Amid Slowing Revenue Growth, More M&A Moves Expected By Brokers

Following up on a very strong 2002, the insurance brokerage industry generated strong revenue growth and profitability in 2003. In our view, the hard insurance market clearly made an early impact on the operating performance of the brokers, as rising rates resulted in double-digit revenue growth and significant profit margin expansion.

However, as we look out to 2004, we expect revenue growth to decline, as premium rate hikes slow and deteriorate in some areas, and we anticipate continued acquisition activity. We expect profit margin expansion to stabilize and possibly decrease as rates soften.

Organic Growth Slowing

With accident-year results looking strong for 2003 and cash flows also robust, the best of the hard market is behind us. Absent a firmer rate market, we do not believe organic revenue growth for the property-casualty brokerage industry will significantly exceed GDP growth.

Last year, reported revenue growth for the publicly traded brokers stayed strong, at close to 20 percent, after 26 percent growth in 2002. However, acquired revenues constituted an important part of that growth, with average organic growth rates falling below 10 percent in 2003.

The brokerage stocks performed reasonably well in 2003, with an index of broker stocks returning just over 11 percent to shareholders in 2003. However, the market appeared to recognize improved fundamentals among the underwriters, as higher levels of premium written in 2002 were earned in 2003, accompanied by a benign loss year. The p-c insurer index returned almost 18 percent during the year.

We expect more of the same in 2004, as broker results push past their peak and underwriters move into their peak return-on-equity years.

An accompanying graph details the relationship between growth in net premiums written by p-c insurers and revenue growth for public insurance brokers. In general, brokerage revenue growth tracks closely with net premiums written. We note that the brokerage revenue growth of the late 1990s was impacted by acquisitions, some of which were private companies. However, overall, the p-c hard market periods the mid-1980s and the years from 2002presentbenefited the top-line growth of the broker group.

Acquisition Activity Could Increase

As organic growth becomes tougher to muster for brokers, and regional banks face their own issues in clawing for non-interest income growth, we are anticipating continued acquisition activity in 2004and it may even include the acquisition of a larger publicly traded broker. We think speculation over such a transaction should keep valuations high.

The insurance brokerage market, particularly the U.S. mid-market, remains highly fragmented and largely comprised of private insurance agencies with under $20 million in annual revenues. Industry sources estimate the aggregation of the top 10 brokers in the United States make up just 10 percent of the mid-market, implying a large basket of acquisition targets.

Already, there has been evidence of appetites for brokers, following the acquisition of McGriff, Seibels & Williams Inc. by BB&T in late 2003 and the announcement of Hub International s participation in the acquisition of Talbot Financial (Safeco's brokerage operations) in March 2004.

In all, we believe the insurance brokerage industry remains a sector with strong cash flows and earnings. However, the managements of brokers will likely face margin pressure, and expense management will become increasingly important to support double-digit earnings growth. As a mitigating factor, current stock valuations for brokerage firms may be held aloft by acquisition speculation.

Jason Busell is vice president of equity research at New York-based brokerage firm Keefe, Bruyette & Woods Inc.

Reproduced from National Underwriter Edition, April 23, 2004. Copyright 2004 by The National Underwriter Company in the serial publication. All rights reserved. Copyright in this article as an independent work may be held by the author.

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Amid Slowing Revenue Growth, More M&A Moves Expected By Brokers

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