The insurance broker sub-sector in North America recorded the highest merger & acquisition (M&A) deal volume in the wider insurance industry during the first quarter (Q1) of 2019, according to PwC’s Insurance Deals Insights Q1 2019.
Based on announced deal volume, PwC reports the quarter’s five most active acquirers as: Patriot Growth Partners, Acrisure, AssuredPartners, Arthur J. Gallagher & Co. and Hub International. In a long-standing trend, these buyers are acquiring regional brokers in order to expand their market reach. PwC expects consolidation in the broker market will keep on driving M&A deal volume in coming quarters.
Three of the five most active acquirers of brokerage in Q1 of 2019 are majority-owned by private equity (PE) firms – Patriot Growth Partners, AssuredPartners and Hub International. This raises the question as to why PE is so interested in insurance brokerage and why they see brokerage as a solid investment.
“PE tends to be a short- to medium-term investor,” said John Marra, US insurance deals leader, PwC. “They could buy a brokerage for $5 million, and that purchase might represent a 5X free cashflow or EBIT (earnings before interest and taxes). They could finance 30-60% of that, then grow the business and sell it for $10 million three years down the road, at a higher multiple than they paid the previous owner of brokerage.”
PE investors typically approach the brokerage space with the idea of introducing efficiencies and rolling up different properties. They’re also looking for financial arbitrage between borrowing big financial leverage on the transaction and then getting the brokerage owner to accept less than the 8-10X multiple that the overall property would be worth, Marra explained. The owner might accept a 5X free cashflow, with the incentive that if they help grow the brokerage value from $5 million to $10 million, they can eventually walk away with more money.
“The thing that has become very attractive about the brokerage space to PE is that it’s a free cashflow business, it’s not capital intensive, and it’s must less regulated than the carrier sub-sector. They can also get quite a lot of financial leverage as the lenders are willing to finance the deals for all the same reasons,” Marra told Insurance Business. “PE will often invest in a brokerage and then they’ll find a very experienced leader to come in and help run the business. They will work with management teams to introduce new incentives and help them execute new business plans and growth strategies.
“I don’t think PE necessarily sees brokerage as a big growth engine because the insurable base in North America is not necessarily growing. It is somewhat growing with new products, but not necessarily increased premium. They’re currently playing more in the brokerage space because of the potential for arbitrage and because they can consolidate. They can pick up many different brokerages, flip them around and increase their value, and then sell them on. That’s what their strategy has been, and they’ve done very well.”