Having almost doubled over the past 10 years, brokerage value may be levelling off with the deterioration of the industry’s results, although a number of factors could just as quickly push the values back up again, according to David Crozier, a principal of .bcc consulting.
In an article published in the MSA Quarterly Report Q3-2012, Crozier noted that broker multiples of 1.5 times net commissions was common more than 10 years ago, but a more frequent starting point in recent years has been 2.75 times net commissions or more.
In a separate article in MSA Quarterly, Graham Segger noted that brokers’ earned gross commissions represented 17.06% of their gross earned premiums. Approximately 8% of gross commissions were paid based on contingent formulae in 2011.
Crozier indicated several conditions are in place to push brokerage’s multiples up further. For example, the insurance industry in Canada is overcapitalized, with some insurers carrying Minimal Capital Test scores of 240% or higher, well above the regulatory minimum target of 150%.
Add to that competitive reinsurance rates, sluggish economic growth, a soft commercial insurance rate environment, and favourable auto insurance results, and insurers appear to have the deep pockets and motivation to drive the acquisitions of brokerages.
Nevertheless, “rate suppression and lower contingent profits have had an effect on the valuation of commercial-only or specialty brokerages,” Crozier writes, citing John McArthur, president of John C. McArthur & Associates.
“If the brokerage has not managed to control expenses during the economic slowdown and soft rate environment, the brokerage’s earnings before income taxes, depreciation and amortization (EBITDA) has deteriorated and the resultant value expressed against net commission or EBITDA has been subject to downward pressure,” Crozier writes.
Crozier likened broker mergers and acquisitions activity in Canada to a game of musical chairs.
Following his analogy, the industry’s deterioration of results over the past few years has provided the tune that keeps brokers and insurers “circling the market, wary of competitors’ strategies,” and looking for a coveted place to be when the music stops and the acquisitions start.
What conditions would stop the music and start acquisitions of brokerages?
“A number of factors could just as quickly change to increase brokerage sale prices, such as improving market conditions in commercial [lines], resurgence in economic growth or rebounding contingent profit commissions which helps to rebuild a stronger EBITDA,” Crozier writes.
