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Fitch: Flat to Moderate Growth for Brokers

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Posted on 04 Feb 2010

Rating agency Fitch has delivered a downbeat outlook for the US broking industry. It says profitability will be flat or improve to a modest degree in the coming year.

Despite a stable performance in 2009, the sluggish global economy will continue to diminish the performance of industry and “organic revenue growth and meaningful operating margin improvement could continue to prove elusive,” said Fitch in its Insurance Broker Industry Outlook report for 2010.

According to the report, the five publicly traded brokers tracked by Fitch – Aon, Marsh & McLennan Companies (MMC), Willis, Arthur J Gallagher and Brown & Brown – experienced negative organic revenue growth turn in the first nine months of 2009. However, consolidated operating income rose by an average of 19% over the same period, with four of these five companies experiencing a year-over-year increase and Brown & Brown’s remaining flat.

This improvement reflects earnings accretion from acquisitions completed in 2008, as well as lower restructuring expenses and the related cost benefits, said Fitch.

On the subject of contingent commissions likely returning to big brokerage business, Fitch notes that despite the potential for incremental revenue generation, the rating firm “does not expect any resurgence of contingent commissions to be an economic windfall for the brokers in its rating universe, particularly since clients and insurers may resist paying additional fees at a time when they are facing cost constraints themselves.”

The industry remains top heavy said Fitch, estimating that the top five global insurance brokers controlled roughly 70% to 75% of the overall insurance brokerage market in 2008 and that the top 10 have roughly an 86% market share. The market is highly fragmented, with hundreds of smaller insurance brokerages in the US, the majority of which report annual revenues of less than $50m. These could be targets for mergers and acquisitions (M&A).

Fitch expects the pace of M&A activity to remain moderate in 2010. While the largest brokers may continue to try to grow in the middle market, Fitch expects any such transactions to be of modest size. MMC is the most likely of the largest brokers to acquire an entity of substantial size.

The larger brokers that Fitch deals with continue to possess qualities consistent with investment-grade ratings, as indicated by the report. Fitch notes that many brokers have adapted to the tougher operating environment reducing headcount and streamlining operating systems.

Aon’s ratings of BBB+ and stable outlook reflect its strong balance sheet and cash flow generation, and very good financial flexibility, said Fitch. Additionally the company competes well with the top three global brokers, with large operations in insurance brokerage, reinsurance brokerage, and human capital consulting. However, Aon’s substantial projected pension obligations and its underfunded status could stress Aon’s liquidity profile and undermine its rating. Although Fitch expects this volatility to decrease over time.

MMC’s financial flexibility has improved over the past several years and Fitch gives it a rating of BBB and a stable outlook. Fitch recognises that MMC’s earnings have been under pressure from restructuring expenses, a softening insurance pricing cycle, and the global economic downturn, and expects improvements as restructuring charges diminish and expense savings take effect. As one of the world’s largest financial services firms MMC is also considered an effective competitor but sees MMC’s consulting and risk consulting and technology subsidiaries as weak. Plus the fact that MMC remains the target of several class action lawsuits adds a level of uncertainty to the company’s rating.

Willis' negative rating outlook of BBB- reflects Fitch’s belief that in a soft market, the firm may struggle to realize the benefits from the acquisition of Hilb Rogal & Hobbs. The global economic downturn could also restrict growth in several key business lines, such as the company’s construction and employee benefits businesses. Finally, Fitch believes the company’s increased debt load following the Hilb Rogal & Hobbs acquisition and the relatively higher cost of the company’s recent debt offerings will put a strain on Willis.

Overall, Fitch believes that Aon and Willis could post the strongest operating results of the largest brokers in 2010.


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