Merger and acquisition activity in the broker sector is set to continue in 2015. What are the potential pitfalls and how can they be avoided?
Consolidation in the Lloyd’s and London market broking sector is set to continue, with a number of big name deals taking centre stage at the moment. But the recent problems at Towergate are a stark reminder that successful deal-making is no easy task.
Broker consolidation was a central theme in Post’s 2014 annual review of Lloyd’s and the London market, and there were two deals in particular that grabbed the headlines.
Willis Group has taken an 85% interest in the Miller Insurance Services partnership, following talks that began towards the end of last year. The deal is subject to regulatory approval and is expected to be finalised in the second quarter of this year.
The tail end of 2014 also saw Hyperion Insurance Group enter exclusive merger discussions with RK Harrison. These discussions are ongoing and the market expects further news in the coming weeks.
Back in 2012, Hyperion also bought Lloyd’s broker Windsor, while more recently it has acquired UK-based Powell Bateson and a majority stake in German insurance distribution group Schouten Sicherheit International GmbH.
The reasons behind these deals are legion and David Howden, CEO at Hyperion, comments: “In both the London and UK retail markets there have been a swathe of deals over the past five years. Some of that is driven by cost, some of it is driven by regulation and some of it is driven by the need for the investment in technology. Some is driven by a simple lack of succession planning.”
Whatever the reason behind each individual merger and acquisition, there are more to come. “I do not think there is any doubt about it,” says Toby Esser, CEO of Cooper Gay Swett & Crawford. “We are going to continue to see consolidation – whether that will be right up to the very largest brokers I am not sure, but we will see consolidation.”
Esser says there are a few factors driving this, adding: “First, there is not enough growth to be able to go without acquisition. Second, the cost base continues to be too expensive and last, London in particular is under pressure to continue to maintain its position in the market. I do not think there is any question there will be changes.”
CGSC is no stranger to consolidation activity – less than 18 months ago it acquired Lloyd’s insurance and reinsurance broking group Newman Martin and Buchan, although Esser says he has no other London market targets in his sights at the moment.
In addition to the internal desire shown by brokers to consolidate and grow their operations, there has also been increased interest in the sector from private equity capital over the last four or five years.
“We are seeing huge interest from private equity in insurance – and particularly distribution,” says Olly Laughton-Scott, founding partner at Imas, a specialist M&A consultancy firm in the financial services sector.
Laughton-Scott says the interest in insurance distribution comes from the fact it is not seen as a capital-intensive industry and that there is potential for acquirers to put in place broad incentive packages at target firms. “It is still a sector where it is possible to buy a business and really provide incentives to the management team,” he explains.
This may be true but it does not mean consolidation is a sure-fire way to deliver success. Indeed, where brokers focus purely on scale and ignore the fundamental building blocks of a merger or acquisition they are almost certain to come a cropper.
Over the years, Howden has led Hyperion in its different forms through many acquisitions, although he is insistent there has been a strong business case behind each one and scale has been a by-product rather than the end goal.
Whether M&A activity helped access a new market or helped develop Hyperion’s footprint in national and international markets, he says all 50 or so deals completed in the past 20 years have been carefully considered.
“M&A activity can accelerate one’s ability to achieve strategic goals, but it does not replace the need to drive business growth through recruiting great talent, coming up with great products and helping clients understand and insure new risks.”
This is the lesson Towergate forgot, according to many market commentators, as it went about building its business and acquiring 175 intermediaries in less than 20 years. The scale it created and the model it employed changed the insurance landscape in the UK, but did not deliver the long-term benefits it could have, as one source, who prefers to remain anonymous, told Post.
“[Towergate was] able to change the terms of trade very significantly to its advantage and, therefore, the acquisitions it was making all seemed to make fantastic sense. But it did not focus on integration, it purely focused on buying.
“All the long-term benefits did not materialise and then the terms of trade moved against [the business]. It got fantastic deals but as those deals became less available, for a whole host of different reasons, the lack of integration then began to catch up with it.”
But for brokers to get the best long-term value out of a merger or acquisition, what are the fundamentals they need to focus on? In short, they need to ensure the two organisations coming together can enjoy a shared culture and operate successfully as a single entity.
