Insurance Business America 9.03 M&A 2021 Executive Insight

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M&A 2021 The market for insurance mergers and acquisitions is hotter than ever. IBA finds out what brokers need to know to navigate it

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M&A INSIGHTS 2021 Insurance Business America uncovers the answers to brokers’ biggest questions about mergers and acquisitions, with expert insight from MarshBerry, Baldwin Risk Partners and Relation Insurance 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.

“Many buyers returned to the market over the course of 2020,” says Trevor Baldwin, CEO of Baldwin Risk Partners, “and we even saw new entrants as agency performance again proved resilient amid times of economic stress, reiterating the quality and durability of the industry as a whole.”

Indeed, 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. Bethan Moorcraft Senior editor Insurance Business America

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M&A What’s the macro overview of US insurance industry M&A trends in 2020?

Phil Trem: We came into calendar year 2020 with an aggressive pace of deal activity, which was a continuation of what we saw in 2019, during which 648 transactions were announced. This total was a significant increase from the prior two years – and the momentum continued until March 2020, when the pandemic struck and the economy halted.

Because the credit markets froze for several weeks in March, April and May, buyers of insurance distribution were limited in the amount of financing they could borrow to complete new acquisitions.

Also, there was significant uncertainty as

to how deep and how long the pandemic would last, making buyers conserve cash, not knowing if it would be a three-month or three-year disruption.

After a slow March and April, government stimulus in June helped stoke the market, and we saw some light from inside what felt like a black hole. Activity picked up into the third quarter and accelerated through the fourth quarter. When the pandemic first hit, we expected that announced M&A transactions in 2020 would total about 500 deals, but actual deal totals set an all-time record of 705 announced transactions.

While 2020 was a roller-coaster year, the fourth quarter exceeded the first quarter’s deal-making pace. Ultimately, the pandemic reminded the investment community how resilient the insurance

distribution market is, and more investors showed interest, creating more demand and increased activity.

Valuations [in 2020] exceeded what were all-time highs at the end of 2019.

Last year, we saw valuations hold even while deal volume slipped in the second quarter as buyers attempted to shift risk back to sellers in the form of performance ‘true-ups.’ Without knowing the impact of COVID-19, some buyers required sellers to have a 12-month performance hurdle, effectively requiring sellers to produce similar earnings performance a year after a transaction closed to earn the full amount of the guaranteed purchase price. However, those terms were short-lived due to the amount of competition for deals in the third and fourth quarters.

In the fourth quarter of 2020, valua-

MEET THE EXPERTS Phil Trem President – Financial Advisory MarshBerry

As president of MarshBerry’s Financial Advisory division, Phil Trem has extensive knowledge in M&A advisory and operations, specifically in the business and technology arenas. He is a trusted partner for buyers and sellers in deal negotiation, due diligence, deal execution and integration planning. His experience encompasses the full life cycle of an M&A transaction, and he works hard to provide clients with a seamless, comprehensive experience.

Trem also contributes to MarshBerry’s consulting practice by helping guide clients in the areas of strategic planning, internal perpetuation planning, agency valuation, financial and organizational development, and compensation strategies.

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Gerard Vecchio Managing director – Insurance Services MarshBerry

Gerard Vecchio joined MarshBerry in 2017 and works with the Insurance Services division, where he provides strategic and operational consulting services to specialty insurance distributors, insurance carriers and outsourced service providers within the insurance industry. Vecchio has nearly 30 years of industry experience and has been a private equity investor in, board member of and advisor to insurance distributors, underwriters, and service and technology providers. Prior to joining MarshBerry, he was CFO and head of business development at Distinguished Insurance Services, where he was responsible for sourcing, financing and integrating insurance broker acquisitions.

Trevor Baldwin CEO Baldwin Risk Partners

Trevor Baldwin joined Baldwin Risk Partners (BRP) in 2009 as a commercial risk advisor, working primarily with healthcare and private equity clients. He then led the firm’s Commercial Risk Management group as managing director before being appointed BRP’s president and CEO. Baldwin has a background investing in and working with companies to shape their goals and success. Before joining Baldwin Risk Partners, he worked for the private equity firm HealthEdge Investment Partners, where he divided his time between working with portfolio companies on operational improvements and assisting in the execution of new transactions.

