This article considers how recent economic and industry conditions and demographic trends are impacting the mergers and acquisitions (M&A) environment and market valuations of agencies and brokers.1
The insurance agencies and brokers industry has grown steadily in recent years due to a prosperous economy, accommodative legislation, and other positive trends within the sector. The growth in the industry has been fostered by hard market conditions, enhancing industry revenue over the past several years through higher commissions. A hard market typically advances higher premium prices in the property and casualty (P&C) and health insurance markets. Total commissions and, therefore, industry revenues are dependent on the level of transaction activity within the industry, as well as premium prices, which differ among insurance products. Additionally, as a result of the economic prosperity in recent years, consumers' disposable incomes have grown, which has led to stable demand for various insurance products and, consequently, higher commissions.2
Another major driver of the industry is homeownership. The US homeownership rate plateaued in the second quarter of 2019 at 64.1 percent, representing a lack of statistical difference from the 64.3 percent rate in the second quarter of 2018 and the 64.2 percent rate in the first quarter of 2019.3 The national homeownership rate is an important factor to consider as expansion in homeownership leads to a higher demand for insurance, thus driving commissions and industry revenue. One headwind impacting the industry has been the preference of millennials toward renting, rather than buying, since the financial crisis. This trend appears to be changing, however, which may be primarily attributed to declining interest rates in 2019. In the third quarter of 2019, the average rate on a 30-year fixed mortgage was 3.69 percent, compared to a 4.54 percent interest rate for the year prior.4
Many industry participants are hopeful that if interest rates remain low, the labor market remains tight, and with the unemployment rate at 3.5 percent as of September 2019, the housing market may finally grow to prerecession levels.5 The growing risk of a recession might hamper this, however, as a growing number of economists (between 30 and 40 percent) are predicting a recession by late 2020. Global economic growth has declined to its lowest level since the last recession, which is said to be primarily attributable to the risk associated with the escalating US-China trade war, with tariffs reducing investment and creating greater uncertainty in financial markets. To prepare for the possibility of a recession, insurance agencies and brokers are focusing on cost-cutting measures to increase operational efficiency and boost productivity.6
The insurance agency and broker industry are in the mature stage of its economic life cycle, which is characterized by a higher level of M&A activity. Accordingly, 649 transactions were announced between the third quarter of 2018 and the third quarter of 2019, marking the second-highest 12-month period recorded, just after the 672 transactions announced in the 12-month period leading up to the second quarter of 2019. Approximately 67 percent of these transactions were backed by private equity firms.7
One of the industry's largest operators is Arthur J. Gallagher, which completed 507 acquisitions from 2002 to 2019, with 48 acquisitions in 2018 alone. A significant portion of these acquisitions are small and focus on niche markets and/or specific geographic areas. For instance, the largest of the 2018 acquisitions was for Pronto Insurance at an acquisition price of $313.5 million. By June 2019, the company reached a market share of 2.3 percent.8
Enterprise value (EV)-to-earnings before interest, taxes, depreciation, and amortization (EBITDA) multiples continue to be the most prevalent when assessing valuation metrics for insurance brokers and agents. Transaction multiples typically reflect the level of risk associated with a company as well as growth prospects.
For purposes of analyzing current market valuations, we compiled valuation statistics for the following group of publicly traded companies (the "Industry Group") that is representative of the agency and broker segment of the insurance industry.
Arthur J. Gallagher & Co.
Brown & Brown, Inc.
Marsh & McLennan Companies, Inc.
Willis Towers Watson, PLC
These graphs illustrate the average next 12-month (NTM) EV-to-EBITDA multiples9 (Figure 1) and the projected long-term earnings per share (EPS) from the third quarter of 2017 through the third quarter of 2019 10(Figure 2).
Figure 1: Average Industry Group and S&P 500 Forward EV-to-EBITDA Multiples Based on NTM
Figure 2: Average Industry Group and S&P 500 EPS Growth (%)
While EBITDA multiples were starting to level out in fiscal 2018, Figure 1 shows these multiples have steadily increased over the first three quarters of fiscal 2019 for the Industry Group. Similarly, Standard & Poor's (S&P) 500 EBITDA multiples have increased in 2019, rising from a brief decline at the end of fiscal 2018. Since May 2018, average EPS growth has risen for the Industry Group with a fair amount of volatility in the last half of 2018. This increase can be attributed to the accommodative economic conditions that have been driving industry demand. Over the same period, average EPS growth for the S&P 500 has been on a downward trajectory overall, which can be attributed to the market impact of political uncertainty stemming from the US-China trade negotiations escalating over the last year.
