An Acquired Taste for Global

How do commercial insurance brokers conquer the world outside their home borders? They choose carefully.

Some build global alliances. Others go the M&A route. And still others look to expand into new markets. No matter how you do it, all paths must be approached with caution.

Building out global alliances of like-minded peers that complement existing operations and help growth is one border-crossing method. The nature of such alliances varies, as does the scope of commitment. Over the past few years, some variations have emerged, such as Renomia’s company-centered networks, in which its members operate independently but support each other in cross-border risk placements. Or Brokerslink’s network of independent brokers, whose members are vested partners and equal shareholders.

For more aggressive “individualists” with the means to scale and vast global ambitions, there are mergers and acquisitions. Recent data from global insurance investment management company Conning show the global deal volume in 2015 was nearly $20 billion. This comprised mostly bolt-on transactions that helped brokers develop broader product offerings. Transformational, large-ticket mergers, such as Willis Tower Watson’s, or BB&T’s acquisition of U.K.-based Swett and Crawford, are still infrequent.

But as more brokers confront complex international business decisions requiring a strategic approach to M&A, both types of deals are expected to increase. Insurance intermediation has always been about clients, so when clients look increasingly beyond familiar markets, brokers need to improve their global competencies to retain their accounts.

It isn’t a simple process, and many brokers continue to approach cross-border deals with extreme caution and due diligence. They make sure operations are compatible and complementary, compliance costs are reasonable and options for legal recourse are clear. Translating values and business models to a new, foreign market is an even tougher challenge, as is understanding how your current acquisitions align with your company’s and clients’ long-term strategy. 

“The fundamental question is how you create something truly global,” says Arik Rashkes, managing director for the Financial Institution Group at Houlihan Lokey, the leading investment bank for global M&A. “The notion is to get something that is very efficient and works on the same platform. But you can also find yourself running a hundred different companies, and that’s what people are hesitant about.”

Private Equity a Key Player

As with domestic M&A, private equity is driving a lot of brokerage M&A activity, both in North America and globally. “The insurance brokerage space has been extremely attractive for private equity,” Rashkes says.

“They have been very deep on insurance brokers for over the last five years, and you can see it all across the board.” What private equity firms naturally love here is a steady cash flow, “something you can predict is a huge thing after they got burned with unstable businesses.”  

Of course, there are obvious advantages to these arrangements for brokers, as they get access to a big capital machine with clear benchmarks for growth and favorable conditions for a leveraged buyout. All this has been good for companies’ price-earnings ratio. But as the interest rate is rising and brokerage price-earnings in North America plateau, the leveraged buyout loses its appeal. The prospect of higher rates this year may push North American buyers to invest more in smaller retailers domestically and globally, and there is no shortage of quality options. As the dollar remains strong against other currencies, solid overseas companies may look like a steal.

Brexit and Trump Shake Up Stable Markets

Another factor that affects global M&A is the increased geopolitical uncertainty. “Cross-border transactions will hurt in the next couple of years due to much commotion and change,” Rashkes says.” Persistent crises in the Middle East and economic troubles in major emerging markets have been a constant backdrop, steering investors toward more stable markets in the United States and Europe. Yet these fairly reliable markets were made much less certain last year by Brexit and the unclear prospects of the European Union framework moving forward, as well as anticipated changes in America’s international and domestic agenda.

President Trump’s dramatic arrival to the White House signaled a new era for both the finance industry and foreign affairs. As we have observed, the current president takes his election promises literally and very seriously. And while we have yet to find out which sectoral and international priorities will top the administration’s agenda this year, it is clear the traditional trade policy, based on a free flow of goods, capital and labor, is being fundamentally dismantled—to the dismay of U.S. commerce and investment partners in Europe, North America and Asia Pacific. If the tide of globalization begins to ebb, so will any residual confidence in global mechanisms protecting foreign investment.

The industry is also closely following how the Brexit process evolves, as it affects Lloyd’s role as a global insurance hub and the U.K.’s access to European markets through the simplified passporting procedure.

Passporting has been a very handy instrument for foreign and U.K. investors to anchor a regional office in the heart of global finance in London, while being recognized by EU states’ licensing authorities as a local entity. As the debate about Brexit’s effect on passporting and the extent of a future U.K.-EU partnership unfolds, companies are confronted with new costs and staggering realities of investing in the EU and Britain.

For Britain-based companies and Lloyd’s, it is essential to preserve the most favorable access to the EU market, which depends on the results of withdrawal negotiations. Under the worst-case scenario, companies’ acquisitions in the U.K. will not enjoy the same benefits as before, which will understandably decrease London’s appeal. In anticipation of that, some global carriers with operations in the City have rushed to exit.

Lloyd’s is not sitting idly either, and is currently working on a contingency plan to absorb associated exit shocks, such as restricted financial market access and more limited access to a potential pool of talent. Lloyd’s accounts for 20% of the City’s GDP and more than £60 billion in written premiums, so there is much riding on the company’s ability to remain in the global insurance marketplace.

Ironically, some industry experts see a silver lining even in the worst-case scenario of Britain’s divorce. They contend London’s independence in financial regulation is worth the cost. Brexit will free regulators and the local industry as a whole from implementing burdensome, Brussels-imposed common market directives, which hurt British sovereignty, not to mention national pride. Euro-skeptics in Britain remember the times outside of the EU when London was a thriving offshore center on steroids for dollar-denominated transactions and a hub for alternative investment and emerging market finance. Nobody dictated when or how authorities would regulate the industry, as is the case with Solvency II and other rules. In return for conceding policy-making power, Brits are troubled by mandatory transfers to support Europe’s poorer regions, which already send labor migrants to the U.K. If done right, they argue, Brexit presents a valuable opportunity to go back to London’s past financial glory and make it more globally competitive and more attractive for potential foreign investment by opening to more capital and less regulation.