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Timothy J. Hall EVP, head of mergers & acquisitions Relation Insurance

Timothy Hall is responsible for all aspects of Relation Insurance’s M&A and integration initiatives and serves as a member of the company’s executive committee. Hall joined Relation in April 2019 after it was recapitalized by Aquiline Capital Partners. Prior to joining Relation, Hall spent more than 13 years as an investment banker, focused exclusively on the insurance sector. Most recently, he served as a partner and managing director at Waller Helms Advisors, where he advised insurance clients on mergers, acquisitions and capital raises. Prior to that, he was a vice president at Macquarie Capital, where he focused on insurance clients.

“For some time, the question has been when will the valuation bubble burst?

While we have not seen that day yet … we are not expecting valuations to increase much further” Phil Trem, MarshBerry tions on top-rated platforms were approximately 10% higher than in the first quarter. 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 – similar to its performance during the Great Recession – 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.

Specialty mirrored retail in this regard.

For some time, the question has been when will the valuation bubble burst?

While we have not seen that day yet, with concerns over potential capital gains tax increases and an uncertain economy, we

are not expecting valuations to increase much further.

M&A activity [in 2020] ended with a breakneck pace that has absolutely continued into the first quarter of 2021.

Demand is being generated by the sheer number of investors who are looking to enter the space. As of now, the supply is holding steady due to 1) firms recognizing that the world around them is more competitive, and they want to partner with a firm that will help them better compete, and 2) concerns about potential capital gains tax increases. The amount of activity is rivaling what we saw in the third and fourth quarters of 2020, and we expect that pace to continue. The industry could eclipse a total of 750 to 800 announced transactions within the retail and specialty arenas in 2021.

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M&A WHOLESALE BROKERS AND MGAs GARNER ACQUIRER INTEREST SPECIALTY DISTRIBUTOR ACQUISITIONS BY BUYER TYPE Insurance broker – independent

Insurance broker – public

Insurance carrier

Bank or thrift

Insurance broker – private equity backed Other

140 120 100 80 60 40 20 0

2013

2014

2015

2016

2017

2018

2019

2020 Source: MarshBerry, 2021

“At a macro level, the fundamental forces that have driven consolidation across the insurance distribution landscape remain as prevalent today as ever” Trevor Baldwin, Baldwin Risk Partners Gerard Vecchio: In 2020, specialty markets completed 123 unique transactions, equal to 17.5% of total announced transactions for the year. Historically, specialty lines have typically comprised 13% to 15% of total annual announced deals. MarshBerry believes that two factors driving the increased number of M&A transactions involving specialty wholesalers, MGAs and program administrators could be 1) an accelerating insurance rate environment prevalent among many property & casualty lines of business, and 2) the low cost of debt capital.

The acceleration of rate increases across a broad number of insurance coverages could situate sellers to be in a better position to meet or exceed future sale price

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incentives that may be tied to revenue or earnings growth, commonly known as earn-outs. There has been an acceleration of insurance rate increases across the business interruption, general liability, commercial auto, umbrella, commercial property and professional liability/directors & officers liability lines of business.

Furthermore, with the historically low cost of debt capital – one could argue that the real cost of debt capital is close to zero – buyers may be incentivized to pay premium valuations due to their ability to finance acquisitions at near zero borrowing costs.

Trevor Baldwin: At a macro level, the fundamental forces that have driven consolidation across the insurance distribution landscape remain as prevalent today as ever. Scale increasingly matters, tech enablement – and the ability to invest in tech capabilities – is increasingly enhancing the value brokers can deliver for their clients, and robust valuations have made it increasingly difficult for principals to economically perpetuate ownership internally.

Additionally, the onset of COVID-19

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in early 2020 and the uncertainty that came with it, coupled with the threat of increasing capital gains tax rates under a new presidential administration, brought a wave of incremental private sellers to the table. While we saw a brief pause in activity from some of the more active acquirers in early 2020 due to the COVID-19 pandemic, activity picked up through the end of the year from both strategic and private equity players.

With the presidential election uncertainty behind us, we expect a continued focus on potential tax increases and availability of attractive debt financing to drive robust M&A activity and sustained valuations through 2021.

