Several factors have sparked a wave of acquisitions in the middle-market insurance industry. The U.S. insurance business is huge, with about 3,000 life insurance companies, 2,000 property and casualty insurance companies and 20,000 insurance brokerage firms. Property and casualty insurers are motivated to sell, due to capital concerns, low interest rates and premium price stagnation. (For more coverage, see Racking Up Regional Insurers.) Private equity firms have been attracted to life insurers, because of low interest rates, attractive revenue streams and potential investment management fees. Buyers have also been drawn to insurance brokerages, due to cash flows, sticky clients and improved efficiencies through scale.

Smaller property and casualty insurance companies, especially those valued at $75 million and under, are being gobbled up by larger companies because most of them don't have access to capital to grow and their returns on invested capital, which are restricted by state regulators, have been poor, says Andrew Barile, an insurance industry consultant in Savannah, Georgia. AmTrust Financial Services (Nasdaq: AFSI), a multi-national specialty and workers' compensation insurer led by Barry Zyskind, is an acquiring company that's been busy in that arena.

The smaller property and casualty firms -- those valued at below $500 million -- have also been hamstrung by an inability to raise rates, due to the recent lack of significant storms that wreak havoc and claims, enabling insurance underwriters to reset their prices, says Bob Shapiro (pictured), an attorney with Carlton Fields Jordan Burt in Washington D.C. who counsels insurance companies on transactional and regulatory matters.

"Companies are realizing that they really can't compete," Shapiro says. "Large insurers can afford to diversify along several different lines, so that if one line has a soft market and they're not able to get rate increases, they can divert capital to other lines. That's not true with the smaller to midsize companies."

"If you're not able to put your capital to work at a decent rate of return, you're going to really suffer," he says. And ratings agencies look unfavorably on insurers without adequate capital reserves, which can force smaller companies to sell to larger, well-capitalized companies.

Shapiro expects a lot of consolidation to occur in the reinsurance market. That's because traditional reinsurance companies, facing increased competition from new entrants, such as hedge funds, and new insurance products like catastrophe bonds, have accumulated enormous amounts of capital on their balance sheets that they aren't able to put to use.

With life insurance companies, the average spread between payouts and return on investments in 2013 was only about 1.1 percent. Private equity firms see that as an opportunity.


Small and Steady

"A lot of these acquirers are basically making a bet when they come in and try to buy a life insurance company that interest rates are going to go up in the future, and they just happen to have the cash to ride out the storm," says Scott Shine (pictured), an attorney at Carlton Fields who advises on M&A in the financial services sector.


Private equity firms that are flush with cash are willing to pick up insurers that won't provide home-run returns, but will deliver small, steady returns, says Shine. Also, demand for annuities and similar products tied to longevity risk (such as life insurance) is expected to increase significantly as the baby boomer generation starts to roll over its 401k funds and other retirement savings.

Another reason that PE firms have been interested in the life insurance space has been the opportunity to manage the investment holdings of acquired life insurers, which tend to share the same long-horizon investments that PE firms specialize in.

"Insurance companies have become hot commodities in the last couple of years," Shine says. PE firms that have made plays in the middle-market insurance space include Apollo Global Management, BlackRock and Guggenheim Partners.

The consolidation trends are not completely unimpeded. Fitch Ratings is predicting that the growth of U.S. PE investment in the life insurance sector will start cooling off because buying opportunities that were available after the 2008 financial crisis have been picked over.

Also, state insurance regulators-especially in New York-have recently shown an interest in tightening regulations to address concerns about private equity ownership, such as requiring ownership to guarantee financing for the insurer, which could create "headwinds" against PE investor interest, says Matthew Noll (pictured), a senior director at Fitch.

On the retail brokerage side of the insurance space, private equity firms have been trying to emulate the model established by AssuredPartners Inc. in Lake Mary, Florida, with the idea of combining enough smaller brokerages to create a national platform that one day can be taken public, Barile says. AssuredPartners, backed by the GTCR private equity firm in Chicago, has made more than 75 acquisitions since launching in 2011, including 20-plus in 2014 .

The recent attention from private-equity-backed acquirers, as well as national publicly traded companies like Marsh & McLennan Agency (NYSE: MMC) in White Plains, New York, that have always been interested, translates into a lot of wining and dining for the middle-market insurance brokerage owners.

