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An Excess of Acquisitions?

Private equity firms are driving heavy M&A activity among wholesalers, MGAs and program administrators.
By: | October 15, 2015 • 7 min read

There’s a war going on in the excess and surplus insurance space. But instead of vying to win hearts and minds, the combatants are after premium dollars. They’re after the infrastructure of the insurance market itself, the distribution channels that can scale up books of business.

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As the proverbial spigots of excess and surplus (E&S) insurance dollars, managing general agents (MGAs), wholesale brokers and program administrators are caught in the middle. They are the spoils of this war.

According to M&A advisory firm MarshBerry, the total U.S. agent/broker deal count for the first half of 2015 was 187, a 21.4 percent increase over the same period in 2014. It’s the highest first-half deal total for the past decade.

Wholesalers, who share their expertise with given specialty lines and businesses to help retail brokers place business in the E&S market, made up 21 percent of the M&A activity. Private-equity backed and independent agencies completed 132 transactions, or 71 percent.

The involvement of private equity marks an important distinction in this current round of M&A conflagration

MGAs, which unlike average wholesalers are also authorized by carriers to underwrite and bind E&S business, are also getting gobbled up by larger players. Full-service, Newport Beach, Calif.-based insurance broker Alliant bought at least four MGAs in 2015 alone.

Program administrators (PAs), which generally manage niche insurance products (say, for gas stations), have seen a hot M&A market too.

Ray Scotto, executive director at Target Markets Program Administrators Association (TMPAA), has seen 40 member PAs merged or acquired in the past five years, half of those in the past two. About one-third of these were acquired by insurance carriers.

Oftentimes, excess distributors are also the predators.

Take the case of Conshohocken, Pa.-based MGA and program administrator, NSM Insurance Group.

“M&A activity in the excess space “is at an all-time high now.” — Kevin P. Donoghue, managing director, Mystic Capital Advisors Group LLC

Before it was acquired in March 2015 by AIG, NSM went on a mini spending specialty insurance spree of its own, picking up American Collectors Insurance, Specialty Aviation Underwriters and Executive Liability Managers Insurance Brokers. NSM’s acquisition activities, and probably its own acquisition, were fueled by a partnership with private equity firm ARBY Partners, according to reports.

The involvement of private equity marks an important distinction in this current round of M&A conflagration. It’s led to this impressive heating up — some would hint overheating — of the market, and newfound risks that insurance insiders find themselves faced with.

M&A activity in the excess space “is at an all-time high now,” said Kevin P. Donoghue, managing director of New York-based consultancy Mystic Capital Advisors Group LLC. Private equity firms are borrowing cash at near zero interest rates, massing a portfolio of agencies, then flipping the scaled-up distributors for much higher multiples.

The Spoils & The Collateral

Carty Y.K. Chock, co-founder and partner in San Francisco-based private equity outfit ClearPoint Investment Partners, has his sights on smaller insurance brokers as part of a larger specialized fund that targets services and processing companies.

Insurance brokers in general are attractive, he said, because of high free cash flow and low capital expenditures. But those on the excess side of the market, like wholesalers, are attractive as well because of their specialization.

Specialization, he said, gives them defensible market position without the underwriting risk, because underwriting risk stays with the carriers, Donoghue added. It’s a pure financial play on the MGA’s and PA’s side.

Wholesalers and their ilk also tend to possess good economies of scale, which for Chock means the ease of scaling wholesaler platforms without growing a fixed cost base. Instead, what you get is an expansion of margin.

“It’s a double-dip for value creation,” Donoghue of Mystic Capital said.

One more benefit: E&S intermediaries have a reputation for being technologically advanced. The entire E&S market is known for creativity in terms and conditions, as well as in customer service, delivering customized products promptly.

Their tech platforms can include robust end-to-end processing, as well as the analytics to empower that customization and adequate, profitable pricing.

“You have to be very cautious when investing in the space. It’s a people-based business, and you have to make sure that book of business continues to repeat.” — Carty Y.K. Chock, co-founder and partner, ClearPoint Investment Partners

What’s especially attractive about them is the repeatability of their revenues, particularly from commissions on their books of business.

