GROWTH IN THE INSURANCE BROKERAGE INDUSTRY: Real Or Manufactured?
The Risk Management Letter - Volume 24, Issue 6
Many investors may wonder why the industry brokerage stocks are lagged behind the remainder of the overall market during 2003, especially in light of the continuation of premium rate stability. The answer lies in companies’ organic growth rates, or lack thereof. The organic growth rate for a company removes the effects of acquisitions and currency fluctuations (for those companies with international operations) and gives investors a clearer picture on how well the company is doing from a pure operational standpoint. Investors generally prefer companies with strong revenue and earnings growth. However, some of these companies that are presenting strong overall growth in revenues and earnings may be masking a slowdown in their organic growth through acquisitions. The industry’s leading brokers were evaluated for this purpose as of September 30, 2003 and the corresponding results were quite astounding.
Importance of Organic Growth
There are only a few methods to truly assess the health of a company and its growth. One important measure is “organic growth”, which sets aside the deployment of capital for acquisitions and measures a company’s success by assessing current results based upon resources owned at the beginning of that period. Organic measures remove any non-recurring, acquisition or foreign currency fluctuations, which can mask the overall pure growth of a company.
Since many of the publicly traded insurance brokers make acquisitions to various degrees, organic growth rates enable an apples-to-apples comparison of results. Exhibit 1 presents a more in-depth analysis on the companies overall growth and reveals interesting information about individual results.
As expected, the more acquisitive brokers like Brown & Brown, Hilb Rogal & Hobbs (HRH) and Hub International (Hub) reflected overall revenue growth rates in excess of over 25% for the nine month period, ending September 30, 2003. When delving deeper into these results however, only a small portion of this growth was generated organically. Of these three, Hub was the only company able to post organic growth in the double-digits, at 13.5%. While both HRH and Brown & Brown reported strong increases, only one-fourth of their growth was organic. This leads to an indication that both companies may be relying too heavily on acquisitions. Because of these below average rates, in relationship to the industry, HRH and Brown & Brown have lagged behind not only their peers, but the overall market in terms of year-to-date stock performance. Investors clearly have concerns about the sustainability of the growth rates for both companies should they confront obstacles with their acquisition strategies.
The main question among shareholders should be, “Why are there not stronger synergies and growth from prior acquisitions”? This could be a tell-tale sign that same companies are not achieving growth from its base, or prior acquisitions and a possible indication that integration is not going as smoothly as anticipated.
U.S.I. Holdings reported organic growth of 5.3%, which placed it at the bottom of the industry segment. U.S.I. has noted that revenue growth was negatively impacted by a moderation in insurance rates. One positive note is that U.S.I. has maintained a good balance between its overall and organic growth.
Willis Group has been the star performer of the leading brokers by organically growing 17.0% for the nine-month period. Preferring to take a different route in comparison to its more acquisitive competitors, Willis has mainly focused on growing its internal operations and made only two acquisitions in 2003. Meanwhile, Marsh & McLennan also posted admirable results with an organic growth rate of 14.0%. Marsh, for the most part, has shied away from insurance brokerage acquisitions, announcing only one transaction, during 2003. Marsh is currently contending with a larger issue - the ongoing troubles at its Putnam Investment Management unit where it has been accused of allowing improper trading of its funds, which may hinder any acquisition activity in the near future until these issues are resolved.
Aon grew 10.0% organically and has been concentrating on improving the results at its brokerage unit. Aon would likely benefit from focusing on its insurance brokerage and consulting practices and divesting itself of its insurance underwriting unit. With merger and acquisition activity picking up in the insurance sector, the likelihood of a sale occurring has certainly increased compared to when it was exploring this option in 2002. A divestiture or spin-off of this unit could increase the stock price a significant amount and making it easier for analysts to value the company and allowing management to focus its energies on its insurance brokerage and consulting units.
Arthur Gallagher reported a healthy organic growth rate of 13.3% and has benefited from their active recruitment and hiring of producers in 2001 and 2002. While Gallagher remains acquisitive, it has maintained a good balance of “hired” and “acquired” growth.
Industry organic growth rates have declined from previous levels mainly due to a moderation in the rise of property & casualty product commission (P&C) rates. Although rates are still moderately increasing, it is not nearly at the same level as in the past few years. This factor, along with tougher comparisons from prior year levels has led to a deceleration in organic growth rates for many industry brokers. It is anticipated that organic growth rates will continue to trend downward in 2004 as these particular factors persist in the near future.
Investors accustomed to upward revisions in earnings estimates after the quarterly announcements should prepare themselves for relatively stable projections until these companies have more clarity on product pricing trends. It appears inevitable that P&C product rates will eventually stabilize further and that the publicly-traded brokers will be forced to become more dependent on their respective acquisition strategies to augment their growth. The key to success will lie in the ability to balance organic versus the overall revenue growth.
A Look Ahead
Two companies that look well positioned for the upcoming period ahead are Willis Group and Arthur Gallagher. Willis Group, with strong internal growth from operations and a continued reduction in debt, has shown that its management is very astute in growing the company since its leveraged buyout that took place five years ago. Arthur Gallagher’s strategy of aggressively hiring producers in its brokerage segment during 2001 and 2002 appears to be paying dividends now as these new hires ramp - up their book of business.
Two companies that may have concerns going forward are HRH and Brown & Brown since both are heavily dependent on acquisitions to fuel their growth. Although Brown & Brown has not shown any signs of a decline in the number of agencies and brokers that it acquires, the list of attractively priced and well-managed brokers may eventually begin to decrease as other insurance brokers and banks continue with their acquisition strategies. As Brown & Brown gets larger, it will either have to make even more acquisitions or increase the size of its acquired agencies to continue at its current growth rates. Otherwise, growth rates may continue to decelerate at this acquisition powerhouse. HRH faces these issues as well as having to mend the slowdown occurring at its Hobbs unit. Although these two companies have rewarded their shareholders quite handsomely over the long-term, investors must consider these issues going forward.
In total, the state of the public brokerage market would indicate that a fair measure of revenues and earnings has become manufactured through the acquisition process. With the impending product rate stabilization, it appears that only those companies who are “fit” will continue to prosper long-term. In the end, only those brokers who effectively manage and balance true organic growth with acquisition growth will adequately satisfy investors while meeting the challenges of a competitive market landscape.