Original Article appeared in Insurance Business America Executive Insights in March 2021
The market for insurance mergers and acquisitions is hotter than ever. IBA finds out what brokers need to know to navigate it.
RESILIENT. It’s a term often used to describe the insurance distribution market, which continues to attract the hungry eyes of the investment community. Despite the COVID-19 pandemic and its socioeconomic challenges, the insurance distribution sector has remained resilient. As such, it’s no surprise that merger and acquisition activity in insurance distribution soared to record heights in 2020.
Deal activity got off to a roaring start last year. Buzzing with energy after a record year of transactions in 2019, well-capitalized acquirers (both private-equity-backed and public companies) continued to build on that momentum and snap up insurance distribution firms. Many of the deals completed in January and February were negotiated and agreed to back in 2019 before the coronavirus pandemic brought the world to a halt.
In March 2020, when the World Health Organization declared COVID-19 a global pandemic, credit markets froze for several weeks, and insurance M&A activity petered off as buyers and sellers tried to assess the potential impacts of the pandemic – but that turned out to be a temporary pause.
The factors driving consolidation in the insurance distribution landscape remained as prevalent in the COVID-19 era as before. For sellers, core motives included a quest for scale and additional resources (especially technology), lack of internal perpetuation, and a desire to capitalize on record-high valuations. Buyers, on the other hand, are interested in agencies and brokerages for their resilience, which has been proven through tough economic times like the Great Recession and the current pandemic. Insurance distributors have been able to produce predictable and consistent revenue streams coupled with high margins, making them attractive from an investment perspective.
According to MarshBerry, the US saw a record deal count of 705 announced transactions in 2020, up from 648 in 2019. In addition, 57 firms made two or more acquisitions in 2020, compared to 49 in 2019. However, the total number of firms making acquisitions was higher in 2019 (202 versus 169 in 2020).
What does all of this mean? According to Phil Trem, president of MarshBerry’s Financial Advisory division, “it likely shows fewer independent firms are buying due to continuing COVID-19 concerns. Those that were in acquisition mode leaned into the accommodating conditions of the marketplace. Fewer firms tried their hand at acquiring, while established buyers took full advantage of a hyperactive market.”
Deal valuations also reached all-time highs in 2020, exceeding the records set at the end of 2019. “In the fourth quarter of 2020, valuations on top-rated platforms were approximately 10% higher than in the first quarter,” Trem says. “So, valuations realized during the pandemic, on average, were higher than they were pre-pandemic, which is not a trend we expected. Because of the resiliency of the insurance industry … existing buyers renewed their acquisition appetite, while new entrants, impressed with this resiliency, added to an imbalance of buyer appetite. With more buyers in the space and heightened demand, valuations were inevitably driven higher.”
It’s unclear how long this valuation trend will last, given the potential for capital gains tax hikes under the Biden administration, but at the onset of 2021, deal activity in the US has kept pace with the frenzied finish of 2020.
“While there remains uncertainty on when COVID-19 will ‘end,’ I believe that the insurance agency acquisition ecosystem has adapted to efficiently and effectively complete transactions in an alternative environment,” says Timothy Hall, EVP and head of mergers and acquisitions at Relation Insurance. “As indicated by the record number of transactions, deals still got done in 2020, and trends point to that continuing in 2021.”
One thing is certain: Investment interest in the insurance distribution market remains high, even in these unprecedented times. With that in mind, IBA spoke to several M&A experts about key themes that are likely to dominate insurance mergers and acquisitions in 2021, from economic conditions and digitization to succession planning and the role of private equity. IBA hopes their insights will provide readers with an enhanced understanding of the current state of the insurance distribution M&A market in the US.
What’s the macro overview of US insurance industry M&A trends in 2020?
Twenty-twenty saw, and 2021 continues to see, a frenzied pace of M&A activity in insurance distribution. A couple of factors helped drive the highest level of closed transactions on record, despite COVID, including an increase in the number of well-capitalized acquirers, both PE-backed and public companies; potential changes in the capital gains and corporate tax rates; and the general resiliency of the insurance distribution sector.
