Independents vs consolidators: who is coming out on top?

The boarded up shops around Perkins Slade’s Birmingham offices are a sign of Britain’s hard economic times. The city was one of the worst struck by the recession, with Jobseeker’s Allowance claimants tripling to 45,000 between 2008 and 2009.

The effects of the economic downturn still linger on and, combined with the soft market, it means that insurance trading is as tough as ever.

Perkins Slade’s recently released 2011 accounts state that 2012 is “expected to remain difficult” amid the challenging economic climate, while it could be a “number of years” before the market hardens.

Perkins Slade’s larger nearby Midlands rival, consolidator Oval, shares a similar sentiment.

Former chief executive Phillip Hodson, quoted in the firm’s 2010/11 accounts, said its brokering arm had “undergone eight years of declining rates and three years of economic malaise”.

Close watch on overheads

The challenges these two must overcome are representative of the obstacles faced by independent brokers and consolidators up and down the country.
So, how are the independents and consolidators coping with the challenges? And who is coming out on top in these hard times?

First, it’s clear that both groups have much in common. Both are having to keep their expense base very tightly in check. Redundancies, wage freezes and a close watch on overheads, such as corporate entertainment expenses, have all been the order of the day.

Despite this, both consolidators and brokers are still investing, in the hope of boosting sales.

Perkins Slade chief executive Nick Tamblyn says his company is investing in technology solutions, new hires and marketing.

“It’s a challenging market,” he says. “The operating profits are pretty flat, and that’s in part because we are investing in the cost base. But, equally, that’s because some of our clients are finding the going tough and have reduced in size. And it’s still a soft market.”

The consolidators are investing too. Oval, for example, is rolling out Acturis software to all Oval acquisitions, and improving placement, customer service and retention.

Where there is a big difference between the two groups is the strategy for growth. The consolidators have a large and diversified business, which is ripe for cross-selling.

Jelf is one of the smaller consolidators that has fared well in the downturn through cross-selling. It has an employee benefits arm, an insurance broking division and a healthcare division.

Jelf’s new business sales increased 14% in the six months to March 2012, driven by organic growth.

Chief executive Alex Alway says: “That [cross-selling] is exactly what we are doing. And if you look at one or two of the other [consolidators’]strategies, such as [those of] Giles, they’ve set up a healthcare arm.

“More and more people are thinking about going back to the same customers and offering them greater levels of service across the same piste.”The smaller independent brokers do not have the same level of diversification from which to extract value, but what many do have are specialist skills.

Since the downturn, schemes have become a breadwinner for brokers. MGA UK General works with brokers to establish schemes deals. Earlier this year it signed a series of such deals worth nearly £30m gross written premium.

UK General’s head of commercial schemes, Tony Bloomer, says: “Right now out there the commercial market is very tough. It’s very static with rate changes, up maybe 5% or 10%. Commercial motor is tough, broker costs are rising, income is flat, so what do you get? Profitability issues.

“I think brokers have had to seriously look at new avenues to run alongside conventional business, and schemes do offer options.

“You can’t differentiate around product anymore, so it’s got be around service - schemes can give you that.”

It’s clear that a tight grip on operating costs, investment and growth strategies have helped brokers fight the headwinds of the soft market and the downturn. But which group of brokers is faring best?

Three groups of brokers

One way of segmenting the brokers is to divide them into three groups: the consolidators; the smaller high street and provincial type independents with SME and personal lines books; and the larger regional independents that figure in many insurer’s top 200 accounts, such as Bollington, Bridge, Henderson.

Starting with the smaller brokers, they have felt some of the greatest pressures. Compliance is burdensome, in terms of manpower to deal with the red

Furthermore, these brokers arguably struggle to receive adequate servicing from insurers.

Insurers, under pressure to deliver shareholder returns amid weaker support from investment returns, have aggressively stripped out costs.

Stuart Randall, founder of Ataraxia, which acquires small brokers and manages their succession planning, says the pressures are immense, but provincial brokers have survived by concentrating on their niches.

“The big issue is that most of the big composites have dismantled their structures that previously enabled them to deal with a large number of brokers,” Randall says. “So they’ve let the small and medium size guys go, by not providing them with service.”

The small brokers may have their challenges, but they are no less serious than the ones facing the consolidators.

All the big consolidators - Giles, Oval and especially Towergate, with more than £900m of debt - are leveraged and looking for exit routes to pay off the debts and/or pay off impatient shareholders.

The debts cast a shadow over their businesses, which are performing well on a day-to-day basis, judging by their operating margins of up to 35%.
Oval’s debt dynamics are the least concerning, with earnings at £15m and net debt at £39.7m. It is freezing acquisitions to concentrate on organic growth.

That luxury cannot be afforded to either Giles or Towergate, both of which need to keep on making acquisitions if they are to have any chance of successfully achieving flotation.

One potential option for Giles’s owners is to dilute their shareholdings to allow for fresh investors and a capital injection.

Towergate may need either fresh investors or a capital injection from its private equity owner Advent to lower debt levels in the run-up to its likely flotation, probably before 2017.

Jelf’s Alex Alway, whose firm has trimmed its debts from £10m to £1m following a private equity capital injection two years ago, believes the days of highly leveraged consolidators are coming to an end, with most having reached the peak of their debt threshold.

“I don’t think we’ll see it as much as it used to be,” he says.

“People are a bit more cautious about rolling up debt, so I think it won’t be seen at the levels that were previously there.”

Regional brokers faring best

Finally, there are the larger regional brokers. It is this group, more than anyone else, that is arguably faring best in the downturn.

The insurers, notably Aviva, AXA and RSA, are desperate to do business with them. RSA has Broker Promise, a vow to respond to a query within three hours for its key accounts. Aviva has its Club 110 for its 250 largest brokers, and AXA is opening more regional offices to build connections.

Larger regional brokers’ debt levels are generally pretty comfortable, and they have just about the right number of staff to deal with compliance issues.

They continue to clock healthy profits. Essex-based Lark, for example, posted year-end 2011 profits of £3.6m, almost double 2010’s nine-month accounted figures.

So while both independent brokers and consolidators may face serious challenges, they are surviving, and at least they are part of a recession-proof industry.

Randall says: “With most other professions you don’t know who’s going to walk through the door, what they want, whether they can afford it. Insurance is the most predictable occupation there is.

“People forget how good insurance is. It may seem a little bit boring at times but, trust me, at the moment boring is good.”

Figures

£10m to £1m
The amount of Jelf’s debt trimmed following a private equity capital injection two years ago

14%
Jelf’s new business sales increase in the six months to March 2012

£30m
Managing general agency UK General signed a series of schemes deals worth nearly £30m gross written premium earlier this year