THE HALES REPORT
1270 Avenue of the Americas, Suite 930, New York, NY, 10020 | [email protected] Issue #7, Vol: 3 April 1, 2019
Inside This Issue U.S. Agency M&A On Track For Another Record. Impetus To Sell Now vs. Later? pg 1 A Decade of Market Share Movements In U.S. Commercial Lines. Notable Moves pg 6 Increased Broker Efficiency Highlighted By Rising Revenue Per Employee pg 8 Willis Towers Makes Largest Acquisition Since Merger, $1.2B For TRANZACT Pg 10 Lloyd’s Posts Another Loss, Expense Issues Remain (>30% Acquisition Ratio) pg 12 PG&E Faces $10.7B+ of Fire Subrogation From Underwriters & A Hedge Fund pg 14 The Private Flood Insurance Market Continues To Expand In 2019 pg 16 Hales Hits & Bindable Quotes pg 18 Hales Q1 Deal Diary & Broker Valuations pg 19
U.S. Agency M&A On Pace For Another Record Year. 1st Quarter 2019 Activity Marginally Higher vs. 2018.
With the quarter coming to a close, 2019 appears on track to be at or near another record year for U.S. agency mergers & acquisitions. The total deal tally of 165 is higher than 139 in Q1:18 and is the largest first quarter on record, surpassing Q1:17.
Note, while Q1 typically sees a fair share of deals (~ ¼ of deals over the past decade were completed during Q1) activity tends to be weighted more towards the back ½ and Q4 in particular (which has represented nearly ⅓ of all deal activity over the past decade). That said, it was a particularly active Q3:18 that helped 2018 eclipse 2017 as the most active year for U.S. agency M&A on record.
Exhibit 1 U.S. Middle Market Agency Transactions By Quarter / Year
591 601 Q1 Q2 Q3 Q4 142 464 149 439 388 354 366 119 331 348 338 104 127 170 106 289 277 268 91 95 86 106 144 95 108 59 220 236 71 94 101 160 67 85 75 86 80 79 150 61 72 68 118 130 69 60 83 72 57 89 75 42 77 80 60 48 52 49 155 139 165 91 109 91 91 98 122 107 88 66 58 62 74 48 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Source: SNL(Preliminary), Factset, other public sources
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The trends remain supportive for further consolidation, and we would not be surprised if potential sellers shorten their time horizon / more seriously consider a transaction this year given:
(i) increased talk of a recession, or at least some marginal decline in the U.S. growth rate later in 2019 / into 2020;
(ii) the ongoing benefit to acquisition pricing/math from low(er) interest rates. While 6 months ago it was thought that interest rates would steadily increase, they have gone the other direction; and
(iii) the looming threat of higher tax rates if Democrats, already energized by the mid-term 2018 election results, gain further power in 2020 (AOC’s 70% income tax bracket could be just the beginning).
A Closer Look At The Trends …
Looking at deals by acquirer type, to no surprise we see continued substantial involvement on the part of private equity (particularly advantaged by low interest rates given the greater use of debt leverage vs. strategic/public broker buyers). PE / PE backed brokers comprised 42% of deals in Q1 (marginally higher vs. 38% of deals in 2018). Public brokers were also incrementally more active, representing 36% of Q1 deals (vs. 35% in 2018). Acrisure represents a lower % of deals YTD as do banks.
Exhibit 2 & 3 Q1:19 Broker Deals By Count (%) 2018 Broker Deals By Count (%) PE / PE Backed Bank PE / PE Backed Bank Acrisure Broker Acrisure Broker Other Other 2, 1% 20, 3% 70, 42% 16, 10% 227, 38% 100, 17%
18, 11% 59, 36% 42, 7% 212, 35%
Source: SNL, Factset, Other Public Sources Source: SNL, Factset, Other Public Sources
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Looking at the # of deals by specific acquirer, newly formed Patriot Growth Insurance Services has the highest tally in Q1:19 (integrated 17 independent agents in January and 1 in February) followed closely by Acrisure already having acquired 16 domestic brokers (Acrisure completed 100 acquisitions in FY2018, see exhibit below). Notably, Broadstreet Partners reached 10 deals this quarter compared to 7 this time last year.
Of the public firms, A.J. Gallagher ended the quarter with 9 acquisitions (above their 5 deals from this time a year ago). Brown & Brown follow closely with 8 acquisitions, marking B&B’s largest Q1 deal tally since 2011, and a big jump from only 2 acquisitions completed at this time last year (activity accelerated in the back ½ for B&B with 23 total deals in 2018, including its largest ever with Hays).
Exhibit 4 Most Active Acquiring Brokers 2012 - Present (Domestic Deals) 2012 2013 2014 2015 2016 2017 2018 Q1-19 National Brokers Patriot Growth (PE) 18 Acrisure (Former PE) 4 5 14 56 64 92 100 16 Broadstreet Partners (PE) 2 3 16 19 36 30 10 AJG (Public) 51 26 47 36 29 26 32 9 Hub (PE) 25 20 25 29 29 42 28 9 AssuredPartners (PE) 27 20 23 24 24 23 33 8 Brown & Brown (Public) 13 4 7 12 6 11 23 8 Alera Group (PE) 22 16 28 2 Hilb Group (PE) 3 2 4 8 14 13 8 2 MMA (Public) 9 4 9 7 7 6 7 2 USI (PE) 13 6 11 6 10 8 4 2 Confie Seguros (PE) 22 14 13 19 16 6 5 0 Sub-Total 169 101 156 213 240 279 298 68 Other 197 135 232 226 224 312 303 97 Total Broker Deals 366 236 388 439 464 591 601 165 Source: SNL(Preliminary), Factset, and other public sources
A Couple “Big Deals” …
So far 2 of the Hales Top 100 brokers have been acquired this year: (i) #72 Bouchard Insurance, with ~$43M of revenue, was acquired by Marsh Agency; and (ii) #84 Tolman & Wiker, with ~$33M+ of revenue, was acquired by AssuredPartners.
