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Contingent commission abolition to cut 25 percent from brokers’ bottom line, says report

Leading brokers could see up to a quarter of their bottom line earnings eroded as a result of abandoning contingency commissions, according to a survey by investment banking and financial consulting outfit WFG Capital Advisors.

In its study of the industry’s top seven brokers, the firm found that the impact on “tax affected” net income represents 25 percent of the group’s composite earnings.

Steven Wevodau, managing principal, commented: “This astounding statistic underscores the vital nature of contingents and the presumed impact to the industry’s leading segment. At a time when product rate declines are severely punishing most firms’ organic growth, the relinquishment of this significant revenue stream presents an ominous outlook to the economic welfare of leading brokers.

Many of these public companies must contend with shareholder demands and market capitalisation issues that press the need for continued growth and enhancement of earnings per share. If this is not likely to occur, severe deterioration of market capitalisation is at risk. This will have a significant impact on the viability of many firms as shareholder confidence wanes and access to capital erodes,” he continued.

Wevodau predicted that the knock-on affect would see an increase in acquisitions in the sector as leading players look to alternative strategies to replace lost revenue streams.

In the November 2004 issue of our sister publication The Insurance Insider, we published a comprehensive table, marking out the significant role contingent commissions played in leading brokers’ revenue streams and profitability.

The fact, as recognised by Eliot Spitzer, that the volume-based deals have “little or no overheads”, and subsequently a relatively high margin, means their abolition deprives brokers of a lucrative contributor to profits.

According to the table below, the big three are particularly reliant on the contribution contingent commissions make to the bottom line.

Marsh’s estimated $845mn in contingent commissions last year was the equivalent of 48 percent of 2003 brokerage profits (excluding earnings from Putnam and Mercer Consulting), the $191mn recorded by Aon made up 32 percent of its earnings for the first 9 months of 2004, and Willis’s anticipated $160mn 2004 figure equates to 37.6 percent of the broker’s 2003 earnings.

BROKERS' DEPENDENCE ON CONTINGENT COMMISSIONS

Broker

Overall contingent commissions

As a % of brokerage revenues

As a % of profits (broking only - unless noted otherwise

Notes

Marsh

$845mn in 2003

12% of 2003 revenues

48% of 2003 profits

% for Marsh only, not MMC

Aon

$191mn for the first 9 months of 2004

4.5% of 2004's 9 months revenue

32% of 2004's 9 months earnings of $600mn

Figures for the first 9 months - relate to Aon's broking arm only; exclude $17mn consulting and underwriting

Willis

$160mn anticipated for 2004

7.1% of 2004's 9 months revenues of $1.687mn

37.6% of 2004's 9 months earnings of $319mn

Only $80mn relates to over-riders. The remainder to "market services". To calculate percentages we have estimated 9 months of commissions arrangements at $120mn (full year $160mn)

AJ Gallagher

$33mn in 2003

3,7% on AJ Gallagher's brokerage revenues and 3% including consulting and risk management revenues

31.7% of AJ Gallagher's 2003 brokerage net earnings of $104.1mn and 25 percent of group net earnings of $129.9mn

n/a 

HRH

$39mn

7% of revenues

35.8 %

n/a

Brown & Brown

$31mn

6.3%

19%

n/a

USI Holdings

$17mn

6%

63.6%

n/a

JLT

$15mn in 2003

1.9% of JLT Group's $772.2mn revenue (£1:$1.8)

9% of JLT Group's trading profit of $165.78mn (£1: $1.8)

Figures include JLT employee benefits arm

Heath Lambert

$2.85mn (£1.85mn)

1% of Heath Lambert's 2003 $291.96mn revenues (£162.2mn)

13.7% of Heath Lambert's 2003 broking profits of $20.7mn (£11.5mn)

HLF says fees are 0.52% of £304mn ($547.2mn) turnover - although this figure includes Heath's disposals programme

 Source: Company announcements; Morgan Stanley

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