A number of large mergers and acquisitions have occurred recently among carriers presenting an opportunity to analyze the parties involved. My conclusion, which correlates with decades of research in almost all industries, is that most large M&A's involve companies that have run out of other options. The old adage, "When you run out of all other options, merge" is still relevant.
The average growth rate of the companies that were buying or selling was 23% less than average over the last five years. This means they are moving backward relative to their competition. A slow growth company buying a slow growth company will not likely lead to a merged company that is growing faster than average, and probably will not even lead to average growth. It does boost market share for the buyer.
Also, in many cases, it makes the buyer look more profitable than it is because to achieve the additional market share through organic growth would require more expenses resulting in higher combined ratios and operating ratios. Buying a company is a capital expense, most often with significant assets that are never depreciated, resulting in interest paid being the only expense hitting the income statement if money was borrowed.
Brokers buying agencies are using the same accounting mechanism to make themselves look more profitable. To the best of my knowledge, there is nothing wrong with the way the accounting is being done. Accounting rules permit this sort of treatment of acquisitions, and it does make firms that grow through acquisitions look more profitable than if they were growing organically. This discrepancy is another reason cash flow is a better measure than income because cash flow considers the principal payments made whereas income does not (although with how lax debt markets are, gaining cash through borrowing can also inflate cash flow).
Buying market share though does not solve the problem of lack of growth. When a company is going backwards because it is growing more slowly than the industry average, it means the premium paid for the acquisition is actually higher than stated, therefore decreasing the ROI. This is one reason why M&A study after study for the last 30 years has shown that the only clear winners in M&A are the sellers. Few buyers generate a true quality ROI.
Private equity and all the free money being printed distorts some of those historic results. When an insurance company with a consistent 106% expense ratio (not a combined ratio but an EXPENSE ratio) is valued more highly than much larger insurance companies that are actually making money, the market is obviously distorted providing more opportunities for people willing to take advantage of this distortion.
In another quite interesting deviation, carriers with true competitive advantages enabling them to grow consistently about 40% faster than the market on a direct basis while still being quite profitable (combined ratios are consistently less than 100%) tend to not do deals en masse with aggregators and networks. On the other hand, the slow growth companies tending to buy/sell do deals with aggregators and networks.
Having a competitive advantage generates growth, profits, and enables a carrier to forego paying distributors extra money that really achieves nothing other than holding more market share than it otherwise would achieve. The organic growth rate of large portions of aggregators and networks is less than industry average, so these carriers are not cutting deals that enable them to grow more quickly. These are purely defensive measures to keep from losing more than they are already losing.
An interesting point is that anecdotally (because objective measures really don't exist, at least none that are publicly available), the data suggests another correlation. That correlation is the companies with competitive advantages run their companies as businesses designed to truly benefit shareholders (in stock companies) for the long run, along with policyholders. As for others, the industry is rife with stories about how executives take actions that are short sighted or entirely selfish. One carrier's executives are pretty much known to run the company for their personal benefit (and this is not to say they are violating any rules or even any ethics, but when a company never makes a profit and the executives always get raises, something is amiss).
In fact, I took a database provided by Joseph Belth in his newsletter where he posted the compensation of dozens of insurance company executives and compared what they were paid versus their companies' five-year results. The correlation was random. This does not mean the good executives are not worth the money. It may mean that the poorly run companies are simply distorting the results. In statistical language, too much "noise" exists.
It will be interesting to see how this recent spate of carrier M&A plays out. My bet is those companies with true competitive advantages will gain even more because they can stick to their game plan while the M&A companies are distracted integrating new people, new systems, cultures, and distribution strategies.
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