Marsh Agency also acquired Employee Benefits Group, putting their Q1 tally at 2 (versus 1 acquisition YOY). Marsh & McLennan has reiterated an ongoing commitment to the Marsh Agency strategy (albeit a bit more selective) amidst the acquisition & integration of #6 worldwide broker JLT (deal closed today, 4/1).
The Hales Report Contact: [email protected] Page 3
Exhibit 5 Hales Top 25 U.S. Agents & Brokers
Rank U.S. Revenue ($,M) '16 '17 Company 2016 2017 % Change Ownership Type 1 1 Marsh & McLennan $6,573 $6,870 4.5% Public 2 2 Aon PLC $3,981 $4,425 11.2% Public 3 3 Willis Towers Watson $3,395 $3,821 12.5% Public 4 4 Arthur J. Gallagher $2,945 $3,177 7.9% Public 5 5 Brown & Brown $1,749 $1,865 6.7% Public 6 6 BB&T Insurance $1,713 $1,754 2.4% Public 9 7 USI Insurance Svcs $1,049 $1,740 65.9% Private Equity 7 8 Hub International $1,281 $1,461 14.0% Private Equity 8 9 Lockton $1,055 $1,171 11.0% Private 11 10 Alliant Insurance Svcs $968 $1,125 16.2% Private Equity 12 11 NFP Corp. $930 $1,069 15.0% Private Equity 14 12 Acrisure LLC $649 $1,042 60.5% PE/ Management 13 13 AssuredPartners $834 $967 16.0% Private Equity 15 14 BroadStreet Partners $423 $481 13.6% Private Equity 17 15 Edgewood Partners / EPIC $245 $386 57.5% Private Equity 16 16 JLT (Marsh 9/18) $275 $365 32.7% Public 20 17 Integro (EPIC 12/17) $221 $347 57.1% Private Equity 19 18 CBIZ Benefits & Insurance Svcs $269 $286 6.3% Public 22 19 Risk Strategies $198 $238 20.2% Private Equity 18 20 Leavitt Group $225 $236 4.7% Private 21 21 Paychex Insurance Agency $171 $207 21.1% Public 23 22 Hays (B&B 10/22) $195 $199 2.1% Private 24 23 Insurance Office of America $181 $199 10.0% Private 26 24 Alera Group $158 $193 22.3% Private Equity 30 25 Digital Insurance $148 $190 28.3% Private Equity Other Notable Deals From The Top 100 25 Crystal & Co (Alliant 4/12) $150 Private 34 32 Regions (BB&T 4/18) $142 $145 2.2% Public 36 33 Wortham (Marsh 6/25) $128 $131 2.1% Private 59 55 Key Insurance (USI 3/29) $55 $60 9.1% Public 80 72 Bouchard Insurance (MMA 1/22) $40 $43 5.9% Private 91 84 Tolman & Wiker (AssuredPartners 2/15) $33 $33 0.0% Private Source Dowling Hales
Pricing remains elevated, as highlighted in Exhibit 6, with peak pricing down marginally vs. the nearly 14x EBITDA we saw in 2018 (reflects some unique / large deals).
Exhibit 6 Guaranteed Multiples
16.0 x EBITDA Minimum EBITDA Maximum 14.0 x 12.0 x 10.0 x 8.0 x 6.0 x 4.0 x Price of Entry 2.0 x 0.0 x 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 Source: Dowling Hales YTD
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Jockeying For Market Share: A Decade of Movements In The U.S. Commercial Lines Market.
Having reviewed 2018 market share changes by line of business in Hales #6 we thought it would be interesting to look at the high level, total U.S. commercial lines market share movements over the past decade. There are several notable trends - see bullets further below for additional thoughts.
Exhibit 7 Top U.S. Commercial Writers 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Mkt Share 1 5.6%
2 5.4%
3 4.9%
4 4.0%
5 3.8%
6 3.3%
7 3.3%
8 2.5%
9 2.4%
10 2.1%
11 2.0%
12 1.8%
13 1.8%
14 1.8%
15 1.7% // #18 #20 #23 #17
#50 #46 #37 #30 #24 #16 1.7%
#25 #25 #28 #26 #28 #33 #25 #25 #21 #18 1.6% Source: Statutory Statements
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Noteworthy movements …
AIG, the long-reigning leader, fell from #1 to #4 in 2015 as the post financial crisis strategy increasingly shifted towards profit improvement. Notably, AIG lost share each year up until 2018, when share remained stable at ~4.0% (helped in part by the acquisition of Validus/Western World which add ~0.3pts to U.S. market share).
We also saw the rise (and fall) of AmTrust over this period, starting from #50 in 2009 (0.4% market share) and rising to a peak of #11 in 2016 (1.9% share). Not surprisingly, amidst a year of tremendous uncertainty in 2018 (characterized by rating agency concerns, delayed financials and a pending “go private” transaction with StonePoint) AmTrust DPW declined 14% and rank dropped to #16. AmTrust remains a major writer of workers’ comp (#5 with 4.6% share).
One of the most notable moves was from Berkshire Hathaway, a company that has consistently been on the rise from #23 (1.0%) in 2011, all the way up to #6 (3.3%) in 2018. This growth primarily reflects the acquisition/expansion of GUARD (acquired in 2012) and ramp up of Berkshire Hathaway Specialty Insurance Company (beginning in 2013). These efforts are seen in rising share of Workers’ Comp (#3 as of 2018) and Other Liability Claims Made / D&O (#1 as of 2018).
While not yet in the top 15, we also believe the rise of Progressive is notable, from #50 in 2009 to #18 as of 2018, primarily with Commercial Auto (the #1 writer now with ~10.5% market share). As highlighted in Hales#23, following the launch of Business Quote Explorer in 2018 we expect Progressive to increasingly move into other lines of commercial business, both as an agent (sourcing business for other companies) and as an underwriter keeping the risk on its own balance sheet.
