The Good: The Position of Insurance Brokers in a Resilient Industry
This week, MarshBerry introduces a series of perspectives on The Good, the Bad & the Ugly of the current insurance brokerage industry. The series discusses what makes the insurance brokerage industry a great and resilient sector, the inherent risks associated with the existential threat posed by COVID-19 and suggestions for responding to this crisis.
Today, we outline attributes that make insurance distribution a long-term, viable industry. Tomorrow, we outline the many latent risks that are materializing as a result of this pandemic. The remainder of the week, MarshBerry suggests ways to combat the related dangers resulting from an economy that remains at least partially closed.
Why is the insurance brokerage industry a great one?
The answer lies in the industry’s position within the overall economy. In a nutshell, any economy requires risk analysis, risk assumption and risk mitigation to survive and function properly. All businesses and consumers require some (or multiple forms) of protection. As a result,
1. Insurance is a “gotta-have,” not a nice to have!
Given the required nature of insurance, MarshBerry’s second proposition naturally follows:
2. Insurance (and insurance distribution) experiences extremely high levels of recurring revenues.
Most consumers and businesses rely on insurance brokers to guide them to an appropriate level of coverage. Most insurance buyers do not have the time (or desire) to re-educate a new broker every time an insurance renewal is due. Consequently, during the last twelve months, the average insurance brokerage posted retention of 91.5%.
In fact, during the depths of the Great Recession (2008–2010), at the insurance brokerage industry’s worst year of revenue retention (81.2%), net organic revenues only decreased by 4.2%.1 (During all other years of that recession, net organic revenues showed positive growth.) Enhancing the recurring nature of revenues is an insurance broker’s ability to control expenses. Did you know that the largest expense in an insurance brokerage is producer compensation? And, producer compensation is virtually all tied to revenue generation and is therefore variable.
In other words, if the revenues do not materialize, there should be no associated compensation expenses. Other operating expenses such as travel, entertainment and lodging can all be readily controlled.
Moreover, in most cases, cash expenditures for capital expenditures and taxes are very low relative to most other industries. For example, capital expenditures for such items as new laptops or servers tend to be reasonably minor capital outlays or can be effectively delayed for short periods of time. Similarly, most brokers that have been effective acquirers of other insurance brokerages have amassed significant intangible assets that, when amortized, reduce or eliminate taxable income (and therefore the payment of cash taxes).
3. Expense controls translate into very predictable and robust free cash flow.
To underline this point, during the worst of the Great Recession, net operating margins ranged from 13.4-13.7%.1 The average operating margin for the twelve prior years (1996–2007) averaged slightly less at 12.8%.1 Strikingly, operating margins held up during the worst recession since the Great Depression! This result points toward a fourth positive attribute:
4. Insurance brokerage demonstrates remarkable stability during economic downturns.
With high recurring revenues and predictable, robust free cash flow, insurance brokerages have been able to borrow significant funds at attractive rates. Over the past decade, it has become routine for the largest brokerages to be levered at greater than five and one-half times free cash flow. In a fragmented industry such as insurance brokerage, such leverage has enabled those acquisitive firms to grow their revenues by 20% or greater year in and year out by making acquisitions.
Finally, competition is limited by the regulatory and specialized nature of insurance. To effectively compete, individual producers and entire firms need to be appropriately licensed and educated in many complicated risks. Those that do not or cannot provide high quality risk management eventually exit the industry.
It should not be lost on most readers that claims could be way down in calendar 2020 as a result of the shutdown of the economy. With many fewer people working, workers’ compensation claims should be reduced. With fewer people driving to work, auto accidents and the corresponding physical damage and bodily injury claims should be lower. The 2019-2020 winter was relatively mild across the U.S. suggesting that property claims should be below normal. If this hypothesis holds, loss ratios at many insurers could be materially less. Moreover, many insureds (both consumers and businesses) are coping with work from home changes, shopping less, isolation, etc. They are not likely to be seeking to change insurance brokers in this tension-filled climate.
MarshBerry believes that these factors could result in:
5. 2020 contingent commissions could be the highest many brokerages have seen in years.
Thus, insurance brokerage is a resilient, recession resistant industry. In fact, in our opinion, when taken together, the mandatory nature of insurance, substantial recurring revenues, low capital expenditure, minimal cash taxes, strong free cash flow, the ability to diversify revenues through acquisitions and the leveragability of insurance brokers enables the insurance brokerage industry to hold the enviable title of:
6. The Greatest Industry on Earth.
However, at the risk of becoming too complacent during these difficult times, MarshBerry will outline in tomorrow’s ViewPoint the multiple risks associated with an economic downturn whose duration is currently unknowable. MarshBerry believes these risks need to be addressed with all due celerity, the ignoring of which could result in significant hardship for individual firms or the entire brokerage industry!
If you have questions about Today’s ViewPoint or would like to learn more, please email or call Gerard Vecchio, Senior Vice President at or 212.972.4886.
Tomorrow’s Topic: MarshBerry examines the many latent risks that are materializing for insurance brokers as a result of this pandemic.
To learn more about how the pandemic is affecting the insurance industry, and how brokerages are evolving their business, register for MarshBerry’s webinar: “It’s Not Business as Usual – But It Is Business – Impacts of the Pandemic for Insurance Brokerage Firms” on Tuesday, March 31, 2020 at 11:00 a.m. ET.
Click HERE to register. Space is limited.
1 MarshBerry proprietary financial management system, Perspectives for High Performance (“PHP”). Only includes firms from U.S. and Canada.
Investment banking services offered through MarshBerry Capital, Inc., Member FINRA Member SIPC and an affiliate of Marsh, Berry & Company, Inc. 28601 Chagrin Boulevard, Suite 400, Woodmere, Ohio 44122 (440.354.3230)