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By ERIN GAZICA, a freelance writer from Pottstown, Pa.

With three of the four largest commercial insurance brokers reporting higher 2009 fourth-quarter earnings compared with the year-ago period, the worst of the financial crisis appears to be behind them, according to an industry analyst.

"The U.S. is still a challenging market for them, but I think the worst is behind us as far as 2009 was concerned," said Keith Walsh, an analyst with Citi Investment Research.

At Marsh & McLennan Cos., fourth-quarter net income declined to $38 million from $80 million in the year-ago period due to the $435 million settlement of a 2004 securities-related class-action lawsuit.

Brown & Brown Insurance reported fourth-quarter net income of $24 million, down $9 million from the year-ago period.

"In 2009 we faced three strong headwinds--decreasing insurance rates, adverse economic conditions, and a soft merger and acquisition environment," said Brown & Brown President and CEO J. Powell Brown, in a statement. "Yet, in spite of these challenges, we became more efficient, added exceptional new talent and maintained the quality of service our clients expect and deserve."

Low interest rates, weak foreign currency exchange rates and higher pension expenses were the brokerage industry's "three-headed monster," added Walsh.

Even so, Walsh praised the brokers for implementing tighter expense controls. "Every one of them have put up numbers that meet or beat expectations for the most part for this quarter, and it just shows you that, through this soft market, the management teams of these companies collectively are much stronger than they have been in the past," he said.

Forced to reinvent themselves as a result of the Spitzer investigation of 2004 and 2005, brokers have become much better at handling difficult economic headwinds.

"The proof is in the results right now because this market for an insurance broker, it doesn't get much more difficult than this," said Walsh.

BETTER MARGINS

And there's still some fat to be trimmed, as Walsh and management believes the firms are capable of still better margins.

Aon CEO Greg Case, in an earnings statement earlier this year, said Aon's brokerage segment was capable of a five percentage point increase in its margins--to 25 percent. Marsh, which is not expected to generate the kinds of margins that Aon is capable of, according to Walsh, is however "back in the game."

Meyer Shields, a principal with Stifel, Nicolaus and Co., pointed to Aon's Web-based GRIP platform, which tracks annual placements and gives brokers a glimpse into underwriters' pricing trends, as a reason for its ability to squeeze more profits from its business model.

"It is probably the most advanced technology in terms of monitoring expenses and making sure that revenues are coming in as agreed and as necessary to match those expenses," Shields said.

"I believe Aon, at 20, can easily get it to the 25 (percent) level, so I think there is more of an upside to the margin on an Aon vis a vis a Willis," Walsh said.

Of the largest three brokerage firms, Willis leads the pack in terms of maintaining margins, reporting an adjusted operating margin of 22 percent in 2009. Walsh said the firm has consistently been a leader with margin, but he is less concerned with where the margin is than where it is going.

The analyst said that, although Marsh doesn't show as much incremental margin upside as Aon, he believes Brian Duperreault, president and CEO of MMC, and Dan Glaser, chairman and CEO of Marsh, have "put that company back in the game as far as getting the margin in a comparable position to where it should be with their peers."

MMC's risk and insurance services segment, which includes Marsh and reinsurance broker Guy Carpenter, pulled in an adjusted operating margin of 18.6 percent in 2009.

"I don't think it's a zero sum game as far as margin is concerned," said Walsh. "I think there are some common-sense best practices that each of these organizations are doing now as far as the expense side of the equation, so we're seeing the brokers in general now are much, much better run companies than they were five years ago."

WHAT'S AHEAD IN 2010

In the near term, the brokers aren't going to have much choice but to run tighter organizations as 2010 is shaping up to be another a difficult year.

"We think 2010 will not be an easy year, but we think it will be a bit better than last year," said Coletta Kemper, vice president of industry affairs for the Council of Insurance Agents and Brokers in Washington, D.C. The demand for insurance products isn't expected to rebound quickly, Kemper also said.

With depressed prices, overall mergers and acquisitions (M&A) activity among brokers is expected to be fairly quiet, said Shields. Willis is more concerned with paying off debt associated with the HRH acquisition in 2008, and dividend commitments and management changes at Arthur J. Gallagher and Brown & Brown are expected to make for a subdued 2010 M&A season, Shields added.

It's a different story at Marsh, however. Marsh is hungry and is "going to be very aggressive domestically," said Shields, as it plans to build out a platform of small and midsize brokerages to compete with Aon.

"They want to buy brokerages that already have the know-how rather than trying to extrapolate from their skill set within large corporate accounts into the middle market," he said. "That's never worked in the past, and I think they're right in terms of just buying that expertise."

February 18, 2010

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