Timothy Hall: 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 equitybacked 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?

Gerard Vecchio: In the specialty market, COVID-19 forced players to spend in order to better underwrite and become more digitally efficient to acquire policy submissions and issue bound policies. Relative to technology, firms are continuing to look at ways to track and move through workflow as more colleagues work remotely. Servicing clients is going to be even more important.

As COVID-19 continues to have a downstream impact on the business community, businesses are looking to their insurance broker to become more of a business partner and financial advisor. Their clients

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“More specialized, consultative brokers are going to have more new business opportunities than the average firm that’s doing business like they were 30 years ago” Gerard Vecchio, MarshBerry want someone who can understand their business and help them make sound business choices – not just provide insurance.

More specialized, consultative brokers are going to have more new business opportunities than the average firm that’s doing business like they were 30 years ago. Additionally, the search for new talent will become more competitive, as firms are more comfortable with remote work environments and are no longer constrained by geography.

Also, be prepared for insurance carriers that are losing money in certain lines of business to not extend that availability or capacity later this year or into 2022. There is business written in the admitted market

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that could – and likely will – move into the non-admitted market, perhaps making this coverage considerably more expensive.

Trevor Baldwin: We saw COVID-19 impact both the supply and demand side of insurance deal-making over the course of 2020. For sellers, the economic fallout and related uncertainty served as somewhat of a ‘shot across the bow’ for agency owners that saw industry valuations trend up and to the right for a decade straight, which, in a vacuum, resulted in increased activity as sellers looked for opportunities to de-risk.

On the demand side, we saw many buyers hit pause at the onset of COVID-19 to digest what impact the pandemic would have on agency performance as access to capital was temporarily diminished.

Many buyers returned to the market over the course of 2020, and we even saw new entrants as agency performance again proved resilient amidst times of economic stress, reiterating the quality and durability of the industry as a whole.

Ultimately, early data indicates that even with the COVID-19 pandemic, 2020 deal activity in the insurance distribution space outpaced 2019. With continued economic recovery and ripe M&A conditions, we expect to see sustained levels of activity and an uptick in the number active buyers in 2021, following the strong end to 2020.

At BRP specifically, we took a thoughtfully front-footed approach to managing the business through COVID, which we think afforded us a number of unique opportunities to capitalize on the dealmaking dislocation that took place post the onset of the pandemic. First, while we conducted a prudently heightened amount of diligence, we did not hit pause on our partnership [M&A] strategy, which presented a competitive advantage during a period of time when others took themselves out of the market.

Second, we took care of our people – continuing to pay bonuses, not cutting pay or furloughing colleagues, continuing to make 401k matches – at a time when many of our peers were doing the opposite, which reiterated our colleague-centric culture and increased the attractiveness of BRP as

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a home for potential partners, which we think will pay dividends for years to come.

Timothy Hall: At the start of lockdowns in March 2020, most firms hit the pause button on M&A to assess COVID19’s impact on transactions under LOI [letter of intent] and those in their pipelines. 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.

Phil Trem: As we hopefully enter the final stage of the pandemic, we are actually at a higher watermark than when we went into it. Valuations have never been higher, interest rates are near zero in real terms, and we doubt we are ever going to see an environment where taxes will be lower.

At some point, we will see valuations shift down and both taxes and interest rates go up. We aren’t sure when those changes will occur, but it will have an effect on the availability of debt capital.

Our advice: Get help if you plan to navigate the M&A market. There are too many

opportunities to misstep and not get the best deal that you deserve.

How have economic factors like low interest rates, a hardening market and consolidation impacted transactions?

Phil Trem: Except for some hard-hit industries during COVID-19, which include hospitals, restaurants, travel and outdoor entertainment, the insurance brokerage market held up well. We saw continued low interest rates, aided by the Federal Reserve providing pandemic relief by supporting liquidity in the non-investment-grade debt marketplace. This allowed M&A deal activity to continue after only a brief hiatus during the second quarter of 2020.