“You have to be very cautious when investing in the space. It’s a people-based business, and you have to make sure that book of business continues to repeat,” Chock said.

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The seller ought to be cautious too. Some private equity firms come armed with industry insiders and expertise. Aquiline Investment Partners is the classic case cited by our sources, run by Jeff Greenberg and a number of key partners who are former insurance executives.

For those considering a private equity investor or who participate in an E&S platform built by private equity, however, the experience can be “interesting,” as Tracey Carragher put it.

Carragher has been CEO of Breckenridge Insurance Group since New York-based private equity firm Arsenal Capital Partners and Carragher’s core management team formed the wholesale broker and program administrator in 2009.

“You have no power unless you negotiate it ahead of time.” — Tracey Carragher, CEO, Breckenridge Insurance Group

Breckenridge has since aligned with a new investor with deep expertise in insurance, but memories linger.

Carragher offered words of wisdom for those insurance professionals looking to follow her path. They include getting deeply familiar with your investor partner to ensure that insurance management’s interests align with those of the private equity partners. Take time to understand the private equity investor’s priorities, exits and goals to squeeze as much value out of their investments in the interest of their limited partners.

Being transparent about exit dates at the get-go, as well as on governance structures and processes, is critical as well.

“You have no power unless you negotiate it ahead of time,” she said.

And one last recommendation is to look for private equity teams with “deep knowledge” of the insurance industry, who will understand the nuances that drive your business plan and financial results in stable and volatile markets.

“You don’t want to go with somebody who is going into it new because they definitely don’t have the juice or the werewithal,” she put it.

“You want a private equity firm that understands insurance, and then, specifically, insurance and services distribution. One should make sure that the firm has a definitive plan for participation in this sector. If not, steer clear.”

Others on The March

The challenge, too, is the competition over these good books of business. Capital is coming from private equity, as well as strategic investors like insurance carriers, who are flush with cash because catastrophes have been minimal in the past couple of years.

Some of this activity is the normal give and take of the insurance cycle. In prolonged soft markets, standard lines P&C insurers tend to take on risks they normally wouldn’t touch, the risks that typically find coverage in the E&S markets, through wholesalers, MGAs and program administrators. But now, standard lines underwriters are willing to target this business.

Henry Witmer, vice president, A.M. Best

Henry Witmer, vice president, A.M. Best

“There’s still some heavy competition going on,” said A.M. Best Assistant Vice President Henry Witmer, speaking to Risk & Insurance® about E&S and standard lines carriers. “There is a lot of crossing the borders between the two types of companies.”

To make bigger inroads into the E&S world, standard lines players can form subsidiaries, or the quickest way is for carriers and brokers to buy their way in — taking over not just the premium dollars and excess distribution routes, but the expertise and technology platforms too.

In this particular cycle, the excess marketplace is particularly healthy — aka, ripe for conquest. According to TMPAA’s Scotto, the program business is one of the fastest growing segments in all of U.S. commercial insurance, totaling about $30 billion in annual premium.

The overall E&S market recently got the thumbs-up from rating agency A.M. Best in its annual segment report on the space. Excess and surplus lines have seen underwriting profit seven out of the past 10 years, including the two most recent. The market wrote more than $40 billion in direct premiums (out of $570 billion for the entire P&C industry).

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The excess acquisition activity plays within larger consolidation trends in the commercial P&C industry.

Whether it’s ACE-Chubb, XL Catlin, Tokio Marine-HCC, Western World-Validus, or Mitsui Sumitomo-Amlin, much of the activity is driven by interest in different lines, specialty expertise, more premium and new distribution channels.

All of the competition could lead to more attention paid to risks, and more competition generally leads to lower prices for consumers.

Or, could consolidation in the overall market lead to higher rates?

The answer will probably become clearer as more battles are waged in this ongoing M&A war.

Matthew Brodsky is editor of Wharton Magazine. He can be reached at [email protected]

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