Now that we are clearly in the midst of a recession - no matter what metric you use or person you ask - the common theme of questioning has predictably drifted from “what will happen” towards “how far will it go” and “how long will it last.”

Clearly the broader economic environment is going to have an impact on the insurance world- and hence insurance M&A. From an economic standpoint, we believe that those two questions go a long way to shaping insurance M&A over the next 12 to 18 months.

Make no mistake, consolidation will continue - likely at a fairly consistent pace - although rationale for transactions may begin to drift.

Traditional Agency M&A Rationale

Traditionally agency acquisitions have been executed in large part to fill out geographic footprints or expand market share in certain locations. Additionally, some acquirers have actively sought new product lines to diversify from their main business. (As an example, a primarily P&C shop buying a benefits agency.)

Multiples in the industry remained high in large part because of the “repeatability” of the revenue stream. With low churn in a portfolio and solid loss ratios, an owner could expect a valuation that would far outpace peers with similar sized companies in other industries.

That said, the continuing soft market has in part thrown a wrench in the works for these rationales. As margins compress, without building unit volume into your book, overall commissions decrease. Thus an acquirer is trying to “catch a falling knife” - not knowing how far a book will slide. The result is often a lower valuation multiple than might have been seen in the past.

 

Effects of the “New Economy”

That being said, the “new economy” is having some interesting effects on traditional agency and broker M&A. Now, as opposed to just filling out geographically, acquirers are looking at their acquisition plan on par with “organic growth.” Without an increase in premium pricing, and with limited opportunity to grow unit counts truly organically, the mandate to grow through acquisition becomes even more imperative.

 

A quick look at the numbers of the major public brokers shows how hard true organic growth is to come by: closing out the 2nd quarter, Arthur J. Galagher had 1.1% organic revenue growth, Willis has 2.0%, and Brown and Brown actually contracted by 7.9%.

With numbers like these, the case for growth through acquisition makes that much more sense.

What to Look for Next

First and foremost, with the above in mind, it stands to reason that the pace of acquisitions will continue. We anticipate that deal pricing might change to some extent, but in large part with acquirers aggressively pursing non-organic growth there shouldn’t be undue downward pressure.

 

That said, we anticipate that another trend which we are likely to see is the rise of acquisitions by smaller, privately held agencies and brokers. In recent years such buyers have found it difficult to compete with well capitalized banks and publicly traded brokers. With bank buyers largely on the sidelines with their own set of problems, and some of the public brokers digesting very large deals, there is a window of opportunity for smaller and mid-sized agencies to cut attractive deals.

In terms of targeting niches, given the soft market benefits heavy agencies continue to be in high demand- accounting for a significant percentage of announced transactions in 2008. This trend is especially pronounced with traditional P&C agencies (or locations) seeking to diversify their product lines and add reinforcement to their revenue streams.

Conclusions

The next months are going to be telling. We anticipate smaller agencies looking to join deeper teams, and acquirers looking to build their books. Now is probably a good time to pursue transactions. As a seller, waiting for the next hard market has its downfalls - if your performance has been in decline, anticipate markets to be looking to thin out appointments of under performers. Taking advantage of an environment where acquirers are still looking to aggressively build their book - and while you have access to good markets - is probably the right time to pursue a deal.