EPS growth for both the Industry Group and the S&P 500 has tapered in the first three quarters of fiscal 2019 after decreasing sharply in January 2019, which coincides with the Federal Open Market Committee's (FOMC) decision to raise its target rate for the federal funds rate from 2.25 to 2.50 percent as communicated in both its first quarter and second quarter announcements.11 On September 18, 2019, however, the FOMC lowered the target rate range for the first time since the 2008 postrecession period, bringing the target range to 1.75–2.00 percent.12 Given the short timeline since this decrease, however, the effects on EPS have yet to be seen within the market.
The market multiples have remained on an upward trajectory for the past couple of years, supported by a prosperous economy and an accommodative interest rate environment. Low-interest rates foster inexpensive debt to finance acquisitions. The average EBITDA margin for the Industry Group has remained relatively unchanged at approximately 23 percent from 2014 to 2019.
Other Market Observations
Effects of the Tax Cuts and Jobs Act
The US Department of Treasury and the Internal Revenue Service has yet to issue guidance on particular provisions enacted through the passage of the Tax Cuts and Jobs Act (TCJA) on December 22, 2017. Accordingly, businesses are doing their best to adapt to the changes enacted pending such guidance. Overall, US insurers have benefitted from the new tax code as the reduction in the corporate income tax rate from 35 percent to 21 percent has boosted profitability and cash flow. However, some believe that despite the positive initial results, the long-term impact of the TCJA is yet to be realized.13
Insurers have started making climate change a central area of concern. One example of this was when Axis Capital became the first US insurer to restrict coverage for coal and tar sands projects on October 16, 2019. The company called the policy its plan to "accelerate the transition to a low-carbon economy." Under this policy, Axis will restrict insurance and reinsurance coverage for new tar sands extraction, pipeline projects, and associated infrastructures. Moreover, Axis will no longer insure companies generating more than 30 percent of their revenues from thermal coal mining, producing 30 percent of their power from coal, or holding more than 20 percent of their reserves in tar sands. While Axis is the first among large US insurers to restrict coverage of the fossil fuel industry, it is likely more insurers will follow suit in the coming years.14
In 2019, technology was the major cost-cutting and growth driver of the insurance agency and broker industry, particularly with the applications of cloud computing and blockchain. Initially, when cloud computing first was embraced within the industry, it was viewed purely as a cost-saving measure, which helped both garner and retain interest. Now, however, the utilization of cloud computing is also focused on matters of efficiency, such as speed, flexibility, and scalability. Accordingly, cloud providers have started gearing their products and services toward focusing on helping insurance agencies gather insights from data pulled from cloud systems at a relatively low cost.
Blockchain's position in the agency and broker industry has been mainly focused around basic education and proofs of concepts thus far. Soon, though, the industry is expected to start utilizing blockchain to launch many applications improving day-to-day operations. This trend has taken off in other parts of the world, such as with AXA in Europe, which offers flight-delay insurance through a platform supported by blockchain.
The recent performance of the insurance agency and broker industry has been enhanced due to beneficial macroeconomic conditions over the last year, with low unemployment, rising consumer disposable incomes, and low-interest rates. Additionally, the market has felt the short-term benefits of the TCJA with lower effective tax rates, although the long-term benefits have yet to be determined. With this economic prosperity, Americans have been able to purchase more products that warrant different types of insurance coverage, thus driving industry demand. Under these favorable economic conditions, M&A activity has been at an all-time high, with a record number of transactions year over year, and an increasing number of these being private equity-backed. Accordingly, valuation multiples have expanded since May 2018, as shown in Figure 2.
The industry also experienced a higher demand for its products due to positive demographic changes, such as increasing homeownership rates, albeit at a slow pace. Looking forward, however, the chances of a recession dampening the US economy are growing, causing insurance agencies to focus more on cost-cutting measures to prepare for the possibility of a downturn. Accordingly, insurers are increasing investments in technology, such as cloud computing and blockchain.
Opinions expressed in Expert Commentary articles are those of the author and are not necessarily held by the author's employer or IRMI. Expert Commentary articles and other IRMI Online content do not purport to provide legal, accounting, or other professional advice or opinion. If such advice is needed, consult with your attorney, accountant, or other qualified adviser.
1 Special thanks to coauthor Z. Eric Stephens, CFA, a senior vice president with the BVA Group, where he focuses on valuations for tax, employee stock ownership (ESOP), and transaction purposes. Mr. Stephens has valued a number of companies related to the insurance industry, including companies that provide warranties and companies that develop software for insurance industry participants.
2 IBISWorld Industry Report 52421: Insurance Brokers & Agencies in the U.S., IBISWorld, June 2019.
3 Quarterly Residential Vacancies and Homeownership, Second Quarter 2019, US Census Bureau, July 25, 2019.
4 "Mortgage Rates," Freddie Mac, October 17, 2019.
5 "The Employment Situation—September 2019," Bureau of Labor Statistics, October 4, 2019.