by Brian Deitz, September 2011

National Underwriter

After a couple of years of minimal (or even negative) organic growth and declining profit margins, insurance agents and brokers have put some halfway decent numbers on the board so far in 2011. Reagan Consulting regularly monitors organic growth and profitability for the industry on a real-time basis. From 2007 through 2010, organic growth averaged less than one percent annually, after averaging nearly seven percent from 2004 through 2007. This year, organic growth stands at 3.3% for the industry through the second quarter, and agents and brokers are projecting organic growth of 4.5% for the full year.

Profit margins are inextricably linked to growth – it is almost impossible to increase profit margins in a negative growth environment. So as growth has rebounded, so has broker profitability, as measured by EBITDA margin (Earnings Before Interest, Taxes, Depreciation and Amortization divided by Revenue). Once consistently above 20%, EBITDA margins dropped to 16.8% in 2009. However, agents and brokers are projecting a return to 20% margins for 2011. The chart below examines agent and broker growth and profitability for the last seven years.

It seems as if things are moving in the right direction. But can this momentum last? To answer that question, we have to look at what has driven the performance turn-around this year. 
 
P&C Pricing

There are two major factors driving broker growth, and one is P&C pricing. The soft market that we still experience today began during the 1st quarter of 2004 – almost eight years ago. However, the soft market is easing, and has been for a little while. After the second quarter ended, the CIAB’s quarterly data showed that for the first time since the soft market began, commercial insurance pricing is basically flat. Per the CIAB, commercial insurance pricing fell only 0.1% in the second quarter. The steady movement towards a flat pricing environment over the last couple of years has been good news for agents and brokers, who typically derive the majority of their revenue from commercial P&C commissions and fees. As the severity of the soft market has abated, commercial lines growth has improved. In 2009, commercial lines pricing declined by 5.4% and commercial lines growth was negative 3.3%. However, the flat pricing in 2011 has contributed to positive 2.2% commercial lines growth for agents and brokers so far in 2011.

U.S. Economic Performance

Though P&C pricing gets a lot of publicity, the performance of the economy has actually been more influential in determining the fortunes of agents and brokers in recent years. In fact, the soft market has been going strong since 2004, but only recently has agent and broker organic growth turned negative. The reason? The “great recession” that started in 2008. Only after the economy started going backwards did brokers’ struggles intensify.

But agent and broker fortunes aren’t instantly tied to economic performance. In fact, there is a lag of approximately 6 – 9 months between economic changes and the impact on agents and brokers. At first, the recession didn’t seem to bother agents and brokers all that much. They were defying gravity. Then, about 6 – 9 months after the recession began, a sharp reduction in exposures coupled with widespread return premiums jolted the industry – and agent and broker organic growth went negative. The chart below shows the quarterly GDP data juxtaposed against the OGP data since late 2008. In that chart, the 6 – 9 month lag is visible. Brokers had a warning period after the recession began, but the effects were inevitable.

 


Source: Reagan Consulting Organic Growth & Profitability Survey, Bureau of Economic Analysis

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Thankfully, when the economy recovered, agent and broker performance also started to rebound – 6 – 9 months later. US GDP regained positive growth in Q3 of 2009, but it wouldn’t be until Q1 of 2010 that agent and broker organic growth did the same. Today, brokers are enjoying the rewards of the 2010 economic rebound. Organic growth has been positive – and climbing – for the last six quarters. And agents and brokers expect this growth to continue to climb to 4.5% throughout 2011.

Will it continue?

While agents and brokers continue to believe that things will go well, there are concerns. US GDP growth dropped to 0.4% in Q1 of 2011 and there is widespread debate about whether the United States is headed toward, or already in, another recession. Agents and brokers haven’t seen the effects of this most recent economic slowdown – but the 6 – 9 month clock is ticking. Are we a quarter or two away from another downturn in agent and broker organic growth? Could a stronger P&C pricing environment lessen the impact of a declining economy this time versus late 2008 / early 2009? 

One interesting thing to watch in the coming months will be mergers and acquisitions activity. M&A activity suffered in 2009 but rebounded slightly in 2010 as performance picked up. It has been even stronger in 2011. Agents and brokers are most likely to enter into transactions when they feel good about their ability to perform after close – thus maximizing the value of the firm in an earn-out. Uncertainty about performance can be kryptonite to M&A activity. Will agents and brokers continue to deliver, or will uncertainty creep back in to the market?