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Insider Comment: Distribution becoming king

The multinational broking giants - namely Marsh, Aon, Willis et al - may still be suffering from the effects of a Spitzer-induced hangover, but elsewhere it is becoming difficult to ignore the growing interest in the industry from prospective acquirers.

And nowhere is this more obvious in the UK where a variety of investors - from insurers, to private equity firms, banks and other brokers - are buying up businesses with significant distribution capabilities.

Recent examples vary from US retailer Hilb, Rogal & Hobbs acquired the independent firm Glencairn earlier this year, to Aon Ltd's swoop for the classic car specialist Footman James. But while these could be characterised as typical consolidation moves, there is also growing interest from insurers to acquire brokers. Indeed, arguably it is AXA that has been the busiest of late, with its imminent acquisition of Smart & Cook the firm's fourth significant UK transaction this year.

What's driving this interest?

As ever, it would appear to be a combination of factors. For seasoned private equity investors, the sector offers non-correlated risk, together with high and regular cash flows in the attractive financial services sector. If you can look beyond some of the downsides - such as the ever-present regulatory issues, high embedded costs and the fear of key staff walking away - then broking currently ticks many of the boxes that investors are looking for.

But for insurers, their interest appears to also demonstrate the growing importance of distribution as a key component of the underwriting process. In theory, there are a number of potential "cuts" available in the chain - from distribution (commission or advisory fee), management, the actual underwriting and then in supplying the capital (which includes reinsurance).

And companies that control this well are highly valued by investors - not least, the UK motor insurer Admiral which trades on a forward P/E multiple of 26 against a "sector" average of approximately 10. The Cardiff-based insurer is admired not only for its controlled underwriting (combined ratio of 89 percent in a soft market) and low expense ratio (14 percent), but in its rigorous approach to capital management and growing profits from distribution, not least its own online distribution platform confused.com.

Although comparisons between AXA - one of the world's largest insurance companies - and Admiral may appear stretched, they both seem committed to growing their share of distribution.

Indeed, it is this trend which the financial services consultants Deloitte identified as a key reason for the higher prices currently being charged by brokers in M&A deals.

"The interest of insurers in acquiring distribution channels has not only increased demand but has fundamentally changed the way in which insurance distributors are valued," noted the Deloitte partner Ian Clark last month.

He continued: "Insurers are increasing the multiples offered by paying upfront a share of estimated future underwriting profits."

It is also a trend that appears to be mirrored in other financial services. For instance, amidst much of the rhetoric surround Barclays' possible swoop for Dutch rival ABN AMRO, was a recognition that the merger would provide more channels and greater access to customers.

It would appear that distribution is becoming increasingly attractive in financial services.

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