By STEVE TUCKEY, who has written on insurance issues for a decade for several national media outlets
The insurance brokerage puzzle saw several pieces rearranged last year as an easing of the contingency ban for the Big Three (Marsh, Aon and Willis) and the global financial crisis paved the way for some major changes.
London-based Willis' acquisition of the Richmond, Va.-based Hilb, Rogal & Hobbs stood out as the major game-changer. The new Willis-HRH combo moved up to the No. 2 spot in North America right behind Marsh and ahead of previous No. 2 Aon.
And while the Wells Fargo & Co. acquisition of the Wachovia insurance brokerage operation was mainly a sideshow in the San Francisco-based bank's snatching of the deposit-rich prize from right under the nose of troubled Citigroup, it did represent some fairly significant insurance account shifting across the country.
Don Bailey, who with the completion in October of the $2.1 billion deal, assumes the title of chairman and CEO of Willis HRH, says the deal represents the largest such transaction over the past decade.
"The Willis organization was looking for critical mass in a number of respects in the United States," he says. "So if you look at the metrics of this deal, it was transformational for us in terms of getting just that critical mass in the United States."
HRH itself had been on an acquisition spree over the past few years "and probably needed to drive some operating efficiencies," Bailey says. The integration of the technology systems of Willis and HRH, along with the imposition of Willis' expense discipline and financial controls and the elimination of HRH's expenses of being a public company, should result in savings of $120 million by next year.
The merger comes as the commercial insurance industry faces its fourth year of a soft market and brokers are still trying to sort out the ramifications of the 2004 contingency fee scandal that resulted in a ban on Marsh, Aon and Willis accepting such payments.
MORE ALIKE THAN NOT
Despite its complications, Willis looks forward to numerous benefits from the merger, such as more than doubling its revenues in the employee benefits field and tripling the company's personal lines business.
As for any cultural differences between the two companies, Bailey says, "If you were to make a list of similarities and differences, the similarities will dwarf the differences."
With Willis' 70 offices and HRH's 140 offices in the United States, Bailey says there was "shockingly little" redundancy with only 15 HRH and Willis offices in the same city.
HRH's focus on the small market will fit with Willis' presence in the middle and large account segment.
But not all observers have taken such a rosy view.
"I clearly think you are going to have some fallout from people who may have been sold to HRH a couple of years ago and now all of a sudden they are part of Willis and its culture," says Robert Lieblein, managing partner of Harrisburg, Pa.-based Hales & Co. Inc. "The impact may not be felt immediately, but clearly in a transaction like that there will be a fallout of key people and producers."
Despite the excellent strategic fit, Lieblein says that the more centralized Willis management approach could create conflicts later on with the more decentralized HRH culture, where much of the decision-making came from the individual offices and individual regions.
As for the insurance buyer, Lieblein said he does not see all that much impact with the most potential for it coming if the buyer's broker decided to leave the Willis-HRH combo because of unhappiness with the new regime.
Overall, he says, clients with smaller books of business will in the long run benefit from the different services and insurance options available from a larger, more powerful brokerage.
Thenew Willis-HRH merger will not come close to the nearly 50 percent market share created by last summer's Aon-Benfield combination in the reinsurance sector, a union that brought reinsurance buyers little in the way of bargaining clout.
Similarly, Willis-HRH clients will not see any discernible new bargaining clout, according to Fitch Ratings analyst Greg Dickerson.
Some repercussions have already surfaced from the Willis-HRH deal.
In June, Greg Arms, who headed up the Willis Global Employee Benefits Practice, announced he was leaving the company to take a similar position at Marsh just as his firm was about to gain momentum from the addition of HRH's considerable benefits practice business. Senior Vice President Chris Burns was promoted in November to replace Arms.
And in October, just as the HRH acquisition made Willis a new player in the small commercial segment, Marsh announced that it had set up a new subsidiary, Marsh & McLennan Agency LLC, aimed at exactly that business. It will operate out of retail outlets across the country starting early this year.
Keefe Bruyette Woods analyst Cliff Gallant says Willis' current relatively low share price reflects widespread investor skepticism for a successful integration of the HRH operation into the Willis fold. He noted that the third-quarter earnings reflected a 10 percent growth in international operations and 2 percent decline in North American business just prior to finalization of the deal.
That decline represents not only softening insurance prices but also a softening of demand for insurance products. It will play a key role in agency deal-making in the near future as many debt-laden small agencies look to sell out to what could be a dwindling number of buyers, which themselves may be wary of taking on any new ventures in uncertain times.
