Scaling Up, Not Shutting Down

Last we spoke, it was early 2020, right before the pandemic started. From your point of view, how has it changed investors’ perspectives of the industry?

I think the one word I’d use to describe it is “resilience.” It only furthered investors’ perceptions of the resilience of the insurance industry and the insurance distribution industry.

When the pandemic started, people were very focused on employee benefits and the implications for coverages, for payrolls, but as folks got comfortable with the risk parameters that we were facing, the result was really twofold. One, a real clear understanding of the importance the insurance brokerage industry plays in helping businesses manage their risk profile. I look at all the seminars and conferences and tutorials that your members provided to small, medium and large businesses at the early stages of pandemic, which were a huge value-add for everybody, and the help getting folks comfortable and understanding their risks and what was likely to happen. Then second, with that coaching and that perspective and the resilience of the business model, investors just really furthered their belief in the stability of both the revenue and the cash flow profiles of the business. As a result, you’ve seen a much more aggressive re-rating of the industry as folks recognize that value-add.

So how much of this do you think is sustainable for the long term?

I think a good portion. If I look at what drives valuations, first and foremost, I look at macro activity and the level of economic activity. I’m personally of the belief that, between the COVID relief, the infrastructure, whatever happens in D.C. with the budget, we are at the early innings of a multiyear economic expansion and, I think, one that’ll be likely unprecedented, at least in my generation and in my work history when I look at what we’re going to go through. That will drive growth and profitability across the board as we look to reinvent the economy.

The second is this concept of appreciation and value-add that the industry provides. You’re going to see more and more investors appreciate that and start to look at the insurance brokerage industry in a much more favorable light with this long-term re-rating. We’ve seen valuations move up, we’ve seen multiples move up, but I think that’s highly warranted in the context of what the business does.

Along those lines, brokerage M&A continued to break records last year with number of deals and, as you mentioned, very high valuations. What was the impact of COVID on the transactions? And are you seeing that continue into this year?

We saw a meaningful shutdown in the second quarter, six weeks or so where deals were really put on pause, and when they did start to come back into the third and fourth quarters, there was a real change in deal structure, with earnouts and deferred considerations being greater portions of transaction consideration.

We were kind of back to where we were, from a deal flow perspective, and we were back to where we were from a deal valuation perspective as well. I think that continues in 2021. One, as I mentioned, this economic activity will continue to drive that broadly. The growth we’re going to see will only push valuations further. There’s also some of this noise around tax reform. That’s bringing many folks into the market that would otherwise not be there. I think that’s going to potentially drive some transaction activity into the third or fourth quarters, which we otherwise might not have seen.

Thematically overall on M&A in addition to the COVID effects, what are you seeing across the board?

There are a few types of transactions happening. One, we expect to see the continued consolidation of the market by the larger businesses. That theme has perpetuated the last 15 years or so. I expect that to continue. Secondly, private equity interest in the business and sector continues and is extraordinarily robust. We’ve seen that with new private equity firms coming into the market and looking to support management teams as they build out businesses and execute on a highly proven strategy. In that same vein, it has also driven valuations, because there’s more private equity players than there have been platforms for them to invest in. We’ve talked about that for many years. I think that has only gotten more concentrated. So I expect that to continue as well. Then lastly, which is an emerging one, but a harder discussion, is potential mergers. There was obviously a large one in the industry which got called off, but some of these mid-market or larger platforms need to think really hard about their strategic future, their direction, and what they’re going to do.

You mentioned the continued consolidation by larger businesses. Can you discuss this trend?

To be honest, mergers of businesses are really, really, really hard, and there are lots of things that need to line up to give it a chance. First of all, there are the social issues. There are four parties that all need to sit down and have it make sense. That’s the owners of the respective two businesses and the management teams of the two respective businesses, and there has to be a coming together around how ownership works, how governance works, how social roles and management roles work. That’s an extraordinarily complex and difficult conversation. And you need some like-minded understanding to make that happen. I think that has been a real consideration for folks trying to have those conversations.

If you get past that point, the second real conversation is how do the financial metrics stack up. How do you manage the “Hey, my business is better than your business” kind of conversation? How do you think about what the right EBITDA is for both of these businesses? How do you think about what the right valuation multiple is for both of these businesses? If you can solve the social issues we talked about to begin with, I think you can get to a good understanding on some of these financial and operational metrics to get to a good spot. But those two elements are going to be the hardest part, to see if that pulls off. Time will tell if there’s the opportunity to do that. I’m cautiously optimistic that maybe there’s a situation or two.

We saw the Aon/Willis Towers Watson planned merger scrapped a few months ago due to an impasse with the Department of Justice. What do you think that means for larger M&A and in brokerage in particular?

From a larger M&A point—and this is across all industries—I think it was a clear message that the current administration was trying to send to the market. I even think the prior administration had a similar view, which is the creation of monopolies or oligopolies is not something that they’re going to easily sanction. I think that was a shot across the bow for the broad M&A market for folks to think about. In brokerage, there are a lot of implications for what this means more broadly. Obviously, we saw the sale of Willis Re to Gallagher. I think you will continue to see a very aggressive war for talent, and I don’t just mean talent out of one or two of these businesses; I mean across the board as folks who have the scale look to build real expertise and capabilities. That will only perpetuate itself. Folks will look for greater scale. Now, there’s less of that impact in the middle-market space, whether it’s retail or wholesale, so I expect that to continue. But more and more of these folks recognize the importance of scale, the importance of institutionalizing their businesses. I think many more management teams are focused on that long term.

You recently led the IPO of Ryan Specialty Group. Anything you want to share about the deal?