Following ACE’s acquisition of Chubb in 2016, the top 3 commercial lines writers have remained unchanged over the last 3 years: #1 Chubb, #2 Travelers and #3 Liberty Mutual.
The Hales Report Contact: [email protected] Page 7
Increased Broker Efficiency Highlighted By Rising Revenue Per Employee, Supporting Sustained Margin Improvement.
Amidst a decade + of ongoing margin improvement at the large public brokers we thought it would be interesting to look at revenues per employee as a measure of productivity & efficiency.
Exhibit 8 To little surprise there has Large Broker Revenue Per Employee ($, K) also been fairly consistent $210 improvement in revenue $208 $198 per employee, which is $198 $203 $205 $194 $201 currently at ~$210K of $197 $195 revenues per 1 employee in 2018 vs. ~$185K 10 $185 years ago (in 2008).
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Source: Company Reports; *Excludes Aon pre 2016 (not comparable)
Note, there is considerable variance in the absolute # (and trend) by company and business segment. See details further below.
Exhibit 9 (Re)insurance Broker Composite Annual EBITDA Margin
25.1% 26.0% 24.4% 23.1% 23.6% 24.0% 22.3% 22.0% 22.0% 20.8% 21.5% 21.1% 21.3% 20.0% 18.4% 18.0% 16.7% 16.0% 14.0% 12.0% 10.0% 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Source: Company Report; D&P Analysis
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On an overall basis (brokerage-only where available) revenue per employee ranges from a low of $185K/employee at Gallagher to $229K/employee at Marsh. We note, however, that the figure can be skewed by various strategies relating to back office support. Gallagher, for example, has substantially expanded its employee base in India as a low cost center for back & middle- office activities. This rising employee count has weighed on the headline revenue/employee number. Gallagher’s elevated M&A pace is also a consideration, as employees join day 1 (while revenues roll in on a delayed basis).
Exhibit 10 Brokerage Revenue Per Employee ($, K) Year Gallagher AON* B&B Marsh Willis** Average 2018 $185 $215 $221 $229 $206 $210 2017 $191 $200 $233 $218 $181 $205 2016 $189 $226 $232 $219 $190 $208 2015 $209 $231 $223 $211 $162 $201 2014 $195 $244 $220 $225 $172 $203 2013 $192 $250 $204 $227 $168 $198 2012 $203 $230 $193 $219 $166 $195 2011 $198 $234 $191 $228 $172 $197 2010 $214 $227 $196 $213 $167 $198 2009 $217 $216 $195 $203 $163 $194 2008 $207 $200 $188 $203 $141 $185 Source: Company Reports *Total company beginning 2017 **Legacy Willis prior to 2016 Average excludes Aon pre 2016 (not comparable)
A closer look by segment (where disclosed) shows that Marsh Mac’s higher productivity is supported by its Guy Carpenter unit, highlighting the high margin nature of the reinsurance business. B&B also provides details by segment, which highlights greater “productivity” within Programs relative to Wholesale and Retail ops (“Services” / TPA ops being at the bottom).
Exhibits 11 & 12 Marsh & McLennan Brown & Brown Revenue Per Employee ($,K) Revenue Per Employee ($,K) Brokerage $229K Total $223K $600 $536 Consulting $242K $600 $495 $500 $500 $409 $400 $400 $287 $300 $300 $202 $206 $207 $182 $200 $200 $100 $100 $0 $0 Marsh Guy Mercer Oliver Carpenter Wyman Retail Programs Wholesale Services Source: MMC 2018 10K Report Source: B&B 2018 10K Report The Hales Report Contact: [email protected] Page 9
Willis Towers To Buy “D2C” Medicare Provider TRANZACT For $1.2B; Likely Out of M&A Market (Again) For Next 12-18 Months.
Willis Tower Watson (WLTW) has been sidelined from M&A amidst its complicated & costly 3-year integration program which ended at year-end 2018. Looking into 2019, management emphasized the improved cash flow position (> $1B per year) and renewed interest in M&A. As the first quarter came to a close, on 3/31 Willis Towers announced the $1.2B acquisition (+$200M earn-out) of “direct to consumer” health care firm TRANZACT.
The firm, and its ~$260M of trailing revenues, will fold into Willis Towers’ existing ~$800M “healthcare exchange” business. Products include Medicare Advantage, Medicare Supplement, Prescription Drug Plan (PDP) and other/ancillary (life, dental, etc). The “exchange” segment has been a growth leader for WLTW (+9% organic as of 2018) and represents ~10% of total revenues.
The upfront purchase price represents a lofty 3.7x forward revenue and ~15x operating income (ex amortization). Note, TRANZACT was acquired by current majority owner Clayton, Dubilier & Rice (CD&R) from White Mountains in 2016 for $255M (~3/4 ownership). WLTW notes the business has since been refocused towards higher growth / higher margin businesses (medicare & life) with secular trends supportive of >25% growth for the next 5 years: an aging population (boomers reaching retirement age), increased comfort with online shopping, generally increasing DTC penetration over time, etc. Management also suggests the mid-20s margin could move higher over time.
From a strategic perspective, this adds digital distribution capabilities and access to a growing market where it would take several years to build a presence (currently <3% of Willis Towers’ exchange revenue).