The brokerage industry also follows the fortunes of the carriers in general, who have been affected by the global financial crisis in any number of ways, including a severe decline in investment income. There was also the virtual federal takeover of industry giant American International Group Inc.
In December, the property/casualty industry reported a rate of return on surplus of 1.1 percent for the first nine months of the year compared with 13.1 percent for the comparable 2007 period, as property/casualty, financial guarantee underwriting and investment losses took their toll.
Insurance Information Institute President Robert Hartwig says the industry is headed toward its second consecutive year of net written premium decline in 2008. It's the first case of two consecutive years of premium decline since the Great Depression era of four straight years of decline in 1930-33.
Declining premiums, of course, mean declining brokerage fees along with the decline in attractiveness as takeover targets for potential agency buyers.
According to nationally recognized insurancee brokerage rankings, with its acquisition of Wachovia Insurance Services, Wells Fargo's insurance unit, Wells Fargo Insurance Services, will become the world's fourth largest insurance brokerage with more than $1.7 billion in 2007 brokerage revenues.
While there is some overlap in Wachovia and Wells Fargo's banking and insurance markets, Lieblein noted that Wells Fargo's second biggest state from a banking standpoint is Texas. "But they have a very minimal insurance presence there, so this is a very good deal for them," he says.
Overall, Wachovia's insurance practice fills in some niches where Wells Fargo lacks insurance sites. On the flip side, Wells Fargo will now have a retail banking presence in certain areas where they have an insurance presence.
Wachovia 's acquisition in 2005 of the Savannah, Ga.-based Palmer and Cay Inc. helped grow its insurance revenues to $422 million in 2007 and gained it traction in the middle and upper middle income market.
Both operations have focused for the most part on mid-market commercial lines business, Lieblein says. "Now there are certain niche practices that Wachovia had from the Palmer and Cay deal, but the bigger picture is you get to fill in the empty spaces from both the retail and the insurance brokerage aspect of the deal," Lieblein says.
While the insurance aspect of the deal may seem like an afterthought, Lieblein says Wells Fargo's success in cross-selling will make it a significant brand addition in the coming years.
"To me, the measurement of success in a bank's insurance operations is how many different bank products, which include insurance, can you cross-sell," Lieblein says.
A DEARTH OF NEW DEALS
As for the prospects of consolidation this year, Lieblein says the credit conditions present severe challenges for new deals. "But we are seeing more sellers coming to the marketplace looking to sell," he says. "What we are seeing are independent brokers with anywhere from $2 million to $20 million in revenue."
But with banks and private-equity funds for the most part out of the picture, the main acquirers are brokerages such as Brown & Brown Inc., Arthur J. Gallagher & Co. and USI Holdings Corp. "So you have less people chasing more deals now, so you will see pricing begin to come down from where it was 12 months ago," he said.
Standard & Poor's Director Steven Ader noted that in 2007 private-equity firms linked to Goldman Sachs and Morgan Stanley purchased USI Holdings and Hub International Ltd. for cash flow multiples up to 12. But last year's credit lockdown put a damper on any such moves, he says.
High interest rates resulting from mediocre brokerage credit ratings, along with diminishing income prospects stemming from the soft market, make daunting obstacles to any new acquisitions.
"But the issue right now is the recession we are in," Ader says, noting that S&P economists, forecasting a 3 percent decline for the fourth quarter of 2008, are expecting further dips this year. "So that becomes a factor as payrolls shrink since many policies are based on payroll or how much construction there is."
An increased number of sellers, with some facing new debt pressures, will not only remove them as possible acquirers but also drive down their price.
"I would say that if you have the financial flexibility and you don't have much of a debt structure, you might say it is a good time to buy, since the prices are favorable," Ader says.
Gallant noted that, while banks may not be acquiring brokers "they still have some pretty big brokerages they will have to divest," which could lead to some M&A action this year.
But don't expect any imminent price firming to make brokerages more enticing, M&A targets. While Fitch Ratings Chicago-based analyst Julie Burke sees some possible upticks in lines such as financial professional liability and property-catastrophe, overall she still sees pricing declines, although not as steep as in years past.
Likewise, Gallant says KBW expects flat pricing for the most part with some possible increases in reinsurance pricing.
While expense-reducing initiatives in recent years have produced impressive results, the "low-hanging fruit" of cost cutting may have already been picked, according to Ader. Brokers' reliance on acquisitions has produced growth, but at the same time it's cost them market share in their core operations.
February 20, 2009
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