that growth is essential – if you’re staying flat, you’re shrinking relative to your competition. Even if your competition is not growing organically, they are acquiring to grow.
“You have to grow to remain competitive and relevant to your carrier partners,” Trem says. “You also need the money to reinvest in the next generation of your organization and for technology. Growth is absolutely essential, however that comes – whether it’s organic or through acquisitions.”
Mid-sized brokers need to be aware of two important considerations in the current landscape. First, if your competitors sell to a national broker, they’re still going to operate in the same space and location, but with significantly more resources. “Brokers need to figure out how to grow and reinvest to stave off the competition when they join up with a new partner,” Trem says.
Some mid-size brokers have an opportunity to make acquisitions themselves. In those cases, the priority should be trying to figure out how to assess new opportunities presented by firms that don’t want to sell to typical brokers.
“Acquiring isn’t as easy as it looks,” Trem says. “Firms need to be careful not to make the wrong investment just because it’s an easy one. Mid-sized brokers need to be careful to find a safe balance.
Take advantage of the market when it’s available or when opportunities arise, but focus on how to grow internally. That should be a primary focus for those firms.”
For Arthur J. Gallagher & Co., making acquisitions is a key component of its growth strategy. The company completed 60 acquisitions in 2012 and again in 2014, 31 in 2013 and 44 in 2015. Traditionally, these have been smaller acquisitions, typically in the range of $1 million to $15 million in annual revenues, but over the last five years, the firm has also completed some much more significant acquisitions – particularly internationally in the UK, Australia, Canada and New Zealand.
“We’re always on the lookout for new opportunities – I’m a full-time M&A sourcer, and we’re going to add people in this role in six regions throughout the US,” explains Bill Bohstedt, corporate VP of mergers and acquisitions at Arthur J. Gallagher & Co. “Those people will be responsible for researching and contacting independent insurance agencies and trying to get into a dialogue about possibly joining us and selling their company. We also ask our local management in branch offices across the country to constantly look to develop relationships with firms that would be good acquisition options for us. We’re all tasked with looking for good potential merger partners.”
When identifying potential acquisition opportunities, Bohstedt considers a few important factors. The first is culture: He aims to find firms with a good reputation and clients, and a business and sales culture that aligns with Gallagher’s.
“We also try to find firms that are very good at what they do in the various business niches in which we operate, like construction, public entity, healthcare, real estate, etc.,” Bohstedt says. “I do a lot of data and internet searches and then contact the owner of the agency to arrange a meeting.”
The increasing numbers of new entrants appearing in the insurance M&A space has provided more competition for experienced players like Gallagher. The firm is often forced to compete for a particular acquisition – and, predictably, that drives up the price. Bohstedt, though, is philosophical about the new players in the space.
“We continue to look for the firms that are attracted to the resources that we can bring to the table,” he says. “If the firm is looking for the things that are in our fabric, then they will fit with us, and we’ll go hard to get them to join us. If they just want to get a high price, or if they don’t want to change anything, they are probably better going to a private equity rollup.”
Although competition may be rife, there are more than 20,000 insurance agencies in the US, so it makes sense to work patiently and sensibly to find the right fit.
“It can be a little harder to continue to find those opportunities right now, so we have to work a little harder,” Bohstedt says. “We’re bolstering our M&A resources to try to get in front of more people.”