PE Is for Prime Enablers
Private equity funds shape how we think about consolidation in insurance intermediation.
PE actors have been instrumental in driving brokerages’ market valuation across the globe and have contributed much-needed capital to ignite recent acquisitions. The annual report on sectoral mergers by Optis Partners, a financial services consulting firm serving insurance agents and brokers, stressed that private equity fueled two thirds of all transactions in 2018. Leader’s Edge reported last year that private equity was responsible for about half of all acquisitions a year earlier, and experts agree there is no slowdown in M&A activities with PE backing.
PE firms are itching for new opportunities to maximize their investment returns. Insurance intermediaries have been a private equity favorite for a while, as brokerages secure steady returns and operate in “a familiar financial services territory that provides steady and predictable cash flow and requires no material capital expenditures as exists in manufacturing or other industries,” says Optis managing director Tim Cunningham.
In fact, according to Optis, insurance brokerages supported by Blackstone, Hellman & Friedman, Apax, Genstar, New Mountain, Madison Dearborn and ABRY were the most acquisitive players over the last five years. Since 2013, the number of acquisitions by PE-backed agencies has tripled to 424, resulting in 1,487 transactions, a compelling sign of the sector’s enduring appeal.
Getting to Know You
As private equity companies get more acquainted with insurance intermediation, brokerages should also take the opportunity to reflect on how these investors interact with their business. For that, it is helpful to establish a few basic principles.
First, time is money. Private equity invests under the premise that the relationship is finite: when the return on investment slumps, capital will find a better home. A Hales report notes a shorter duration of recent private equity investments in the sector among traditional PE players.
Second, private equity companies are different in their investment strategies: they develop their own specialization in target industries, company size, or level of diversification. Some may single out financial services as their focus, while others keep a more diversified, balanced portfolio and add, say, technology to the mix. For the record, technology and financial services have been among star performers, resulting on average in multiples of two times invested PE capital.
Private equity companies also differ in their level of involvement with a brokerage’s operations. Most maintain control over the brokerage’s board and share equity with the brokerage’s management and key staff. But some PE firms opt for a hybrid ownership, offering lines of credit while the brokerage’s management keeps control of the board.
Finally, funds develop different competencies within a brokerage’s life cycles. Brokerages go through various maturity levels, and while some private equity companies acquire brokerages at inception, others would prefer more mature operations. We have seen companies being passed around by private equity players, with some brokerages even returning to their original investors. According to Bain’s analysis of global private equity, “previous PE ownership generates a reliable track record and reassures buyers that any time bombs have likely been found and defused. Research consistently shows that sponsor-to-sponsor deals have performed at least as well as primary buyouts over time, often with less risk.” Apax’s recent sale of AssuredPartners to its original founder, GTCR, is a good example of a brokerage emerging after each transaction with a higher valuation and increased confidence in growth.
Capital Crossing Borders
As in the United States, brokerages abroad are changing ownership from one private equity company to another, and PE firms are maintaining stakes in several agencies. As capital moves freely across borders, investors find new targets outside their familiar markets.
Aquiline, BGC and Madison Dearborn Partners (MDP) are just a few of the players that facilitated recent big-ticket investments in the London market. Last year, global wholesale and reinsurance brokerage Ed was acquired by New York-based BGC from the private equity powerhouse Lightyear Capital. Prior to this, BGC purchased Lloyd’s specialty brokerage Besso to start its insurance portfolio.
Globally recognized KKR has recently added a large Scandinavian brokerage to its existing stake in U.S.-based USI, while Aquiline, which owns the U.K.-based reinsurance brokerage TigerRisk, agreed to acquire Relation Insurance Services, based in California, in February 2019. MDP has cast a wider net in global brokerage investment by buying stakes in NFP in the United States, Navacord in Canada and Ardonagh Holding in the United Kingdom.
Ardonagh is a fascinating case of a U.K. brokerage and its private equity owner coming together to launch a U.K.-based general and specialist insurance powerhouse with a larger cumulative market share and stronger borrowing power. In cooperation with credit investor HPS Investment Partners, MDP was instrumental in bringing together Ardonagh’s companies: Towergate, Autonet, Chase Templeton, Ryan Direct and Price Forbes. Before this partnership came to fruition, MDP and HPS already had a stake in all companies, even though the brokerages continue to operate under separate brands.
Why go through the trouble of consolidating so many players? In this case, the acquiring private equity firms said in a press release they “intend to explore options to consolidate and optimize the group’s capital structure in the loan and bond markets, including the refinancing of existing debt.” As a result, the biggest borrower in the new company, Towergate, will get a reprieve from its corporate debt obligations, which cost the group $58 million annually. When the new partnership attacks the existing debt, it will be able to negotiate better terms and a lower interest rate as a group, as opposed to Towergate operating alone.
PE Competition Heating Up
We are in a perpetual state of change and disruption, impacted by private equity’s quest for higher returns globally. Experts forecast private equity will continue driving brokerage market valuation up in the near future, albeit at a more measured pace, while the entry cost for new PE companies will become more burdensome. Cunningham sums it up: “For new private equity players the question is: do they have the right management team in place, with deep bona fides and relationships within the industry, to attract the right, high-quality acquisitions?”
As competition heats up, investors are expected to devise innovative partnerships driven by higher efficiency, better technology integration, and the quest for market leadership. Horizontal partnerships, based on existing stakes in companies, push market consolidation boundaries for private equity firms. If this model works well for Ardonagh, there is no shortage of private equity firms with appropriate targets to replicate its success.
This story can potentially be complicated by brokerages’ evolving relationships with insurtech, as both technology and financial services remain the mainstay of private equity companies. As insurtech becomes ingrained in increasing operational efficiencies, will we also see vertical partnerships with insurance agencies, facilitated by private equity? According to Bain, “PE firms are paying closer attention to what might disrupt their carefully prepared value-creation plans. Not only are they running through more robust downside scenarios to pressure test investments, but they are also anticipating other challenges—how to cope proactively with digital disruption or how to negotiate issues like consolidation in the supply base.”
As funds compete to raise money for investment, performance pressures motivate their management to increase profits by crossing geographical and sectoral boundaries. Flexible investment models and expertise in sectors under management seem conducive to setting precedents for PE-driven partnerships we have yet to see.