Exhibit 13 TRANZACT Year Ending Jun-16 Dec-16 Dec-17 Dec-18 Dec-19 Dec-20 Source: CD&R CD&R CD&R WLTW Guide Guide
Revenue $214 $231 $218 $260 $325 $405 YOY Change 8% -6% 19% 25% 25% Accounting change Op Income $46 $54 $50 $65 $81 $103 Op Margin 21% 23% 23% 25% 25% 25% Source: Company Reports, Company Guidance
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“We are delighted to announce the acquisition of TRANZACT which represents a significant growth opportunity in the direct-to-consumer U.S. health care space and speaks to Willis Towers Watson’s renewed focus on strategic M&A opportunities. This deal will accelerate our direct-to-consumer strategy and help create an end-to-end consumer acquisition platform.” - Willis Towers CEO John Haley
While the company’s increased M&A appetite has been clear, this is larger than the ~$400M placeholder suggested for M&A in 2019 (management previously earmarked half of deployable cash flow). Thus, the initial $1.2B purchase price will be initially funded entirely with debt, with WLTW suggesting they will de-lever over the next 12-18 months. We take this to mean other meaningful M&A is likely off the table for the foreseeable future (again).
Note, public brokers generally target debt-to-forward EBITDA of ~2-2.5x on a GAAP basis in order to maintain investment grade ratings (in unique circumstances leverage will move higher for a limited time, for example Marsh’s acquisition of JLT). Pretty much all brokers are running near (or above) stated debt thresholds.
Exhibit 14
3.5x Broker Debt Leverage Ratios 3.0x 3.0x 2.6x 2.4x 2.5x JLT 2.2x TRANZACT 2.0x 2.0x Hays 1.5x 1.0x 2.1x 1.7x 0.5x 1.2x
0.0x Marsh Mac PF Willis TW PF AJ Gallagher Brown & Brown PF Aon Source: Co Reports,
The Hales Report Contact: [email protected] Page 11
Lloyd’s Posts Another Loss Making Year. Expense Issues Remain w/ Acquisition Ratio >30% (Again). Slight Underlying Loss Ratio Improvement.
Despite an increased and ongoing focus on profitability improvement Lloyd’s continues to struggle, reporting its second consecutive loss in 2018 (even when using a “normal” assumption for catastrophes). While the underlying loss ratio was marginally improved, expenses remain an issue, in particular the high costs of distribution. Lloyd’s acquisition ratio inched higher in 2018 to 30.2% vs. 30.1%.
The acquisition ratio is up nearly 5pts over the past decade, as brokers have pursued numerous strategies to grow their “share” of the economics in a softening market (enhanced commissions, fees for data/“analytics,” subscription market “surcharges,” facility commissions, etc). While the trajectory is clearly an issue, we note the ratio is overstated somewhat given client rebates and revenue sharing agreements typical in the Lloyd’s market.
Exhibit 15 LLOYD'S ACQUISITION RATIO TREND 31% 30.1% 30.2% 30% 29.7%
29% 28.8% 28.1% 27.6% 28% 27.4% 27.3% 27.5% 27.0% 27% 26.3% 26.4% 26%
25% Y2007 Y2008 Y2009 Y2010 Y2011 Y2012 Y2013 Y2014 Y2015 Y2016 Y2017 Y2018 Source: Company Reports; Hales Analysis
Lloyd’s will continue to target expense reduction in 2019 through its “growing adoption of the London Market Target Operating Model initiatives that will deliver efficiencies.” The annual report noted ~39% of “in scope” market contracts were bound electronically as of year-end 2018, greater than the initial 30% target. Lloyd’s expects by year-end 2019, at least 70% of its contracts will be placed electronically. Further reinforcing the digitalization of Lloyd’s, brokers will be “required to connect to a recognized electronic placement platform by 6/1/19.” While moving in the right direction, much work remains.
In total Lloyd’s reported a loss of £1.0B in 2018 (with a 104.5% combined ratio), improved from a loss of £2.0B in 2017 (114% combined ratio). “Normalizing” for catastrophes (using the trailing 10-year median), Lloyd’s still generated a slight underwriting loss in 2018.
The Hales Report Contact: [email protected] Page 12
The AY loss ratio assuming “normal” catastrophes improved by ~1pt YOY to 66%, but still remains in the mid-60% range. The overall expense ratio remained relatively flat in 2018 at 39.2% with modest improvement from G&A expenses.
CEO John Neal noted, “this performance is not the standard that we would expect of a market that has both the heritage and quality of Lloyd’s and we are taking further actions.” While performance was poor in 2018, the ongoing vision for the market and actions being taken (including rate increases / restricted appetite) are important to watch.
The annual report also provided an update on the 2019 business plan review which targeted the worst performing lines of business and resulted in £3B of “poorly performing business removed from the market.” Still, GPW was +6% in 2018, with growth in all lines (excl. Aviation) as market conditions were broadly improved with rates increasing across many classes of business. Overall pricing was +3.2% in 2018.
Exhibit 16 LLOYD'S 2018 RESULTS Income Statement (£,M) 2014 2015 2016 2017 2018 YOY Chg Gross Premium Written £25,259 £26,690 £29,862 £33,591 £35,527 6% Net Premium Written £20,006 £21,023 £23,066 £24,869 £25,681 3% Net/ Gross 79% 79% 77% 74% 72% -1.7pts
Net Incurred Claims £9,590 £10,262 £12,987 £18,250 £16,438 -10% G&A Expense £2,171 £2,343 £2,464 £2,307 £2,270 -2% Acquisition Expense £5,485 £5,913 £6,741 £7,362 £7,600 3% Investment Return £1,038 £402 £1,345 £1,800 £504 -72% P/t Income £3,016 £2,122 £2,107 -£2,001 -£1,001 -50% P/t Income (Ex-FX) £3,078 £2,192 £1,529 -£1,939 -£993 -49%
ROC 13.5% 8.7% 7.8% -7.2% -3.6% ROC (Adj. For Normal Cats) 8.7% 6.0% 9.6% 1.9% -0.6%
Loss Ratio 49.2% 49.9% 57.3% 74.5% 65.3% -9.2pts G&A Ratio* 11.1% 11.4% 10.9% 9.4% 9.0% -0.4pts Acquisition Ratio* 28.1% 28.8% 29.7% 30.1% 30.2% 0.1pts Expense Ratio 39.3% 40.1% 40.6% 39.5% 39.2% -0.3pts C. Ratio 88.4% 90.0% 97.9% 114.0% 104.5% -9.5pts PYD -8.1% -7.9% -5.1% -2.9% -3.9% -1.0pts Cat/ Major Losses 3.4% 3.5% 9.1% 18.5% 11.6% -6.9pts Ex Cat AY C. Ratio 93.1% 94.4% 93.9% 98.4% 96.8% -1.5pts Ex Cat AY Loss Ratio 53.9% 54.3% 53.3% 58.9% 57.6% -1.3pts
10Y Mean Cat Loss 9.0% 6.8% 7.0% 8.1% 8.3%
Source: Lloyd's; Hales Analysis *Lloyd's only disclosed its acquisition and G&A ratio for the past 3 years, values shown are Hales' calculation.