John Eltham, the head of North American Broker Business at Miller Insurance Services, in London, says the Brexit referendum has made a major impact on the rate of exchange movements relative to the British pound. “As we earn much of our income in foreign currency but pay ourselves in sterling, this has had a positive effect on profit margins,” says Eltham, who is also the chair of the Council’s International Working Group. “It has simultaneously made the relative cost of acquisition in USD terms lower and therefore more attractive. It is not by chance that Aon chose to re-domicile in London and that foreign capital continues to flow in to the City with investments in both broking houses and major insurance carriers.

“The London insurance market has built a unique infrastructure and concentration of knowledge. This is supported by the entrepreneurial spirit that has seen London establish itself as the leading global financial center, fueled in part by the cosmopolitan nature of its inhabitants. This spirit will not alter post-Brexit.”

Better Buyers than Sellers

While the regulatory uncertainty in London and the U.S. is new, local regulations and compliance rules in other countries such as China have and continue to pose challenges for foreign investors. “Foreign-owned brokers have to go through a set of costly requirements in China, including restrictions on the form of establishment and capitalization levels which are attainable only for the top 10 to 15 global players,” says Alex Yip, Lockton’s CEO for Greater China.

We have also seen insurance companies reducing their exposure in the Chinese market or exiting it altogether. One reason is a growing uncertainty over how national regulators respond to general market volatilities and capital outflows, which underlie the fundamental state of China’s evolving financial system and the government’s goal to keep tight controls over the renminbi. Restrictions on transfers abroad, implemented last year, were disruptive to companies’ operations, affecting their ability to repay loans to overseas investors or pay dividends to foreign stakeholders. Provincial authorities add another layer of bureaucratic riddles, so the cost of compliance adds up, as foreign investors burn money on higher capitalization, local staff training and new technology. 

On the other hand, China and Japan have been on a global shopping spree. Although an Asian investor has yet to acquire a sizeable Western brokerage, the conditions are ripe for local capital to move offshore. Last year the Chinese completed the most international M&A by volume after the U.S., acquiring 777 companies at a combined value of $225 billion. And several insurance companies were targets for Chinese and Japanese investors. Asia has become an increasingly expensive market, as assets have increased in price partly due to foreign investment. Economic growth has slowed or stagnated in some cases, and both countries have amassed a large stash of dollars they can’t spend domestically because of the lower return on investment.
In China’s case, the government is specifically pushing state-owned companies to invest abroad to gain knowledge and a foothold in key markets through the “Go Global” or “One Belt, One Road” initiatives. Both initiatives encourage corporations to diversify investments and seek strategic partners among foreign companies to strengthen their global competitive advantage.  

… And the Pursuit of Technology

Access to technology is an ever-important part of a brokerage’s strategic planning. For some, acquisitions can help gain advanced technologies that transform distribution channels, improve the client interface or provide better telemetrics and predictive analytics capabilities.

According to CB Insights, which tracks insurtech activity, the United States claims the largest share of investment in insurance technology startups at 59% of global deals in the sector. At the same time, smaller markets in Europe, and especially the Nordic region, have moved faster toward e-commerce and operational digitization and showed significant progress in automation and machine learning.

As companies’ profits suffer due to claims unpredictability and low interest rates, cutting operational cost through technology is top of mind for senior management. McKinsey estimates that over the next decade the insurance sector in Europe will shed around 250,000 jobs due to modernization, and most of those losses will happen in repeatable and support functions related to reporting and analysis. As a result, most of the client interface—from risk insurance purchase to claims processing—would happen exclusively online. 

Asia is on the other end of the spectrum. Its growing population and challenges associated with traditional insurance distribution make it an interesting target for overseas insurance technology investors. Difficulties in raising capital and an insufficient number of skilled entrepreneurs in the sector, coupled with the inherent cultural aversion to startup failures, result in a weaker early-stage startup ecosystem in most Asian economies. The lack of quality filters present in the United States and Europe will be unlikely to produce highly competitive Asian versions of Zenefits and Lemonade, conceding the market to foreigners with advanced business acumens, deeper insurance expertise and available cash for a more aggressive expansion.

In 2015, U.S. and local private equity firms invested $1 billion in Chinese online-based Zhong An Insurance, the largest transaction in p-c insurtech that year. The transaction gave U.S. investors a shot at capitalizing on the fast-growing insurance segment and a stake in the first licensed online insurer that “aims to extend its disruptive approach to the traditional insurance industry.” Accenture estimates that China’s online insurance premiums will grow to more than $60 billion by 2018, increasing the segment’s local market share to 12%. Even though China, India and Japan account collectively for 11% of insurtech deals, Forbes forecast that in coming years we will see more experienced investors from the United States and Europe in this market.

It might feel at times as if the investment world we know is folding. Overall political uncertainty, the lingering economic slump, low interest rates and the lack of confidence in globalization put major cross-border investments on hold. Experts predict that in coming years we will still see activities on the fringe, with smaller deals likely to dominate. Eventually, we are heading toward a busy long-term scenario for global M&A, but only after Europe is in a better place politically, the United States is clearer about its healthcare reform and international affairs, and leaders of emerging markets get their management and operational house in order.

Gololobov is The Council’s international director. Vladimir.gololobov@ciab.com