Have we hit the ceiling for the sale price of insurance brokerages?

According to a report released by Moody’s Investor Service earlier this month, the global market for mergers and acquisitions is at its highest level in many years. The report from Moody’s deals mainly with international insurers and reinsurers, including US health insurers. Nevertheless, the over-heated market for Canadian insurance brokerages is being driven by many of the same factors mentioned in Moody’s report. These factors include historically low interest rates, the desire to seek advantages of scale, and the desire to expand geographically.

As if to prove the point, on the same day that the release of the Moody report was in the news, it was also announced that Rogers Insurance Ltd. had acquired controlling interest of CCV Insurance & Financial Services Inc., a brokerage based in Brampton, Ontario. The acquisition of CCV represents the strategic expansion of Rogers into the Ontario marketplace. No information was released as to the sale price of the brokerage but presumably it was in line with current market conditions.

Although at the end of the day the price paid for a brokerage is based on a multiple of normalised EBITDA (earnings before interest, tax, depreciation and amortisation), most people think in terms of multiples of commission. At one time, the going price for an insurance brokerage was 1.5 times commission income. Those days are gone. The new norm is 3.25 to 3.5 times. Part of the explanation for these higher multiples is the fact that brokerages are more profitable today than they were decades ago. Technology has played a part in this. So, too, has the introduction of Direct Bill. As brokerages have become more profitable, this has led to an increase in EBITDA.

But there are other factors, beyond increased profitability, that have led to the increase in the multiples being paid for brokerages. For brokerages that are looking to grow their top line in a sluggish economy, organic growth is slow and tedious. Growth by acquisition is fast. And, at the moment, the cost of borrowing is relatively inexpensive thanks to low interest rates. This makes growth by acquisition all the more attractive. Central bankers reduce interest rates in an attempt to stimulate the economy. Just as low interest rates have stimulated demand and increased the prices for homes and condominiums, they have worked their magic in lots of other areas, including the selling price of brokerages.

Although no one has a crystal ball to predict exactly when interest rates will start climbing, there is no doubt they will increase. It’s therefore a question of when, not if.

An increase in interest rates is one of a number of factors that would have a dampening effect on the market for insurance brokerages. Another factor is a reduction in the size of the automobile insurance market. Automobile insurance accounts for roughly half of the premiums collected by the private insurance industry in Canada. There are reasons to think the premiums derived from automobile insurance may diminish in future. Ontario automobile insurance accounts for half of the Canadian total. In Ontario, the provincial government promised a 15% reduction in automobile insurance premiums from 2013 to 2015. The actual reduction turned out to be less than 7%. Although the provincial Liberals’ majority government has some breathing room before facing the electorate, it is reasonable to assume there will be a push for further rate reductions over the remainder of the current government’s mandate.

Perhaps a more significant, although long term, threat to the Canadian automobile insurance market is the advent of the driverless car. I have attended two conferences this year at which it was predicted that private automobile insurance will be a niche, or even an obsolete, product by 2030. Whether this will actually be the case is anyone’s guess. It’s hard to imagine the market for automobile insurance will disappear anytime soon. Still, it is fair to assume that the introduction of driverless cars, coupled with the expansion of car sharing services such as Zipcar, will take a bite out of the premiums and commissions associated with the insurance industry. Should this happen, it will lead to a reduction in the sale price of brokerages.

The market remains robust for insurance brokerages. The question at hand is how long these heady days can last.