The Hales Report Contact: [email protected] Page 13
PG&E Faces $10.7B+ of Subrogated CA Fire Claims From Insurance Companies & Hedge Fund Baupost.
A recent filing related to PG&E’s Chapter 11 bankruptcy details the subrogation claims being pursued by major insurance companies and hedge fund Baupost Group due to PG&E’s role in the 2017 and 2018 CA fires. Based on information currently filed in bankruptcy court (as summarized below), Baupost is one of (if not the) largest holder of subrogation rights against PG&E, having acquired the rights to nearly $2.6B of related claims payments. The filing details total claims paid subject to subrogation of ~$10.7B.
Based on our analysis of subrogation filings related to the 2017 and 2018 Northern California wildfires, Baupost has acquired subrogation rights from American Family, Ameriprise (IDS Property Casualty), Capital Insurance Group, CSAA and certain subsidiaries of Nationwide. Whether Baupost or other financial investors look to further acquire subrogation rights as the bankruptcy proceeding moves forward will be an interesting topic to watch.
As background … In certain scenarios, Baupost / other financial firms view subrogation rights (purchased at a discount) as a potentially valuable “asset class.” In the PG&E bankruptcy, where subrogation rights are equal to other unsecured credits, this type of transactions fits closely with distressed debt investments (a more traditional form of investment amongst financial firms). For sellers / insurance companies, the transaction provides a quicker and certain subrogation recovery that can be booked immediately (although at a discounted amount). The alternative would be to continue to pursue the full subrogation recovery in bankruptcy court which could take a number of years.
Note, estimated industry losses from the 2017 (excluding the Tubbs fire which PG&E is not responsible for) and 2018 No. CA wildfires currently stand at $3.6B and $10.0B, respectively. The PG&E 10-K indicates estimated liabilities for the firm of $3.5B and $10.5B, respectively. PG&E filed for chapter 11 bankruptcy in January.
As just referenced, a group of insures, jointly represented by law firm Willkie Farr & Gallagher, was the first to disclose paid losses they believe PG&E is responsible for in bankruptcy court. As there are a number of other subrogation filings against PG&E related to the same events, this is not a complete listing of dollar subrogation claims. That said, it does represent the larger companies with direct exposure to the fires.
Exhibit 17 on the next page summarizes those with subrogation claims >$25M.
The Hales Report Contact: [email protected] Page 14
Exhibit 17 Subrogation For Losses Related Gross Paid to the Following Subrogation Claimant Subrogation 2017 No. CA 2018 No. Ca Amount* Wildfires Wildfires
$2,569M
$2,322M
$887M
$829M
$665M
$651M
$533M
$437M
$274M
$313M
$185M
$81M
$80M
$35M
$32M
$26M Source: PACER, United States Bankruptcy Court – Northern District of California; Hales Analysis; Notes: *Amounts represent claim payments to underlying insureds; PG&E was found not liable for 2017 Tubbs fire by CAL Fire (the largest wildfire by loss size in No. CA during 2017).
The Hales Report Contact: [email protected] Page 15
The Private Flood Insurance Market Continued To Expand In 2018.
The stand-alone flood insurance market has been a topic of discussion amongst legislators, P/C (re)insurers, the Federal Emergency Management Agency (FEMA), etc. for a number of years. It’s viewed as one of the few potentially meaningful “growth areas” for the P/C insurance industry given the substantial protection gap (2017 is an excellent case study with ~$245B of economic catastrophe losses incurred but only ~$120B insured). That said, there have been several inhibiting factors (namely NFIP rate suppression) to expanding a private flood solution.
Since the National Flood Insurance Exhibit 18 Program (NFIP) initially expired in NFIP Debt Outstanding ($,M) September 2017, Congressional $40,000 $16B Debt legislative efforts to pass a long-term $35,000 Forgiveness extension have stalled. The most $30,000 recent draft legislation calls for a 5- $25,000 year extension but also includes $20,000 forgiveness of the $21B+ of debt the $15,000 NFIP owes the U.S. Treasury and largely $10,000 excludes programs aimed at expanding $5,000
the private market. $0
2007 2008 2009 2005 2006 2010 2011 2012 2013 2014 2015 2016 2017 2018 Soure: CongressionalResearch Services
In the absence of legislative change, FEMA has made several changes to the NFIP with the goal of improving consumer awareness and moving closer to “risk-based” pricing adequacy (a new policy rating/ pricing model will be launched in late 2020). FEMA also appears to support the growth of the private market. Notably, FEMA eliminated the non-compete clauses with Write Your Own (WYO) carriers which account for 80-85% of NFIP policies underwritten. The impact of the pending rating revisions remains TBD.