Many questions need to be asked. Do the brokers coming together have the same view on client service? How do they remunerate their staff? What sort of benefits are offered to employees and how flexible are they? What degree of freedom do employees have to feedback ideas and contribute to the business? Are they pushed in terms of professional development and actively given more responsibility in managing their part of the business?
A warts-and-all view
It is difficult to get a warts-and-all view of another company’s culture as an outsider – but that is not to say buyers should go in completely blind.
Esser comments: “It is always a bit of a challenge to understand a business’s culture before acquiring them, but businesses do carry a reputation and there are occasions when it is pretty obvious that a business would or would not be a good cultural fit because of the behavioural patterns they show in the market.”
Similarly, many deals are done on the back of existing relationships, and these can help inform the management of both parties as to the likely success of moving closer together. “Most of the deals we have done are with people we have traded with for many years,” says Howden.
While it is easy to make such statements, creating a well-oiled brokerage by merging two firms is no easy task and it boils down to investing a huge amount of time to really thrash out the details of how the enlarged operation will work in practice.
David Lambert, insurance transactions leader at EY, is under no illusion about some of the difficulties involved in bringing two brokers together. “It is about making sure there is complete clarity on what the teams do, how they are rewarded and compensated and identifying the people you must keep on side in both organisations.”
What makes this more difficult is that many brokers have an established history and Lambert adds: “These organisations have grown up over a long time – either organically or inorganically – with a whole bunch of specific ways of rewarding and measuring their teams and it is very difficult to realign those when you are putting organisations together.”
Period of upheaval
The thought of growing the business and outgunning competitors may be exciting, but the desire to get the deal done cannot come at the expense of properly thought-out processes that guide the merging businesses through this period of upheaval.
It is also important that communication channels remain open and information is quickly and consistently distributed to the relevant parties including staff, clients and shareholders.
In many instances, companies have lost control of this process and been forced to make hasty responses to leaks or found themselves facing questions from disgruntled staff and clients who have been left in the dark. Neither of these creates a good basis to build on – and can destabilise things moving forward.
Lambert accepts brokers going through a merger could put in place the detailed plans they require without recourse to external consultants. But he does feel it is not as easy as many think, and that for the management teams of both organisations to work directly with each other during these negotiations can be difficult.
“It is often good to have a neutral participant who can speak candidly and take some of the flak when there are unpopular decisions being made to balance the cultural fit and alignment of both businesses,” comments Lambert.
Similarly, he says it is difficult for stakeholders to remain truly objective. He continues: “The other way consultants like us can come in is to challenge the status quo in both organisations. It is very difficult for incumbent managers to look objectively at their own business and the business that is being bought.”
Even where brokers get the cultural and strategic fit right, they may find there are challenges to overcome as a new entity. In selling a stake in its partnership to Willis, for example, there may be several issues that Miller now has to deal with, having given up its independent status.
David Ross, former CEO at Arthur J Gallagher International, who has left to take up the reins at Towergate, has said the deal marks the loss of an important independent firm and is “a bit of a tragedy”. Given the acquisitive nature of his past and present employers, some would question his right to criticise, but he is not alone in his view.
Certainly Esser believes there is a powerful differentiation to be had from independence, and he comments: “If you are an independent retail broker and you are looking for access to the London market then you do not really want to be dealing with someone who competes with you – whether directly or indirectly.”
Before any deal completes there will be logistical hurdles to overcome and some unforeseen issues to contend with. In giving the requisite warranties on the business, sellers may be left with an overhanging liability. Additionally there may be unresolved tax issues or potential liability claims that the buyer will have to deal with in the future.
These clearly present a problem for any buyer and they will look to price in the worst-case scenario to protect themselves should these issues come to fruition at a later date. As such, M&A insurance is something brokers may want to bring into play. Beazley, for example, offers a range of covers in this market and has an appetite for financial services and insurance businesses that not all others do.
John McNally heads up the transaction liability team at Beazley and believes the cover can bring a measure of certainty and comfort to both parties during negotiations. He says policies can cater for “any contingent issue that creates a pricing obstacle or completion obstacle between buyer and seller”. He adds: “On a broad basis insurers can look at that and put cover in place at a price that is going to be more effective for sellers and give buyers downside protection in the event that something goes wrong. It allows sellers to exit on a cleaner basis and without having this overhang of indemnification and potential liability.”
Whether or not brokers involved in M&A take up this cover is their call, but it looks likely there will be a lot more deals for McNally and his team to go after.
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