"What it's done is raise the price of what the retail insurance broker can get for his agency, just because there's more people interested in buying," Barile says.

Hub International of Chicago-- an insurance brokerage offering property and casualty, life and health, employee benefits, investment and risk management lines-- was one of the busy acquirers on the middle-market insurance front in 2014 with some 29 acquisitions.

The deals included purchases of Davenport, Iowa-based Ruhl & Ruhl Insurance in December; Fotek Insurance Agency, a New Jersey provider of employee benefits, in November; and Marrs Maddocks & Associates Insurance Services Inc., a San Diego area insurance provider, in October. In July, Hub International bought Gibson's Insurance Agency, a Manitoba, Canada-based insurance brokerage firm, giving the company more than 16 Canadian offices. Also in 2014, Hub International bought MGA Partners Inc., a managing general agency in Ontario, Canada, with six locations; California human resources software company Algentis LLC; and Peterson Milaney Insurance Associates Inc. in Westlake Village, California.

As investors have been drawn increasingly to the financial services sector, insurance companies have benefitted, says Charles Kline, a partner at the Century Capital Partners private equity firm in Boston. Century backs three insurance brokerage investments: BroadStreet Partners, which takes majority investments in independent insurance agencies; Integro Insurance Brokers, which has North American, United Kingdom and specialty divisions; and Ascension Insurance, a retail property and casualty insurance agency.

One example of growth on the brokerage agency side is Confie Seguros, owned by the Avery Partners private equity firm. Confie Seguros was founded in 2008, starting with a focus on insurance lines catering to the Hispanic consumer, one of the fastest growing markets in the U.S. Since Avery acquired the company two years ago, Confie has expanded to include businesses aimed at middle-class America customers and small commercial lines, nearly doubling in size.


Hub and Spoke

About 50 percent of the business is now from the Hispanic market, one of the fastest growing segments in the U.S. "We're not just focused on the Hispanic consumer," says co-founder Mordy Rothberg (pictured). "We're branching out."

The company works through a hub-and-spoke business model. "Once we have a hub in a region, there are tremendous economies of scale," Rothberg says. "In the vast majority of acquisitions that we've done, we've significantly grown the operations."

The hub-and-spoke model allows the company to adjust to regional differences, including different state regulations, unique carriers and local community differences. "What's attractive about our business model is that we take advantage of our infrastructure and our scale," Rothberg says. The company now has annual revenues of $350 million, and it expects to double that within five to six years, Rothberg said, with growth coming both through acquisition and organically. Confie Seguros has more than 560 offices, including 40 that it opened organically this year.

One advantage with the retail insurance brokerage business over commercial brokerage is that there is no concentration risk, where too much business comes through one customer or one underwriter. Another aspect that appeals to investors about the insurance brokerage business is that it doesn't generate risk.


Great Cash Flows

Insurance as a whole, on the distribution side, is attractive to investors because it has great cash flows, there's no inventory and we're selling a product that's required. If you're an individual, you have a home, you need insurance; if you have a car, you need insurance; if you're a business, you need insurance," Rothberg says. "If you know how to sell and you know how to service, you're really going to make a lot of money in insurance distribution."

Private equity firms have been less enthused about the insurance underwriting business because the value of a potential target company can vary widely, depending on which actuary is evaluating reserves and potential loss payouts, Barile says. Those concerns apply to both the property and casualty insurance businesses and the life insurance sector.

"They're more comfortable in the insurance brokerage space, where when you look at the profit margin of a brokerage firm, it's pretty simple arithmetic-revenues less expenses, and everything is quantifiable," Barile says. But with an insurance underwriter, four different actuaries can come up with four different opinions that swing the value of the company from 100% of book value to 50%.

Barile predicts the next frontier for middle-market acquisition activity in the insurance sector will come from captive insurance companies-entities created by private companies so they can write their own insurance policies on everything from cyber liability to directors' liability to pollution. With 6,000 captive insurance companies in the U.S., many will aim to maintain their growth through acquisitions. "If the corporation that owns them isn't growing, then the captive insurance company isn't growing," he says.

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