“If there are agencies with a portfolio of risks that will enjoy prolonged benefits of a hard market, they will garner significant attention” Timothy J. Hall, Relation Insurance

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M&A HARDENING RATES COULD IMPACT ACQUISITIONS YEAR-OVER-YEAR CHANGE IN COMMERCIAL P&C RATES Q1 2019

Q2 2019

Q3 2019 Q3 2020

Surety bonds

0%

5%

5%

10%

15%

20%

25%

5%

10%

15%

20%

25%

5%

10%

15%

20%

25%

10%

15%

20%

25%

0%

5%

10%

15%

20%

25%

0%

10%

15%

20%

25%

5%

Workers’ comp

10%

15%

20%

25%

Umbrella

0%

5%

Commercial property

Commercial auto

0%

0%

D&O liability

General liability

0%

Q2 2020

Q1 2020

Construction

Business interruption

0%

Q4 2019 Q4 2020

-5%

0%

5%

10%

15%

20%

25%

Employment practices liability

5%

10%

15%

20%

25%

0%

5%

10%

15%

20%

25%

Source: MarshBerry, 2021

Insurance rate increases or a hardening rate environment only aided in sellers wanting to sell now. For those that have built-in growth revenue from a hardening market, sellers are encouraged to evaluate selling now. The hardening market may actually help firms hit some or all of their earn-out goals.

Trevor Baldwin: We believe certain

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industry, economic and political factors – such as low interest rates, availability of the COVID-19 vaccine and more stability following the presidential election – will continue to drive heightened M&A activity in the insurance space. Smaller companies will continue to look to partner with larger organizations that can provide resources, support and, perhaps most importantly, continued reinvestment in the business to stay on the vanguard of the insurance distribution industry.

Timothy Hall: 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 prolonged benefits of a hard market, they will garner significant attention. Small and middlemarket 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 demand­-

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To learn more, contact Tim Hall, Executive Vice President and Head of Mergers & Acquisitions at (312) 714-7279. relationinsurance.com

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M&A ing 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 opportunity for expansion via organic hiring of teams and producers.

What is the significance of technology and digitization in insurance deal-making today?

Trevor Baldwin: Technology and insurtech have become increased areas of focus for many buyers, which has been accelerated by record amounts of capital

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 retain 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 a 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.

“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” Timothy J. Hall, Relation Insurance investment in private insurtech companies and robust valuations for these companies in both the private and public markets. Digital players are developing insurance-specific products at a rapid pace, providing significant investment opportunity for private equity, brokers and insurance carriers. As brokers continue to enhance their product and service offerings and the digitization of insurance continues to evolve, we expect insurtech deal activity to continue to accelerate.

Timothy Hall: Value-add technology and the efficiencies it can bring are paramount in agency acquisitions. Sellers traditionally have not invested in new technology on the same breadth or scale that

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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?

Phil Trem: Historically, the resiliency

of the industry is why private equity has a strong interest. During tough economic times, such as the Great Recession and the current pandemic, people still buy insurance. When you look at this from an investment perspective, the return on investment is fairly high, given the low risk profile for the investment. There are very few other industries that can give a consistent, predictable return without having a high floor for risk, or low bar, depending on how you structure the deal. In addition, based on the 25,000-plus insurance agencies and brokerages in the marketplace, there are considerable opportunities to grow a firm through acquisition.

We also recognize that many investors have turned to private equity because of a dearth of opportunity to invest in the public market. That, in turn, has led to more capital across the private equity industry looking to diversify their portfolios. Traditionally, financial services have not been the first investment area for most private equity funds, but today, insurance is an attractive industry because it has been stress-tested and offers portfolio diversification for private equity funds.

Considering that the public markets will likely not increase dramatically the number of new public companies coming to market during the next three to five years – and hence there remains a limited supply of public companies into which such large investors as public and corporate pension funds can invest their capital – there is a very good chance that more money will continue to flow into private equity, making this a long-term and not a cyclical trend.

Trevor Baldwin: We believe there are several reasons why private equity has shown a particular interest in the brokerage space. First, our industry has proven to be recession-resistant. Second, highly predictable and recurring revenue streams, coupled with high margins, have allowed our private equity peers to finance deals with large amounts of debt. We believe the sizable leverage profiles of many of these private equity-backed businesses demand a myopic focus on margin to ensure covenant compliance, which restricts growth

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and investment.

