Broker revenue grows as rate hikes continue

Insurance brokerages continued to benefit from a favorable business environment over the past year.

Economic expansion, hardening rates in many lines and the effect of inflation on insured values all stimulated revenue growth.

But with rising interest rates slowing down the previously electric rate of mergers and acquisitions in the sector, growth through M&A will likely diminish, several experts say.

Brokerages may also be affected by the Federal Trade Commission’s recent proposal to ban noncompete clauses in employment agreements.

Rate hikes, particularly in the property insurance sector, are driving up revenue for brokers. While increased retentions and other program adjustments mean that higher premium rates don’t always directly correlate with higher commissions and fees, brokers are still seeing solid increases in organic growth.

John Howard, chairman and CEO of Charlotte, North Carolina-based Truist Insurance Holdings Inc., a unit of Truist Financial Corp., said there have been “significant” rate increases for catastrophe-exposed property.

“We are seeing a reduction in limits, a reduction in industry capacity. We are seeing tighter terms and conditions. As a result of those things, our clients are retaining more risk and paying more for the coverage they purchase,” he said.

“My expectation is that the second half of this year is probably going to resemble the first half of this year,” in terms of rates and market conditions, Mr. Howard said.

Further rate increases in catastrophe-exposed regions will likely depend on what happens during the hurricane season, said J. Powell Brown, president and CEO of Brown & Brown Inc. 

“I do believe, if we get through a moderate storm season in Florida, that there will be some mitigation of rates by year end or into early next year. I don’t know if that means a flattening of rates or a slight decrease, but I think it’s got to moderate at some pace,” Mr. Brown said.

The hardening property market creates more work for brokers because it’s harder to place risks, said Meyer Shields, Baltimore-based managing director at Keefe, Bruyette & Woods Inc. “But, net net, it’s a tailwind to revenues.”

John Wepler, chairman and CEO of Woodmere, Ohio-based mergers and acquisitions consultancy Marsh, Berry & Co. Inc., said insurance brokers are under pressure because they have to deliver rate increases while buyers are scrutinizing purchases more closely. 

Rate hikes stemming from higher property losses and increased court awards can be explained to clients, said J. Patrick Gallagher Jr., chairman, president and CEO of Arthur J. Gallagher & Co.

“Professionally, we can explain what’s going on, but it doesn’t make the news any more bearable,” he said.

Retentions

Policyholders are retaining more risk as a result of the rate hikes, several brokerage executives said.

“Clients are actively engaging in other ways to finance the risk,” said Eric Andersen, president of Aon PLC. “They’ve gotten much more aggressive in how they finance it themselves or mitigate it themselves versus spending money in the marketplace.”

Marsh clients retain about $70 billion of risk in their captives, said Martin South, president and CEO of Marsh LLC. 

“In the last couple of years, clients have had to retain more market risk,” he said.

Brokers are also benefiting from generally positive economic conditions, despite continued fears of a recession.

“The economic outlook seems probably better in the remainder of the year than we anticipated as the year started. I thought we might have a slowdown in the economy by Q4. I think that slowdown, if it happens, isn’t until next year,” Mr. Brown said.

Concerns about an economic slowdown are not showing through in Gallagher’s data, Mr. Gallagher said.

“Our commercial middle market clients are doing great,” he said. “I think we are in a good spot.”

With the disruption from the pandemic largely over, companies are trying to grow their business, which provides opportunities for brokers, and they are also more concerned about issues such as cyber risk and geopolitical risk, Mr. Andersen said.

Inflation

Inflation, which has come down from the peaks of 2022 but remains relatively high, is generally beneficial for insurance brokers, experts say. It drives up insured values and grows payrolls, which leads to higher premiums and, therefore, increased commissions.

“Inflation raising the value of assets is going to change the price of coverage,” said Carl Hess, CEO of Willis Towers Watson PLC.

Inflation, interest rates, cyber risk and climate change are all “headwinds for everybody else and tend to be a tailwind for insurance brokers,” said Gregory L. Williams, CEO of Acrisure LLC. “It’s why you’re seeing such strong organic growth from insurance brokers over the last couple of years.”

Publicly traded brokerages are also benefiting from good management, said J. Paul Newsome Jr., managing director with Piper Sandler & Co. in Minneapolis.

“When you look at the overall profit margins, the discipline with respect to acquisitions and capital management, every one of these companies is as well-managed as they’ve ever been. … I think that’s underappreciated,” Mr. Newsome said.

Brokers have been able to consistently expand their profit margins since the financial crisis, but there are signs that margin expansion may be slowing, he said. “It’s a high-class problem, but investors are primarily concerned about whether they can continue to improve margins,” he said.

Mergers & acquisitions

One of the issues that may slow growth is a reduction in M&As. Prior to the steady rise in interest rates that began last year, acquisitive insurance brokerages, many of which are backed by private-equity funds, pursued aggressive acquisition strategies, with some companies buying dozens of rivals in a year.

A slowdown in M&A activity began in the second half of 2022 and persisted in the first half of this year, as interest rates pushed up the cost of borrowing to fund the deals.

Brokerages will likely have to continue to grow organically but accept slower growth through acquisitions, Mr. Shields said.

M&A activity is slowing in the brokerage sector, said Mr. Williams of Acrisure, which has been the most frequent buyer of other brokerages over the past several years. “When you look at the higher cost of capital, I don’t think it should be a surprise to anybody that that’s the case.”

“With interest rates up, there’s a natural slowing of activity,” said Mr. Hess of WTW.

But as technology gets further embedded in the brokerage sector, pressure to consolidate will rise, he said.

Consolidation in the brokerage sector will likely continue, despite rising interest rates, said Ilene Anders, chief financial officer of Alliant Insurance Services Inc.

“There’s a lot of investment dollars that have found their way to our industry, so it’s remained competitive from an M&A standpoint,” she said.

Noncompetes

The brokerage sector could also be affected by the FTC’s recent proposal to ban noncompetes because, the agency said, they prevent workers from freely changing jobs.

While brokerages usually use nonsolicitation and nondisclosure agreements rather than noncompetes, some fear the FTC may seek to broaden its proposed ban to include other types of restrictions. In addition, there has been a rise in litigation between brokers over alleged breaches of employment agreements over the past several years.

A shortage of staff among brokers, driven in part by private-equity-owned brokers reaching a size where they need more managers, appears to have led to a rise in poaching suits, Mr. Shields said. Most of the disputes are settled through cash settlements, which will likely continue, he said.

Brokerage executives say they need to be able to protect their businesses, especially when they purchase other brokerages.

“I am talking about professional services (companies) oftentimes we purchased at substantial multiples. I should have an expectation, and so should my shareholders, of ownership,” Mr. Gallagher said.

In addition, brokerages seek to protect their data and teams that they have developed, Mr. Andersen said.
 

Michael Bradford, Jon Campisi, Matthew Lerner and Claire Wilkinson contributed to this report.