Higher borrowing costs from rising interest rates could have a dampening effect on insurance broker deal-making in the U.K. that relies on debt financing.
The Bank of England has increased interest rates three times so far in 2022, taking the rate to 1% from 0.25% at the beginning of the year. Rates are already at the highest level in two decades and could increase another two or three times before the end of 2022, according to Seán Kemple, managing director of Close Brothers Premium Finance.
“I think that’s going to put more of a squeeze on repaying your debt and also being able to obtain cash or debt to be able to use for acquisitions,” Kemple said in an interview at the British Insurance Brokers Association, or BIBA, annual conference.
Many brokers’ plans envision generating two-thirds of their revenue growth from acquisitions and a third from organic growth. But if higher rates make it more difficult for brokers and private equity houses heavily involved in U.K. broking M&A to access money, there will be a switch toward emphasizing the organic channel, said Kemple.
The U.K., like the U.S., has long had a highly active broker M&A market, in part because of the large numbers of small- and mid-sized brokers ripe for buying. Several specialist broker consolidators operate in the market, including The Ardonagh Group Ltd., Global Risk Partners Ltd. and PIB Group Ltd. Many broker M&A strategies are backed by money from private equity houses or credit investors.
Limits to impact
Even as they move higher, interest rates do remain low compared with historic norms, and debt financing is still relatively cheap, said Bill Cooper, head of capital advisory at TigerRisk Capital Markets & Advisory (UK) Ltd. Cooper does not anticipate a “dramatic” impact on M&A, but there will be some effect, he said in an interview at the BIBA conference. Much of the effect of higher rates will be confined to the riskier, more leveraged end of the market, Cooper added.
More expensive debt will also not affect all prospective buyers of insurance brokers. There are a lot of extremely well-funded private equity firms and brokers that will continue making deals at pace, said Kemple.
High broker valuations may put some pressure on private equity-fueled broker M&A, according to Simon Collings, managing director of national broking and placement at Arthur J. Gallagher & Co. in the U.K.
The typical private equity model is to buy brokers at between 8x and 12x earnings and to sell them at prices of between 14x and 18x earnings, Collings said.
“There is absolutely nothing for sale south of 14x anymore,” he said in an interview at the BIBA conference. “So the challenge for [private equity] is how they buy low enough to make their return.”
Private equity may move some capital out of insurance and into other sectors where they can make less expensive acquisitions, said Collings. Higher borrowing costs work to Gallagher’s benefit, he said, as they mean the company does not need to raise debt to make purchases.
Though the pace of deal-making may slow in the near future, insurance brokers will continue to draw attention from private equity houses and other financial investors because of their cash-generative nature, according to Cooper.
“The debt-leverage point might take the froth off the pricing a bit, but I don’t think it will change the underlying attractiveness,” he said.