There are approximately 30 firms that are serial acquirers of insurance agencies. Most of these buyers are private equity-backed firms, while public companies like Gallagher, Brown & Brown, Baldwin Risk Partners, and Marsh – via Marsh & McLennan Agency – are also extremely active. The pool of acquirers who have financial sponsors grew in 2020 as several new firms were formed.
Firms that are electing to sell or partner with an ‘aggregator’ firm range from true platforms with significant revenue – more than $20 million – to smaller ‘tuck-in’ agencies. Twenty-twenty saw an uptick in the number of top 100 broker acquisitions and a significant uptick in tuck-in activity among all players. Firms that are selling do so for a variety of reasons, including a desire to crystallize their investment – and likely single largest asset – at current market valuations, a lack of internal perpetuation, and a recognized need for additional scale and resources.
Valuations continue to remain strong. Firms with scale, a dominant geographic presence, and/or specialization can command premium multiples. Valuations continue to be buoyed by more
PE-backed firms entering the market and the continued availability of debt capital at historically low-interest rates.
How did COVID-19 impact insurance deal-making in 2020? With the situation still uncertain at the onset of 2021, what’s to come?
At the start of lock-downs in March 2020, most firms hit the pause button on M&A to assess COVID-19’s impact on transactions under LOI [letter of intent] and those in their pipe-lines. Buyers dug into books of business to review the underlying business segments and the customers of target agencies. Some firms put in place transaction structuring mechanics that provided for downside protection; however, once there was greater visibility into what underlying customer segments were being impacted the most – i.e. hospitality – those measures were either reduced or went away.
One of the biggest areas impacted was transaction timelines. Deals got pushed out a month or two starting in March, which created a bottleneck effect for the rest of 2020. It was also exacerbated in part by the presidential election and a strong desire on the part of sellers to get deals done in 2020 to avoid any impacts from a potential change in capital gains tax rates.
While there remains uncertainty on when COVID-19 will ‘end,’ I believe that the insurance agency acquisition ecosystem has adapted to efficiently and effectively complete transactions in an alternative environment. Even in a post-COVID world, firms will continue to use certain tools, like videoconferencing, that allow for greater productivity and are more cost-effective. As indicated by the record number of transactions, deals still got done in 2020, and trends point to that continuing in 2021.
How have economic factors like low-interest rates, a hardening market, and consolidation impacted transactions?
Industry dynamics always have an impact on M&A, whether directly or tangentially. Interest rates, insurance pricing, and consolidation are all interwoven and can help accelerate or decelerate M&A activity.
Today’s interest rate environment continues to provide the necessary fuel for acquisitions to persist at their current pace. The industry has proven to be resilient, and lenders have gotten comfortable with the industry trends and cash flow profile. However, if
debt capital suddenly becomes scarce or too costly, it will have a material and immediate impact on both the pace of transactions and valuations.
Insurance pricing will continue to drive analysis around pursuing agency acquisitions that focus on certain industries or lines of business. If there are agencies with a portfolio of risks that will enjoy the prolonged benefits of a hard market, they will garner significant attention. Small and middle-market pricing are the most-watched metrics for most aggregators and their acquisition targets, and those two segments are starting to see continued upticks.
Consolidation across the industry – both with carriers and large brokers – continues to emphasize the need for greater scale and resources. As carriers get larger, they will have increased volume requirements that smaller agencies may not be able to meet, putting them at a further disadvantage. They will either lose the client or will have to access the market via an intermediary and give up economics to do so, thus limiting the amount of earnings they can reinvest in growth.
On the broker side, clients are demanding more from their brokers. Larger firms can continue to invest in technology and resources to better serve their clients. This will force firms to either make those costly investments themselves or partner with a larger agency that already has those in place. The impact of scale and readily available capital puts further pressure on smaller agencies. The consolidation of large brokers also creates an opportunity for expansion via organic hiring of teams and producers.
What is the significance of technology and digitization in insurance deal-making today?
Value-add technology and the efficiencies it can bring are para-mount in agency acquisitions. Sellers traditionally have not invested in new technology on the same breadth or scale that larger firms have. Sellers no longer view a robust technology offering as a nice-to-have item; if a buyer isn’t bringing technology enhancements as a value proposition to the table, they are going to lose out on more transactions than they win. Sellers that view tech as mission-critical are focused on how a buyer can help them grow, drive a higher retention rate, and be more profitable over the long term – which is the type of firm every buyer wants to partner with.
