Producers Battered By U.S. Financial Crisis

The country's economic meltdown, fueled by a subprime mortgage crisis that prompted chaos on Wall Street and nearly destroyed American International Group, was the dominant topic of discussion at a major gathering of insurance agents and brokers this month, with most expecting further turbulence ahead for several insurers and their producers.

Indeed, the timing of the Council of Insurance Agents and Brokers' annual Insurance Leadership Forum–coming less than a month after an $85 billion federal government credit facility was set up to ease liquidity issues at the parent company of American International Group, prompted by the trading of credit default swaps–put the industry's woes front and center in discussions about the impact of the economic crisis on the industry.

In interviews here, several brokers said difficulties facing AIG's parent–now seeking to sell off parts of the company to repay federal loans–have clients reevaluating their positions with the insurer.

In addition, while dealing with the fallout from AIG's problems, there is a growing view here that the market is moving into a flattening phase.

LoriAnn Lowery, president of North America Lloyd's, a U.S. representative of the London-based insurance market, said the industry is in generally good shape, although there may be some pricing issues related to directors and officers coverage.

Shareholder litigation is mounting in the wake of the declining stock values related to the subprime crisis, creating potentially higher levels of D&O losses, she noted.

She said many brokers who discussed business with her at the conference were primarily concerned with taking messages of stability in the Lloyd's market back to their customers–something she assured is not in dispute. “Swings [in the markets] are based on emotion, not fact, and we need to communicate our stability [to policyholders],” she said.

With capital drying up, producing reductions in capacity, H. Wade Reece, chairman and CEO of BB&T Insurance Services Inc., said the industry will probably see pockets of softening and hardening as a flight to quality begins to take hold.

Mr. Reece said while he is not a fan of government intervention, in the AIG situation, coming to the insurer's rescue was probably the right thing to do because of the company's economic entanglements.

The move, he added, gave BB&T time to review the situation with clients. He said it is still too soon to know where the firm's clients will eventually decide to place their business, but it would be in everyone's best interest for AIG to stabilize their situation.

“We have no idea what the [overall] impact will be from AIG on the marketplace,” said Patrick J. Gallagher Jr., president, chairman and CEO of Itasca, Ill.-based insurance broker Arthur J. Gallagher.

He said future relationships with AIG will play out as customers react to circumstances. While some clients asked for their accounts to be moved, the great majority are taking a wait-and-see attitude, he reported.

“Everyone is nervous,” said Robert J. Lieblein, managing partner for Hales & Company, a brokerage consulting firm based in Harrisburg, Pa. He noted how uncertainty over AIG is prompting large risk managers to look at alternatives, positioning themselves for carrier switches if needed.

Woody Ratterman III, senior vice president of business development for the consulting firm Marsh Berry, said that on issues of pricing, many insurers cannot touch AIG, especially in markets where it writes niche business, adding that AIG writes a lot of this business.

The turmoil at AIG could embolden other insurers to try to get their foot in the door on business that may have been the exclusive domain of the insurer in the past, said Mr. Ratterman.

Responding to a question about recent comments by AIG CEO Edward Liddy that AIG will maintain underwriting discipline, John M. Wepler, president of Marsh-Berry, said while the company has always remained price-competitive, Mr. Liddy was apparently sending the signal that the insurer would not become irrational in its pricing.

The brokerage consultants, who specialize in merger and acquisition advisory services, also warned that the combined impact of the ongoing credit crisis and losses suffered because of the subprime mortgage meltdown mean lower sales prices for agencies.

There are more sellers than buyers–and because of that, the value of agencies is coming down, Mr. Wepler said.

“There are fewer buyers, and we are seeing a lot of pullback,” Mr. Lieblein agreed. “There are only a handful in the marketplace.”

AIG's financial difficulties underscore the impact of the credit crisis on the insurance industry, Mr. Wepler said, noting that one reason AIG had to seek a loan from the federal government was because private companies would not lend to the firm.

The increased cost of capital is making it more difficult for other players, especially private equity firms, to access the kind of capital they need to finance the purchases, he noted.

In addition, banks are reconsidering their involvement in their insurance operations, according to Mr. Wepler, adding that tough times and losses from the subprime mortgage meltdown have banks supporting core interests, rather than investing in insurance.

“Banks are in turmoil,” Mr. Wepler said, noting that some are selling their insurance assets to raise capital.

Mr. Lieblein said there are currently only four major players in the insurance agency acquisition world, and all are insurance brokers–listing them as Brown & Brown, Arthur J. Gallagher, HUB International and Wells Fargo. Hilb, Rogal & Hobbs was a major player, but with its acquisition by Willis Group Holdings, it is out of the picture, he added.

Mr. Wepler said 14 of the top-100 brokers in the United States are in play to be acquired, accounting for approximately $1 billion in revenue. However, he added, whether those deals will take place is now in question due to the economic climate.

Brokers are also being a lot more careful about their purchases, he said, noting that they are performing their acts of due diligence carefully before pulling the trigger on a deal.

One shift in thinking that is taking place is that while some firms are pulling back on acquisitions, regional brokers are becoming players in buying agencies–but not on a large scale, according to Mr. Wepler.

The strategy, he noted, is that agencies are becoming more affordable, with prices coming in at the range of five- or six-times earnings, where in the past it could go as high as seven- to nine-times an agency's annual earnings figure.

Firms continuing to secure high multiples are benefit agencies–something that has not changed in the past, said Mr. Wepler. Uncertainty over the future of health care insurance after the election is driving brokers to get into that business, or find agencies that can reinforce what they have. Prices there can range at seven-times earnings or higher, he said.

However, being an insurance agency with a book of business is not enough any longer, Mr. Wepler noted. Those who are looking to acquire are seeking agencies that are profitable, predictable and display substantial organic growth.

“We are seeing a resurgent focus on organic growth,” said Mr. Wepler, noting that agencies are changing their thinking about producers, getting rid of those who are failing and bringing in new blood.

Patrick T. Linnert, executive vice president at Marsh-Berry, noted that agency principals no longer want people who aim to build a book of business and plan to live off of it by maintaining it for the rest of their careers.