Watch out for a change in the game plan

What was a credit crunch is now officially a recession and, depending on which economist you believe, may become a depression. But is anything really changing in corporate insurance distribution?

On the face of it there would appear to be little difference. Eighty per cent of SME business continues to be distributed through the broking channel and the leading group of regional brokers that has emerged in the past five years – or the consolidators as the market now knows them – are all still here, although the pace of acquisition has slowed.

Whether it be Towergate, Bluefin, Oval, Giles or Jelf, all have amended their business plans as market conditions have demanded and as their businesses reach a degree of maturity.

What was a seller’s market fuelled by competition between the consolidators and the availability of cheap finance resulting in inflated sales prices, has now become a buyer’s market with purchasers facing limited competition and acquisition prices falling.

Much of this change has been driven by the availability and cost of debt as the credit crunch bites with its well publicised impact on the UK’s banking community.

The heady days of debt being freely available at five to seven times earnings has long gone and leverage has returned to more constrained levels. At the same time the cost of borrowing has risen as existing debt packages come up for renewal.

All of this has been compounded by the merger of Lloyd’s TSB and HBOS – two of the more active lenders.

Having said all of this, you cannot change demographics overnight and as a 2007 IMAS survey showed, two-thirds of broker principals were over 50 – therefore the need for an exit, such as selling to a consolidator, remains.

Plus, the one thing that definetely will follow the recent Turner Report on regulation is a more intrusive FSA. It is worth remembering that it was the introduction of FSA regulation which kickstarted much of the consolidation activity in the first place.

The result is likely to be a the same number of sellers but fewer buyers, at least in the short term.

So what are the consolidators doing? Their first phase of development was characterised by the maximisation of their revenue deals. By concentrating their underwriting partners and delivering volume they were able to negotiate strong commission arrangements and to develop their MGA capabilities.

As the market has hardened some of these deals have come under pressure, but nothing life threatening.

Consolidators now show a growing maturity in their business models. This is the time to examine cost base and to force through the required rationalisation of acquired businesses.

Recent announcements from Towergate, always the market leader, have shown their new organic growth and focus on cost control. The question is has consolidation stopped all together or has it merely paused for now?

Perhaps the answer lies in how the major consolidators are tackling the recession. Pressures on cash flows from customer insolvencies, increased bad debts and late payments, increased finance costs and a lack of credit are all impacting broker businesses.

Increases in claims costs also are putting both loss ratios and workloads under pressure and customers are becoming more cost conscious in buying cover.

All of this requires a broker to be more cost efficient; this is the path that the major consolidators are now taking.

My crystal ball tells me that we are likely to see a small group of consolidator brokers focused on organic growth trading off of a reduced cost base. They will still be hungry to acquire when finance becomes more freely available.

What was a fully intermediated market will become more concentrated with the further development of tied and multi-tied business models and more mature MGA operations.

There may be some mergers among the consolidators but this has long been muted so don’t hold your breath.

But the shape of UK SME distribution definetely will change. Many of the consolidators now have full UK coverage, they are advanced in developing their MGA capabilities and they will have a far more effective operating model.

In addition, broking software has moved on, making the transaction of business far more efficient.

These changes will remove many of the factors that have made regional broking an unattractive market for the global brokers and other large US retail brokers.

With a market that has consolidated significantly, with maturing operating platforms and a low dollar exchange rate, it could soon be the time for the big boys to join the game and take control of regional broker distribution by acquiring the consolidators in what was once a closed shop to them. IT

Ian Clark Insurance Partner at Deloitte LLP