This strategy has proven quite successful for many private equity firms, and we expect to continue to see new entrants in this space.

That being said, as the industry continues to consolidate at a rapid pace, we anticipate that the number of private-equity-backed buyers will decrease over time as privateequity-backed firms combine and a reduced number of available high-quality platforms makes it harder for new entrants to scale in the same manner.

Timothy Hall: 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 insur-

“Traditionally, financial services have not been the first investment area for most private equity funds, but today, insurance is an attractive industry because it has been stress-tested” Phil Trem, MarshBerry

PRIVATE EQUITY PLAYS A BIGGER ROLE ANNOUNCED US TRANSACTIONS BY BUYER TYPE Insurance broker – independent

Insurance broker – public

Insurance carrier

Insurance broker – private equity backed

Bank or thrift

Other

700 600 500 400 300 200 100 0

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

2020 Source: MarshBerry, 2021

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M&A ance 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?

Phil Trem: The first thing an independent agency can do to navigate private equity is to realize they don’t know what they don’t know. Because today’s market is inundated with information, many sellers feel like they have enough insight to complete their own transaction. In some instances, these firms get a decent deal, but they may be leaving significant value on the table. The

focus should be on finding the right fit. It’s not just a person that you like – it’s understanding what is possible and what is available to you.

In an overcrowded buyer market, you owe it to yourself to make sure you are getting the right cultural and business alignment that can drive the best deal terms and future success of the seller. Very similar to the role brokers and agents play on behalf of their clients, MarshBerry provides this guidance to its clients seeking a strategic partner or owner. When clients need insurance coverage and want to know what carrier is best, it’s the broker’s responsibility to help them find a fit. That’s similar to MarshBerry’s role – to help firms find the best fit.

Be careful when a buyer or investor tells you they are going to treat you fairly and that you don’t need an advisor. It is ironic

“In an overcrowded buyer market, you owe it to yourself to make sure you are getting the right cultural and business alignment that can drive the best deal terms” Phil Trem, MarshBerry

THE TOP 10 INSURANCE M&A PLAYERS TOP BUYERS IN ANNOUNCED US TRANSACTIONS, 2020 Private equity backed

Public

Private

1

Acrisure Total deals: 76

2

BroadStreet Partners Total deals: 61

3

World Insurance Associates Total deals: 42

4

HUB International Total deals: 30

5

AssuredPartners Total deals: 28

6

PCF Insurance Services Total deals: 27

7

Alera Group Total deals: 20

8

Gallagher Total deals: 20

9

Hilb Group Total deals: 19

10 Risk Strategies Company

Total deals: 19 Source: MarshBerry, 2021

that many buyers try to convince you not to hire someone to support you, but they in turn bring on advisors themselves. If not MarshBerry, look to another firm for support. Any advisor is better for you than no advisor.

Specifically, if looking for private equity funding, many think that all private equity is the same. In doing your homework, you’ll realize if you’ve met one private equity firm, you’ve likely only met one private equity firm. Each has different investment strategies and different approaches to how they build a portfolio of companies. One size definitely does not fit all.

Trevor Baldwin: Independent brokers and agents have a number of potential paths to pursue when deciding on their next partner. The private equity model is highly focused on leverage to generate returns. While the high margin profiles of

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the businesses in our industry are conducive to supporting this model, we believe that a constant focus on margin detracts from creating real value through growth and innovation.

In addition, the requirement of private equity firms to exit their investments during a finite time can create a divergence of interests between short-term gains and long-term reinvestment and success.

At BRP, we are focused on a durable, purposeful growth strategy that is achievable through partnering with high-quality insurance entrepreneurs and allocating growth capital to partner firms to perpetuate their growth trajectories.

Timothy Hall: 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 differ. 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?

Trevor Baldwin: First, know your goals.

There are plenty of questions a seller should think about. How long would you like to work? Do you want to get equity into the hands of colleagues in the firm who are ramping up in their careers? How

important is perpetuating the growth of your business?

Second, do your research. Understand the differences between what a third-party buyer or an internal transaction brings to the table and ask detailed questions of each.

There are pros and cons to any scenario you choose. If you desire, talk to an investment bank or professional in the industry that can help guide you through one of the most important decisions in your life.

