The second half of 2012 saw a flurry of merger and acquisition activity among benefits brokers, partly due to anticipated changes in capital gains taxes, but also due to impending health care reform compliance deadlines.
The trend was largely driven by smaller brokers selling out to larger brokers with the expertise and resources needed to help employers comply with the Patient Protection and Affordable Care Act, according to industry observers.
As a result of health care reform, there was a 19% jump in 2012 in employee benefit-only deals compared with 2011, totaling 81 and representing 25% of all deals completed last year, according to a report Willoughby, Ohio-based Marsh, Berry & Co. Inc. produced for the Washington-based Council of Insurance Agents & Brokers.
Arthur J. Gallagher & Co. led the charge, picking up 36 brokerages in 2012, 22 of which were benefits operations. AssuredPartners Inc., a new entrant to the brokerage market that was formed in 2011, jumped into the second most active position with 25 deals in 2012, many involving middle-market property/casualty and benefits firms. Hub International Ltd. made 22 acquisitions in 2012, 11 of which involved benefits operations.
Because of the threat to small-group business posed by PPACA and the overall transformation of the health care distribution market, many benefits agencies sought a sale in 2012, according to Rob Lieblein, Harrisburg, Pa.-based executive vice president at Marsh Berry.
“Eighty-one (or 25%) of the 325 deals completed in 2012 were benefits-only deals,” Mr. Lieblein said. That's up from about 12% four years ago, he said.
Another “reason you saw so many last year was because of the tax changes,” he said, referring to the 2012 expiration of the Bush-era tax cuts that resulted in capital gains tax rates increasing to 20% from 15% for most individuals. Agency owners worth $10 million, for example, would pay an additional $500,000 in federal capital gains taxes if they waited to sell in 2013.
Because of the year-end rush, the inventory of available benefits brokers declined in the first half of 2013, but “now it's starting to build back up,” Mr. Lieblein said.
“We'll still see a lot of mid-market benefits firms continue to consolidate with national players” to position themselves to be able to provide more consultative services to employers, he said.
“Small firms can't provide the services these employers need,” Mr. Lieblein said. “What a consultant needs to know now is a night-and-day difference. They need higher levels of expertise, medical directors, actuaries, wellness coordinators. It's hard for a $4 million or $5 million firm to compete.”
“Many firms that were solely employee benefits or had a significant benefits focus and didn't have the scale to address ACA were driven to partner with larger firms that had the resources to meet clients' needs to comply with and navigate through health care reform,” said Timothy J. Cunningham, managing director of Chicago-based Optis Partners L.L.C., a financial and management consulting firm serving the insurance distribution industry. “I think we'll see more activity in (the third and fourth quarters) as the pipeline fills up again.”
Besides the need to step up expertise and services, small to middle-market firms with a majority of their business under 100 lives are consolidating in anticipation that they will lose this business to the new insurance exchanges being created under the reform law, experts say.
In fact, the prices being paid for these brokerages has been declining in reflection of that business exodus, said Ken Crerar, CEO of the Council.
“You don't know what you're buying right now,” he said. “If you're under 100 lives, your valuation is going to be much lower because of ACA and how the market is changing and what levels of service you have to provide. If you're sitting in a firm focused on small group — or small-to-midsize group, even — one of the big questions is if you have the resources to provide the level of services you need on a consulting basis to maintain that business.”
“If I was a firm and was struggling with what to do because I was worrying about margins and business dynamics and could get a decent valuation out of a firm like Hub or USI with a strong benefits-bent, you'll be in a situation with more resources to provide your clients and have the ability to maintain good margins,” Mr. Crerar said.
Atlanta-based broker Digital Insurance Inc. made eight of those types of acquisitions in 2012, and it is looking for brokers that focus on small business because it has the technology to administer benefits at lower cost, said President and CEO Adam Bruckman.
Digital Insurance also has been partnering with other benefits brokers to provide administrative services for smaller employer groups, and is preparing to launch its own insurance exchange in several states, he said.
“I'm hearing that some of the smaller shops are looking to be acquired or are selling off their benefits books of business to concentrate on more profitable property/casualty business,” said Robert Klonk, CEO of Oswald Cos., a multiline insurance broker based in Cleveland.