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By STEVE TUCKEY, who has written on insurance issues for a decade for several national media outlets

The first American insurance agency opened in 1795 in Charleston, S.C., and advertised "a choice of underwriters, as well as all possible indulgence in the payment of premiums."

But the agency's effort to move the game forward by processing new fire insurance applications for the Insurance Company of America apparently failed due to home office fears that agents might favor their own clients at company expense.

Historians generally date the start of the American insurance agency system when the London-based Phoenix Insurance company appointed its first U.S. agency in 1804, offering limits of $40,000, way above the going rate for domestic companies at the time.

Despite its initial reluctance, INA turned out to be a leader in establishing agencies as a means of geographic expansion in an era with no form of communication other than what could be carried on the back of a horse or a wind-driven vessel crossing a vast ocean.

What a difference a couple of centuries make.

While the 2008 combinations of Willis and Hilb Rogal & Hobbs and the insurance brokerage operations of Wells Fargo and Wachovia banks represented some of the biggest deals in recent years, they merely capped nearly two centuries of buying and selling and, ultimately, consolidating, of the businesses that keep the users and purveyors of insurance products operating at greatest efficiency.

The Willis HRH deal represented the traditional "eat or be eaten" philosophy of growing market share, which has resulted in the dominance of the so-called Big Three today. Despite the setback the trio suffered nearly five years ago when the practice of accepting contingent commissions from insurers put the compensation system and the outsized role of the top players under an unwanted scrutiny, no agency threatens their top spots.

The Wells-Wachovia deal, on the other hand, was an afterthought of the acquisition by Wells Fargo of the ailing Wachovia last fall as the credit crisis gained in intensity. In that sense, it is emblematic of how the industry ebbs and flows with the general overall tides of the industries they protect from financial ruin.

The ultimate "people" business, insurance brokerage can claim more than its share of colorful characters whose so-called "better mousetrap" was simply their own innate ability to get the best deal for their clients and convincing other clients of their prowess in that regard.

W.F. Alexander stands out among the insurance leaders of the late 19th century who helped take his father and uncle's rural Virginia Alexander & Alexander agency to the top rung. It was sold after more than 100 years to what became Aon Corp.

MARSH SETS THE TONE

History has fated the surnames of Henry Marsh and Don McLennan to remain forever linked in tripping mellifluously off the tongue, but in Bogardus' telling, they had sharply contrasting personalities and just might not have cared for each other all that much.

Bogardus described Marsh as a natural producer, "suave, flamboyant, and confident in his ability to influence people and events that was fearless and took risks to produce accounts."

Early in 1910, Marsh noticed a newspaper item that reported that the president of American Telephone and Telegraph Co., Theodore Vail, was sailing at noon for London. "Without baggage, Marsh boarded the ship and secured a deck chair next to Vail's, then booked passage on the same return trip as his quarry. He developed a relationship with Vail, and M&M was appointed AT&T's broker in September of 1910," Borgardus wrote. McLennan apparently played the role that W.F. Alexander's brother took on in reining in some of his partner's more extravagant and colorful efforts in securing business.

Just over 50 years after Marsh's spontaneous ocean cruise, M&M's public offering represented the next step that foreshadowed the dominance we see today of the giant public brokerages.

Bogardus wrote that M&M needed to overcome the financial burden of buying out employee shareholders when they turned 70, died or ceased to be officers, directors or employees. The formula for redeeming shares required paying out 50 percent of the share's book value, plus 50 percent of each of the share's net earnings for the next 10 years, so "this liability severely constrained the firm's financial resources."

The brokerage's need for acquisitions was the second reason behind the offering, with publicly traded stock becoming an acceptable vehicle for acquiring privately held agencies.

"Most agencies could be acquired at a multiple of seven or eight times earnings," Bogardus wrote, in his book published in 2003. "M&M's public sale was set at 23 times its 1961 earnings."

While seven years would elapse before another such brokerage offering, in the end most sizable agencies ended up going the public company route as risks were becoming more complex in a technology-driven world. The Boeing 747 Jumbo jet, for example, which could seat nearly 500 people, meant that a liability insurer's exposure had tripled almost overnight.

Chicago insurance pioneer Patrick Ryan remains another outsized figure, who in 1982 acquired the Combined Insurance Corp., a profitable door-to-door business, and the seed of what was to become Aon with the acquisition of Rollins Burdick Hunter agency.

The stage was set for the late 20th century mergers-and-acquisitions free-for-all that shaped the brokerage industry today. Overall, the insurance industry was in flux as mass tort liabilities, the rise of personal computers and the Internet, and the intensely competitive environment fueled by excess capital and deregulation of certain markets led carriers and brokerages to seek solace in scale.

The 1990 merger of Corroon & Black and Willis Faber "startled the insurance world," according to Bogardus, but the new entity soon faced challenges from internal difficulties and the fact that Willis Faber continued its policy of working through correspondents. "Curiously it extended this practice even as other major brokerages built global organizations that gained control of local operations," he wrote.

Eight years later, the leveraged buyout group of Kohlberg Kravis Roberts & Co. along with five British and American insurers, took the Willis Corroon Group PLC for $1.4 billion. Three years later, the new entity went public as Willis Group Ltd.

Aon's acquisition of Alexander & Alexander in 1996 created the world's largest insurance brokerage for a brief moment in time until M&M regained the title with the $1.8 billion purchase of Johnson & Higgins in March 1997.

"Although the combination created an awesome powerhouse, its parts required several years to integrate and many challenges arose," Bogardus wrote.

Aon and Marsh competed in the last years of the 20th century for acquisition of foreign agencies, with the latter retaining its top position in revenues. The last great blockbuster deal in the 1990s was sealed on August 28, 1998, when Marsh acquired the British insurance agency Sedgwick for $2 billion.

CENTURY OF MEGALOSSES

The threatened great insurance loss event set to take place when the clocked turned on the second millennium failed to materialize. But that was more than made up for the following year on Sept. 11, 2001, when the industry suffered tens of billions of loss in a single morning.

Meanwhile, the brokerage industry soon faced its own modified Armageddon.

The investigation started in October 2004 by New York Attorney General Eliot Spitzer into the practice of some insurers paying top brokers fees contingent on certain performance factors proved a game-changer. Marsh felt the greatest impact losing its chairman, Jeffrey Greenberg, in the aftermath, which would ultimately lead to the same fate for his father, legendary AIG chairman Maurice "Hank" Greenberg.

The 2008 Willis HRH deal could only take place once the ban on contingency fees agreed to by the Big Three was amended to permit limited acceptance of such revenue.

Meanwhile, the hard market engendered by the Sept. 11 attacks and hurricanes Katrina, Rita and Wilma four years later soon turned to mush once more, creating top- and bottom-line challenges for the brokerage industry dependent on commissions from softening prices. And of course, an economy contracting at an alarming rate will also obviate the need for insurance products.

No one can predict with certainty what impact the financial meltdown will have on the increasingly important role banks were playing as insurance brokers, buyers and ultimately sellers, as household names such as Wachovia and Commerce Bank faded into the oblivion of toxic assets.

But the industry remains profitable despite its challenges, and no one expects an end to the wheeling and dealing that has transformed it over more than two centuries.

February 20, 2009

Copyright 2009© LRP Publications