Exhibit 19 Top-20 WYO Carriers Based On 2018 DPW ($,M) $700 $617 $600 $513 (Mkt Share Next to Company Name) $500 $400 $266 $300 $251 $248 $148 $200 $137 $120 $104 $58 $55 $100 $52 $49 $47 $39 $32 $31 $20 $19 $17 $15 $0
Soure: STAT Data; Hales Analysis The Hales Report Contact: [email protected] Page 16
While the private flood insurance market Exhibit 20 continues to grow, it remains relatively Flood Insurance STAT DPW/ Mkt. Share small compared to the NFIP. In 2018, the $4.5 $4.0 $4.0 U.S. private flood insurance market grew $4.0 $3.8 10% 16% 18% $3.5 by ~10% to $694M based on statutory data. 15% $3.0 12% 11% Notably, the data does not include private $2.5 flood insurance premium underwritten by Private Flood $2.0 NFIP Direct* WYO
Lloyd’s (a recent Wharton study suggested STATDPW ($,B) $1.5 75% 72% 72%
Lloyd’s held 20-30% of all private market $1.0 flood risk outstanding). That said, the $0.5 private flood insurance market continues $0.0 2016 2017 2018 to grow both in terms of premium dollars Source: STAT Data, FEMA Data; Hales Analysis;*Hales Estimate and market share.
Exhibit 21 summarizes company premium data and respective market share/ change. While much of the focus in the market is on residential risk, increasing commercial take-up rates is also a key to mitigating risk (more holistically). Currently, flood insurance is not standard coverage in Business Owners Policies and only represents 5% of NFIP policies in force.
Exhibit 21 Private Flood Insurance Market Share Data - 2018 STAT DPW ($,K) Company 2018 DPW 2017 DPW YOY Chg Mkt Share 2018 Rank 2017 Rank YOY Chg FM Global $299,749 $263,313 13.8% 44.0% 1 1 Assurant $83,042 $89,901 -7.6% 12.2% 2 2 Zurich $77,128 $63,839 20.8% 11.3% 3 4 ↑ 1 AIG $59,759 $65,989 -9.4% 8.8% 4 3 ↓ 1 Validus (Western World) $2,088 $7,756 -73.1% Swiss Re $49,688 $41,520 19.7% 7.3% 5 5 Berkshire Hathaway $19,837 $27,603 -28.1% 2.9% 6 6 Liberty Mutual $19,329 $15,460 25.0% 2.8% 7 7 Alleghany $17,571 $13,197 33.1% 2.6% 8 8 Allianz $15,924 $11,496 38.5% 2.3% 9 9 HCI (TypTap) $12,205 $8,752 39.5% 1.8% 10 12 ↑ 2 Chubb $8,135 $9,972 -18.4% 1.2% 11 10 ↓ 1 Tokio Marine $7,854 $9,388 -16.3% 1.2% 12 11 ↓ 1 Progressive (Ttl. Co.) $6,070 $1,778 241.4% 0.9% 13 14 ↑ 1 American Stratgic (ASI) $5,995 $1,778 237.2% Munich Re $4,921 $3,989 23.4% 0.7% 14 13 ↓ 1 Nationwide $2,561 $951 169.4% 0.4% 15 17 ↑ 2 Palomar $2,255 $664 239.6% 0.3% 16 18 ↑ 2 Cincinnati Financial $1,934 $1,018 90.0% 0.3% 17 16 ↓ 1 Bankers Financial $1,749 $1,747 0.1% 0.3% 18 15 ↓ 3 State National (Markel) $1,144 $71 1502.2% 0.2% 19 26 ↑ 7 Hanover $616 $482 27.6% 0.1% 20 19 ↓ 1 Universal Group $500 $350 42.8% 0.1% 21 20 ↓ 1 XL $361 $2 NM 0.1% 22 28 ↑ 6 Hartford $262 $256 2.2% 0.0% 23 21 ↓ 2 MS&AD $259 $184 40.7% 0.0% 24 22 ↓ 2 Sompo $194 NA NA 0.0% 25 Ttl. Top-25 $695,136 $639,677 8.7% 100.2% All Other -$1,543 -$7,423 -79.2% -0.2% Ttl. Market $693,594 $632,253 9.7% 100.0% Source: Statutory Statements; Hales Analysis;*Hales Est. Based no Fire & Allied Lines DPW The Hales Report Contact: [email protected] Page 17
Hales Hits:
A Delaware court fast-tracked a hearing on the poaching dispute between #9 U.S. broker Lockton and #10 Alliant. With litigation also in Missouri (Lockton headquarters) and Colorado, the Delaware court agreed to expedite Lockton’s efforts to preserve trade secret, contract interference & irreparable harm claims. Lockton alleges that Alliant “poached” from a Denver-based unit, “Mountain West,” 26+ employees (incl 7 producers) and “millions of dollars in revenue.” The Lockton affiliate has more than 400 employees and 2,000 customers in the Southwest + Seattle. Vice Chancellor of the Delaware court remarked: “The complaint depicts Alliant as essentially the Viking raider, the Norse raider of the insurance industry that knows how to land over the beaches and take over the town or monastery, while hiding its own involvement or limited involvement.” The court has provided 45 to 60 days to prepare for and schedule a preliminary injunction hearing. Certain defectors have sued Lockton over its noncompetition agreements. Jurisdictional issues are likely to slow the process. A Missouri court (which rejected a Lockton motion for a temporary restraining order) set a related hearing for April 25.
The Florida Senate Banking and Insurance voted to limit rate increases on state-run Citizen to 5% per year (vs. the current limit of 10%). St. Petersburg Republican Jeff Brandes (the lone “no” vote) was quoted in the press: “We are moving beyond the world of insurance. We should not call it Citizens Property Insurance anymore, because if we adopt this bill, they’re moving into charity status and away from insurance…Insurance is rate reflecting risk.” Doug Broxson (Chairman of the Committee) remarked: “Does it make any sense for rates? Absolutely not. But it’s the right thing for the people of Florida to do to help people in a tough time.”
According to the NOAA Spring Outlook, nearly 2/3rds of the lower 48 states face an elevated risk of flooding through May, with 25 states being at risk of “major or
moderate flooding.”