Third, prepare in advance. Successful planning will help you achieve your most desired outcome. Succession planning should be discussed and reviewed at least once a year.

Timothy Hall: 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 a 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.

“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” Timothy J. Hall, Relation Insurance

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SPECIAL PROMOTIONAL FEATURE

M&A

An inside look at M&A strategies for MGAs Arrowhead’s Chris Walker and Steve Bouker walk IBA through the ins and outs of acquisitions in the MGA market TODAY’S MGAs are engines of profitable growth, heating up the M&A space, according to Steve Bouker, Arrowhead EVP, and Chris Walker, Arrowhead CEO, both of whom are part of the leadership team of Brown & Brown National Programs. Both have 30-plus years of experience and have seen the evolution of the MGA model during their careers. They sat down with IBA to discuss the state of the programs market and what it’s like to be part of National Programs.

What are the major trends you’re seeing in the MGA market?

Chris Walker: The programs space was once driven by top-line growth. Loss ratio was a consideration, but it wasn’t the primary concern. Today, we see a heightened awareness of profitability for all parties. The loss ratio has to be acceptable to the carrier partner, and commission levels have to allow the program administrator to make a profit. It’s about the longterm sustainability of the program.

Another trend is specialization – having underwriters who truly understand their niche and can underwrite that business to a very profitable level. This expertise in specialty niches has helped MGAs become profitable growth engines for insurance companies.

Steve Bouker: Program administrators have been legitimized because they’re

generating the results that insurance company partners need to see. They’re now seen as experts in specific lines of business.

As a result, insurance carriers trust quality MGAs with their capacity.

WHAT BROWN & BROWN NATIONAL PROGRAMS LOOKS FOR WHEN ACQUIRING AN MGA

So what does that look like?

SB: An example is earthquake. An insurance company might have a multiline underwriter who’s concerned with the entire property: the buildings, their contents, all the different coverage parts and perils. On the other hand, a program administrator might focus on one peril such as earthquake. By doing that, the MGA can be more surgical and bring specialized expertise and experience to generate a more carefully underwritten book of business.

As a specialty underwriter, an MGA can demonstrate its value proposition to the various distribution channels [with] specialized forms, more focused rates and a more informed, available underwriting staff. Producers become very comfortable working with MGAs because of that specialization.

What’s your outlook for M&A activity in the programs space?

SB: We’re seeing higher and higher valuations for acquisitions. Acquisition targets are paying attention; many of them are looking to monetize the businesses that they’ve

Are the people and culture a good fit?

Is underwriting integrity a key value?

Do they have a unique product or business model?

What can we add to make the business even stronger?

What are the company’s long-term prospects?

Source: Brown & Brown National Programs

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built. But because the valuations and multiples are high, acquirers are more selective than ever. If you’re going to pay these types of valuations, you need to make sure you’re acquiring a very high-quality business. It’s critical to understand all aspects of the business, not just the financials.

National Programs will continue to be very selective, looking for teams that have demonstrated experience, expertise and the ability to generate profitable results for their carriers over time.

CW: We’re bullish on M&As. Brown & Brown has tremendous history, expertise and resources in the acquisition space. We continue to seek out opportunities for businesses that fit our culture and have a particular specialty. We think M&A activity is going to be pretty robust in the next three- to five-year window.

acquired Arrowhead, we were jointly held by a private equity firm and management, so it felt like our company and financial future were at stake. But reflecting back on these nine years, the experience has been very positive. Joining a firm that’s steeped in the insurance business was the best thing to happen to us.

What was it like to be acquired

by Brown & Brown’s National Programs?

SB: There’s always some trepidation when

CW: We were impressed with the speed at which Brown & Brown moved. They were very thorough; they met with us in person several times and conducted a complete due diligence. But there was no foot-dragging, which you often see in these situations. Once

you’re going from a private environment to a public company. When Brown & Brown

they felt good about what they saw, they moved quickly. The transaction was closed, and they let us run our business.

What does National Programs look for in an acquisition prospect?

SB: [There are] four things we’re looking for. First is the team, the organization’s

“We continue to seek out opportunities for businesses that fit our culture and have a particular specialty.