From a pure transaction perspective, technology has allowed acquirers to be much more efficient in getting transactions closed. Pre-COVID, buyers and sellers would meet in-person, multiple times, prior to signing an LOI. They would then meet in-person for due diligence at least once and then again at or near closing to meet employees. This required a lot of coordinating of schedules and traveling and generated a lot of wasted time and expense.
With COVID and the advancement of videoconferencing technology and more interactive data rooms, firms can streamline a lot of the process remotely, reduce overall costs and increase the number of firms under diligence at the same time. Travel can be limited to a smaller group of people and more targeted. These will become ingrained practices and will continue beyond COVID.
Why does private equity continue to have a strong interest in the brokerage/agency channel?
Ten years ago, there were six to eight PE-backed insurance brokerage firms. Today, there are 24. The proliferation of private equity’s interest in the insurance brokerage sector is driven by the underlying trends of the sector and the macroeconomic environment.
Insurance distribution has all the attributes that private equity looks for when building an investment thesis: a compulsory product with mostly recurring revenues and a variable expense model that drives high cash flow and requires low capital expenditures. The sector is also extremely fragmented and ripe for consolidation, with the ability to drive meaningful scale and synergies through M&A. It can also be further diversified via organic growth through expansion into lines of business, geographies, carrier markets, and accounts.
Insurance distribution has never had the ‘sizzle’ of some other sectors; however, the industry tends to hold up well in the face of economic uncertainty or a recession. Lenders enjoy the recurring cash flows in the business and are willing to provide debt capacity to further fuel growth. Institutional investors and lenders have seen the favorable results of some earlier entrants and view it as repeatable, given the fragmentation in the industry and the efficiencies that scale can produce.
Unless there is a disrupting event, I view private equity/alternative capital as a continued, long-term player in the insurance distribution sector. As the crop of 24 PE-backed brokers grows, recapitalizations will likely include more longer-term capital providers like pension funds, sovereign wealth funds, and family offices.
How can independent brokers and agents navigate private equity for their own best interests?
Independent brokers have more partnership alternatives/models now than at any other time in the sector. There are public companies, later-staged PE-backed firms, newer PE-backed firms, and large management-owned private companies. All of them have different approaches to valuation, transaction structure, production compensation, equity structure, and integration. Buyers are transparent about all of this, and it is to the benefit of a potential seller to learn for themselves how each differs. Understand what the growth and return targets are and how the firm is tracking towards those.
If someone is considering a partnership with a specific firm, I would encourage them to engage in direct conversations with prior sellers that have partnered with that buyer. That’s something we offer up at Relation in every discussion – talk to the folks who have been in your seat before and pick their brains on what was successful and what life is truly like post-transaction.
What are three key elements to successful succession planning?
The most successful succession plans I have seen focused on the people and the outcomes for each were developed in advance and were adaptable to the changing market environment.
First, determine who are the key constituents – owners, producers, staff – in the agency and what defines victory for each of them. This is critical because it allows a principal to determine whose input they need to get before key decisions are finalized and from what viewpoint those individuals will be perceiving the succession plan. The succession plan needs to work for all components; however, some constituents, such as producers, will have greater input on the plan than others.
Second, start thinking about timing before you think you should. A proper succession plan takes time to develop and implement. You will need time to prepare the agency, regardless of the final outcome. If it is a sale to a larger firm, there are a number of items you can do to get the firm in the best possible light: consolidate compensation plans, cut excess expenses, better track and report organic growth, etc. If it involves internal perpetuation to the next generation, you will need to ensure they are ready and able.
Third, things change. Markets adapt. What you laid out five years ago may not be feasible in the current environment or desirable. Flexibility is key to executing on a succession plan, whether it is a sale to a larger firm or internal perpetuation.
Connect with Tim Hall
Are you interested in exploring an opportunity to grow with Relation? Email Tim Hall, Head of Mergers & Acquisitions for Relation, to discuss joining the Select Family.