Cohen & Company announced the completion of Insurance Acquisition Corp’s Initial Public Offering, the blank-check company sponsored by Cohen & Company and formed for the purpose of M&A in the insurance industry. The details of the IPO included ~15M units at a price of $10.00 per unit, which includes ~2M units issued pursuant to the
underwriters' over-allotment option, for gross proceeds to the Company of $150.7M.
Cornerstone Research published its annual Securities Class Action Settlement Review for 2018 noting a sharp rise in settlement values ($5B vs. the near record low $1.5B YOY) with the increase driven in large part by 5 settlements of at least $100M (including a single $3B settlement). There was also an uptick in settlement values of $10-50M. The total # of settlements declined to 78 from 81 YOY.
The Hales Report Contact: [email protected] Page 18 U.S. Deal Diary – Q1 Updates: The 4 deals over the past 2 weeks put the total Q1 count of deals at 165 (vs. 139 total in Q1 2018). So far this year, the deal tally of 165 is higher than 139 at this time last year.
Exhibit 22, 23 & 24 U.S. Middle Market Agency Transactions By Quarter / Year
591 601 Q1 Q2 Q3 Q4 142 464 149 439 388 354 366 119 331 348 338 104 127 170 106 289 277 268 91 95 86 106 144 95 108 59 220 236 71 94 101 160 67 85 75 86 80 79 150 61 72 68 118 130 69 60 83 72 57 89 75 42 77 80 60 48 52 49 155 139 165 91 109 91 91 98 122 107 88 66 58 62 74 48 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Source: SNL(Preliminary), Factset, other public sources
2019 Most Active Acquiring Brokers - Monthly (Domestic Deals) 2018 Jan-19 Feb-19 Mar-19 19 YTD National Brokers Patriot Growth - 17 1 - 18 Acrisure, LLC 100 4 6 6 16 Broadstreet Partners 30 4 3 3 10 Arthur J. Gallagher & Co. 32 5 1 3 9 Hub International 28 1 3 5 9 AssuredPartners, Inc. 33 4 3 1 8 Brown & Brown 23 1 4 3 8 Seeman Holtz 17 2 - 2 4 NFP Corp. 17 2 - 1 3 Alera Group 28 - 2 - 2 Hilb Group, LLC 9 1 - 1 2 RSC Insurance Brokerage, Inc. 8 1 - 1 2 Marsh & McLennan Companies 7 1 - 1 2 USI, Inc. 4 - 2 - 2 Sub-Total 337 43 25 27 95 Other 264 36 22 12 70 Total Broker Deals 601 79 47 39 165 Source: SNL, Factset, and other public sources through YTD The Hales Report Contact: [email protected] Page 19
2019 U.S. Middle Market Brokerage M&A Since February Acquiree Date Acquirer Acquiree State 1-Feb Alera Group, Inc. Broad Reach Benefits, Inc. NJ 1-Feb Alera Group, Inc. Whipple & Company, Inc. FL 1-Feb Hub International Fortenberry Mcnamara LLC MS 1-Feb BroadStreet Partners, Inc. Certain insurance assets FL 1-Feb World Insurance Associates LLC KK Insurance Agency Inc. NJ 1-Feb Brown & Brown, Inc. Undisclosed Business N/A 1-Feb BroadStreet Partners, Inc. Certain insurance assets MN 1-Feb BroadStreet Partners, Inc. Certain insurance assets IL 1-Feb Insurance Strategies Consulting, LLC Paramount General Agency TX 3-Feb Private Investor- Kimberly Cunningham Bob Snyder Insurance Agency, Inc. CO 4-Feb Hub International Assets of US Insurance Source, LLC and its certain affiliates TX 4-Feb USI Insurance Services, LLC GFI Insurance Brokerage, Inc. NY 5-Feb AssuredPartners, Inc. Francis Hall Insurance Services PA 5-Feb Relation Insurance, Inc. J. Deutsch Associates, Inc. NY 6-Feb Brown & Brown, Inc. Lambert, Riddle, Schimmel & Company, LLLP VA 6-Feb Hub International Motorsports Book Of Business N/A 6-Feb Reliance Global Group, Inc. Undisclosed niche insurance agency N/A 7-Feb AssuredPartners, Inc. Hardy Aviation Insurance, Inc. KS 11-Feb Ryan Specialty Group, LLC Westphalen Insurance Service Inc OK 12-Feb Arthur J. Gallagher & Co. Surety Solutions, LLC/Agency Multiplied, Inc. OR 12-Feb Brown & Brown, Inc. Smith Insurance Associates, Inc. PA 12-Feb California Insurance Specalists Wm K Lyons Agency Inc CA 12-Feb Patriot Growth Insurance Services, LLC Turner Insurance & Bonding Company AL 12-Feb Ryan Specialty Group, LLC International Specialty Insurance, Inc. NC 12-Feb USI Insurance Services, LLC U.S. Risk Insurance Group, LLC TX 13-Feb Reliance Global Group, Inc. Undisclosed insurance agency N/A 13-Feb Reliance Global Group, Inc. Undisclosed insurance agency N/A 14-Feb OneDigital Health and Benefits, Inc. Veritas Risk Services, LLC IL 15-Feb Brown & Brown, Inc. Donald P. Pipino Company, LTD. OH 15-Feb AssuredPartners, Inc. Tolman & Wiker Insurance Services, LLC CA 15-Feb Ryan Specialty Group, LLC Myron F. Steves Company TX 18-Feb SSM Insurance Services, Inc. Copeland Insurance Services CA 18-Feb SSM Insurance Services, Inc. Mission Benefits, Inc. CA 18-Feb SSM Insurance Services, Inc. Scarborough Insurance Agency, LLC CA 18-Feb SSM Insurance Services, Inc. Ahern Insurance CA 