We think M&A activity is going to be pretty robust in the next three- to five-year window” Chris Walker, Arrowhead culture. Are they a good fit? Do they appreciate underwriting integrity the same way we do? Second, is there a unique quality to that prospective acquisition from a strategic standpoint? Does it have a unique product or a unique business model that’s of interest?

www.ibamag.com

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SPECIAL PROMOTIONAL FEATURE

M&A THE SECRET SAUCE TO NATIONAL PROGRAMS’ M&As

30

Carrier relationships

240+

Technology and operational support teammates

25,000

Distribution partners Source: Brown & Brown National Programs

premium in the marketplace, we’re able to attract high-quality carrier partners. We can establish a dialogue with them at the CEO level about their interest in allocating capacity toward the program market we’re looking to acquire.

Second, it’s innovation through technology: deploying intelligent technology and people to craft superior, tailored products and services, simplifying the insurance process for our producers and their clients.

CW: I would say our overall market position, size and influence are a big advantage. National Programs is well known.

People take our calls. So we can help push new initiatives and ideas because of our position.

Each program is powered by a robust shared-services mechanism, from point-

“Our corporate culture is built around a decentralized working environment, where the individual companies retain their own culture and the entrepreneurial spirit on which they’re built” Steve Bouker, Arrowhead Third, what can we add to make the business even stronger? And fourth, what are the long-term prospects of the company?

We’re not acquiring companies for the short term; our strategy is to buy and hold. This is different than other models looking for a quick return.

Walker: I’d emphasize the organization’s culture. Is it thriving, inclusive and diverse?

Are they specialists in their field? Do they have enduring carrier relationships? And to Steve’s point about long-term viability, can we make that business stronger by integrating it with our distribution network, actuarial services, modeling capabilities, technology infrastructure and agency management program?

What differentiators does National Programs have that attract other firms for acquisition?

SB: First and foremost, our carrier relationships. With $3.5 billion in written

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of-sale and policy administration through operations and customer service. We have our own claims TPA and other ancillary services like subrogation, SIU and Medicare compliance. And a powerful sales multiplier is National Programs’ network of over 25,000 distribution partners, made up of retail agents, wholesalers and online aggregators, financial institutions, and industry associations.

What can a firm expect from Brown & Brown’s acquisition process?

CW: Brown & Brown has a team that does this for a living. They’ve built a process that’s efficient and effective. It’s a delicate balance between being thorough, leaving no stone unturned and not getting in the way. For example, data requests can be a big time and resource drain on the acquisition target.

When Arrowhead was acquired, we set up a data room so that they were able to get our

information at any time with minimal effort on our part.

SB: Another edge we have is that the insurance professionals and our M&A team work together on the acquisition.

So the acquisition target has discussions with people who understand the business side. Chris and I have walked in their shoes because we, too, were acquired, and we have experience in the business. That makes for a very constructive due diligence.

What makes your company’s culture unique?

SB: Our corporate culture is built around a decentralized working environment, where the individual companies retain their own culture and the entrepreneurial spirit on which they’re built. They retain their identity in the market, but at the same time leverage the extensive resources of National Programs. It’s the best of both worlds.

We want to be entrepreneurial, nimble and responsive to our customers. That’s why the decentralized environment works.

If we were to centralize everything, we would become a giant bureaucracy. We wouldn’t be able to be as responsive and as entrepreneurial.

CW: The organizations we acquire were successful to begin with. We don’t want them to lose their entrepreneurship, creativity or specialization. Instead, we want that to continue to grow and flourish.

SB: We’re looking to acquire firms whose leaders want to continue to grow and build their business. They like what they’re doing; they like the products; they like the sales; they like working with their teams. But maybe they’ve reached a point where they need the assist of additional carrier capacity, additional distribution and additional technology capabilities. If so, we’d like to talk with them.

To learn more about becoming part of Brown & Brown National Programs, contact Scott Penny at spenny@bbins.com or Vaughn Stoll at vstoll@bbins.com.

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Represents BRP Group’s year-over-year organic revenue growth 2020 YTD as of 9/30/2020 as compared to the average organic revenue growth for the same period of the U.S. publiclytraded commercial insurance brokerage firms.

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