There’s really two interesting takeaways that I came away with from the transaction that your readers might appreciate. One is, this was the first IPO of an insurance wholesaler. We had to go through a meaningful amount of market education as to what a wholesaler is, what an MGA is. Yes, there are a few of the public companies that have portions of this in their business, but when it’s 100% of what you do and where you play in the insurance ecosystem value chain—for us insurance geeks, we understand the unique dynamics about it, but for the public investor, it was a very different part of the ecosystem that they’ve never seen before. I thought the education process and informing them about the business and the long-term value proposition was pretty interesting.

Second, and we’ve seen this in some more recent insurance deals in general, the investor interest continues to be extraordinarily strong for the right company and the right opportunity. There aren’t many mid-market growth opportunities in financial services for public investors at this point. Many FIG [financial institutions group] assets are balance sheet exposed, whether that’s cat risk or mortgage lending or credit lending, so you’re actually taking underlying credit risk. That’s not the case in the insurance distribution business. When you have something that fits the FIG bucket with real stable revenues and cash flows and economics, investors really have understood and gravitated to it, going back to my earlier comments on why valuations in the sector have continued to rally.

On this topic, you mentioned the middle market. Do you think that other brokerages will be prompted to consider an IPO that may be in the same space?

I don’t know if it prompts action, but it definitely needs to be part of the conversation for everybody in the insurance distribution world more so than it ever was before. Going public is never an easy conversation. It’s an extraordinarily personal decision for many companies, and it has to be the right thing for that company and that management team. Otherwise, it is not going to work. But, if someone is going to consider that path, there are really important considerations around it, which are time, significant cost, and as a public company, there’s the pressure of quarterly earnings and the stocks reporting and leverage limitations, etc. So it’s not a free option, and it’s not a panacea for all, but for some it might make sense. What it really comes down to is, do we think there’s a valuation differential in the private market versus the public market that justifies that cost and that time and that effort to make it worthwhile. Does the IPO discount overcome what could be an M&A premium? It becomes a very personal decision for many of those folks across the industry thinking about it.

Let’s talk about SPACs. We’ve seen them in the insurance industry recently. Hagerty, a specialty insurer, is merging with a SPAC to go public. Do you think that this is something more companies should consider as an alternative to a traditional IPO?

SPACs are getting a lot of attention today. And they do in some instances serve a very real purpose. Like an IPO, I think SPACs also should be part of the conversation for folks. But that is not to say it is an absolute slam dunk for many. SPACs are logical alternatives or plans if, one, there’s a real benefit for a company to market forward projections. So if there’s a transition in the business model or if there’s a change in trajectory for the earnings and you need to really explain to the market why, SPACs offer you the ability to directly engage with investors on a forward look. The second is, if there’s a need for a significant pool of capital, more so than you can get in a traditional IPO, to allow something such as de-leveraging. That’s a tough one to justify, because you can do big IPOs. But they serve a purpose there. And the third thing is, does the SPAC you’re partnering with bring something special to the business—additive to the business that is going to further its strategy?

But that doesn’t come for free. SPACs are more diluted than a traditional IPO, they have more costs involved in them, between the founder shares and the warrants, and the nature of a SPAC transaction also means there’s typically less institutional support in the market for a company than there is in a traditional IPO. Folks need to be very smart and aware of the pros and cons and dynamics and take a comprehensive approach to it as they evaluate a SPAC. I will also point out we’ve had some of these more recent insurtech SPACs that are not necessarily trading well, and investors are somewhat hesitant at this point given some of the most recent experience.

We’ve talked a lot about IPOs, SPACs and insurtechs, all of which fall into your purview in the work that you do. Can you give us some thoughts on recent high valuations for insurtechs? We’ve seen a lot of billion-dollar valuations. What’s up ahead for that group?

I continue to believe that technology will be a game changer for this industry. I look at the innovation and efficiency drive that traditional insurance companies are going to need. And I look at the customer experience they’re going to need to offer to their, for example, personal lines policyholders. Our phones have meaningfully changed our interaction with many things across financial services, but insurance has been slow to the game here. We’ve probably ended up in a spot where there’s more hype than reality for some of these situations today. But the long-term thematic of driving that efficiency, improving the customer experience, continues to resonate. I think in the insurance distribution space, finding ways to empower producers and brokers to effect the sale, to help companies manage their exposures, needs some real innovation and drive, and I think that’ll drive a lot of things going forward.

To the point on these valuations, look, I’m talking to you now in late August, and who knows where this will be by September/October, but we are in a very dynamic valuation environment today. A lot of the companies that are public out there have had very difficult quarters recently. Investors are trying to understand what is your real growth trajectory and what is your path to profitability. Until we get a little bit more clarity around that, those two elements are going to weigh on valuations. Hopefully, that transitions over time. As that becomes clearer, the continued long-term need for that innovation will become apparent. Maybe we’re in a period right now where it’s going to take a little bit more time for that to be clearer.

So what I’m hearing is, in the insurtech world, when we see these innovative focuses on efficiencies for running operations or better risk management for clients, those are really key to being successful and what the industry seems to really need.

Yeah, I think that’s right. If you talk to any of these large carriers, they’ll tell you about the 40 legacy infrastructure systems they run on and how they have a bunch of programmers working on Cobalt or C-plus or some type language from the ’60s where they’re typing in ones and zeros. But bringing that all together is important, and you think about the efficiencies they can drive if they can find a way to effectively do that. Some people have said, “Forget about even trying to do that. I’m just going to start from the beginning.” And there’s some real merit to that. I mean, it’s kind of like why Tesla didn’t go work with Ford. Musk said, “I’m going to build my own car because you don’t understand what the car needs to do.”

On the distribution side, it’s producer empowerment. What tools can you give them? What tools can you help them give to small businesses to help them (1) produce or sell and (2) help small businesses really manage their exposure in their claims.