19-Feb C&S Insurance Agency, Inc. Francis M. Walley Insurance Agency, Inc. MA 19-Feb Integrity Marketing Group, LLC Senior Select Insurance Group, LLC GA 21-Feb Evraz Plc Ideal Adjusting, Inc. TX 21-Feb GTCR LLC AssuredPartners, Inc. FL 25-Feb Reliance Global Group, Inc. Undisclosed insurance agency N/A 27-Feb InterWest Insurance Services, LLC Placer Insurance Agency CA 28-Feb Reliance Global Group, Inc. Undisclosed insurance agency N/A 1-Mar Engle-Hambright & Davies, Inc. J. Seltzer Associates PA 1-Mar Hilb Group LLC Marsh-Kemp Insurance Agency, Inc. MA 1-Mar Insurance Group of St. Charles County, LLC BLP Insurance Services LLC GA 1-Mar WTPhelan & Co. Insurance Agency, Inc. Robert J. Cappadona Insurance Agency MA 1-Mar BroadStreet Partners, Inc. Book of business FL 1-Mar BroadStreet Partners, Inc. Certain insurance assets CA 1-Mar BroadStreet Partners, Inc. Certain insurance assets TX 1-Mar World Insurance Associates LLC MedNET Financial, Inc. NJ 4-Mar Hub International Integrated Risk Solutions, Inc WI 4-Mar Kingsway Financial Services Inc. Geminus Holding Company, Inc. PA 4-Mar Marsh & McLennan Companies, Inc. Employee Benefits Group, Inc. MD 4-Mar Reliance Partners, LLC CTS Insurance Agency, LLC CA 4-Mar NFP Corp. Wright Insurance Agency FL 5-Mar Relation Insurance, Inc. Villane Ward Insurance Services, Inc. CA 6-Mar Synchrony Financial Pets Best Insurance Services, LLC ID 7-Mar Hub International Peak Financial Group, LLC TX 8-Mar AssuredPartners, Inc. Duffy & Livingston, LLC NJ 8-Mar Brown & Brown, Inc. Austin & Austin Insurance Services, Inc. CA 11-Mar DiBuduo & DeFendis Insurance Brokers, LLC Dority Insurance & Financial Services, Inc. CA 11-Mar Hub International Insurance Exchange, Inc. MD 11-Mar Arthur J. Gallagher & Co. Merit Insurance CT 12-Mar Hub International Insurance Programs Of America Inc./Risk Advisors of America LLC FL 12-Mar RSC Insurance Brokerage, Inc. Krauter & Company, LLC NY 13-Mar Arthur J. Gallagher & Co. Iowa First Insurance Agency IA 14-Mar Brown & Brown, Inc. Cossio Insurance Agency LLC SC 14-Mar Reliance Global Group, Inc. Platinum Benefit Advisors, Inc. MI 15-Mar Brown & Brown, Inc. Medval, LLC MD 15-Mar Hanson Insurance Group KMI Insurance LLC OR 19-Mar Hub International RiteHealth Solutions, Inc. CO 22-Mar Seeman Holtz Property and Casualty, Inc. Kaercher Campbell & Associates Insurance Brokerage LLC CA 25-Mar Arthur J. Gallagher & Co. McLean Insurance Agency VA 26-Mar Seeman Holtz Property and Casualty, Inc. Prey Insurance Services, LLC WI Source: SNL, Factset, other public sources; Note: Does not include some deals where target was not disclosed; Excl. Acrisure Deals. The Hales Report Contact: [email protected] Page 20
Public Broker Valuations:
Exhibits 25, 26 & 27
Broker Price Performance vs. S&P 500 (Since YE'16) 50.0% 45.0% S&P 500 (26.6%) Broker Composite (43.5%) 40.0% 35.0% 30.0% 25.0% 20.0% 15.0% 10.0% 5.0% Source: Factset
0.0%
2/28/17 5/31/17 8/31/17 1/31/18 2/28/18 4/30/18 5/31/18 7/31/18 8/31/18 1/31/19 2/28/19 1/31/17 3/31/17 4/30/17 6/30/17 7/31/17 9/30/17 3/31/18 6/30/18 9/30/18
10/31/17 11/30/17 10/31/18 11/30/18 12/31/17 12/31/18 12/31/16
Historical Public Broker EV/EBITDA Public Brokers Middle Market Sub Composite 14.0 13.3x
12.0 12.7x
10.0
8.0
Source: Company Reports, Factset *As of Year-end 2018
6.0
Q2-13 Q4-13 Q1-14 Q3-14 Q2-15 Q4-15 Q1-16 Q3-16 Q1-17 Q2-17 Q4-17 Q1-18 Q3-18 Q1-13 Q3-13 Q2-14 Q4-14 Q1-15 Q3-15 Q2-16 Q4-16 Q3-17 Q2-18 Q4-18
Current
Public Broker P/E vs. S&P 500 - 5 Year Brokers S&P 500 22.5
20.0 19.0x
17.0x 17.5
15.0
12.5
Source: Company Reports, Factset
10.0
1/14 7/14 9/14 3/15 5/15 7/15 1/16 7/16 3/17 5/17 1/18 3/18 9/18 3/14 5/14 1/15 9/15 9/16 1/17 7/17 9/17 5/18 7/18 1/19 3/19
11/17 11/18 11/14 11/15 11/16
The Hales Report Contact: [email protected] Page 21
Important Disclosures
This report does not provide individually tailored investment advice. It has been prepared without regard to the individual financial circumstances and objectives of persons who receive it. This report is not an offer to buy or sell any security or to participate in any investment. The firm has no obligation to tell you when the opinions or information in this report change. The information and statistics contained herein are based upon sources which we believe to be reliable, but have not been independently verified by us. The firm makes every effort to use reliable comprehensive information, but makes no representation that it is accurate or complete. The firm may, at any time, hold a position in the public shares or private equity of any companies discussed in this report.
The Hales Report Contact: [email protected] Page 22