The road less travelled

Probably the prevailing perception of Towergate, and Messrs Cullum and Homer, among provincial brokers is a combination of begrudging admiration for the empire they have built but also gall and suspicion at the commission levels it commands from insurers.

Its acquisition of Fusion has obviously been instrumental in establishing and achieving its modus operandi. However, has it been the roaring success they had hoped, particularly given the staff that left when Towergate took over?

Homer: "It's been a great success - the Fusion model is at the heart of where Towergte is going with its underwriting agency divisions. We lost two or three senior people in the city of London and the insurance press carry stories on an almost weekly basis of teams leaving Heaths or Aon or Benfield. Of course we were sorry to lose them but we've just recruited a cracking guy, Mark Harris from Willis, but that doesn't get the same level of reporting. You'd expect in the London market to lose people occasionally but the fact that in the first year Fusion has been part of our group it's been a soft market I think is more pertinent to Fusion's performance than anything else."

A great bottom line

Cullum: "This is a virtual insurer model and we have a plimsoll line beyond which we will not underwrite business and that is really important. What that means is, in a soft market is we walk away from business we feel is seriously under priced. The top line will have been affected in 2006 but we've had a great bottom line which has exceeded expectations. In the top line we've seen business go because we're not prepared to stand shoulder to shoulder with people who we think are seriously underpricing business."

Another prevailing view is that commission paid to Fusion is sapping the market. So if, for example, 44% is paid to Fusion - plus enhanced profit share - and 20% to an average broker with standard profit share, apart from the volume leverage how can Towergate justify the extra 24 plus percent on the composites' groaning expense ratio?

Cullum: "24% additional commission is a misnomer because, unlike the average broker, we do everything an insurer would do. If you take Royal & SunAlliance, for example, their UK expenses are circa 17.5%. We do virtually everything they would. OK, we still have to make a contribution to their fixed costs but when you start to break it down and consider we are doing all the quotation, all the policy delivery administration, the survey and risk management, handling the claims and health and safety then actually earning 35 or 40 points, which we may be in certain areas, is relatively modest - but we're paying it away. A total of 50% of that we have to pay to other brokers so in this case - we're paying them 20% to 25% - we're then doing all the expenses. So actually our margins are quite modest when you start to break it down. A lot of people misunderstand and think we are just being greedy but our margins for our wholesale business are pretty modest.

"The main point is that we're doing everything an insurer does and that is what is misunderstood. We know some of the big regional brokers have gone to some of the carriers we work with closely and said, fairly pointedly, we want to same deal as Towergate, and the insurers all said you can have it if you can deliver the additional work that we get from them. Then the penny drops and they think 'actually we can't do the actuarial analysis and we haven't got the IT system to do the underwriting'."

Homer adds: "Peter has been trying to work out this return on capital model for 10 years, to get insurers to trust the idea that other people can do the underwriting and policy administration more efficiently. A lot of big insurers have identified that it is OK to ourtsource back office functions to India, and in doing so have decided they can give up some of the things they used to do to trusted partners. The outsourcing concept isn't that different to what we bring to the table. The difference is we're mainly from an underwriting background - we've got the scars on our backs and we know how it feels to lose money at underwriting and we know what we need to do to correct pricing, so I think insurance companies relate to our team."

Homer: "Amanda Blanc and Clive Nathan have been through underwriting cycles and understand the technology of underwriting. And, to put it crudely, it's different to a bunch of brokers deciding they can underwrite. It's quite different from a broker who has delegated authority and a cheque book to pay claims. We're not just a consolidator, this is an underwriting business that we are paying for and some insurers will gripe about it, why? Because it threatens their model."

Traditional insurers

So what does that leave traditional insurers with as their core business if Towergate is just using them as capacity providers? Homer: "They can help us with product development, research, pricing and modeling in addition to capital provision. Also a global insurer like Axa can raise capital more cheaply than we could so it's an efficient way for them to provide capital to partner with us on the specialism and expertise. We have no ambition to become an insurance company to compete against them. We are part of their distribution chain - we're partners and we lock into long relationships, we're going to be here for a long time so, yes, there is some grumbling inevitably but I think they view it for what we are, which is a partnership. We're big now and we're big partners, just like the building societies in the 1980s were partners with insurers and there was concern about what will the Halifax do with their portfolio, you can see the same questions being asked. However, at no stage do we ever think about doing anything other establishing long distance partnership arrangements - that's the way we work."

So what has been the best thing that has happened for the group this year? Cullum: "The biggest breakthrough for us in the past 12 months is Bridget Macintyre joining RSA. Prior to her arrival RSA were lukewarm but with Bridgette coming from NU, and having seen it was working well for them, suddenly we've got from almost a zero position with RSA to, as we've just announced, a deal with Paymentshield, where suddenly we've got £160m of household business."

Cullum continues: "I think a lot of insurers are still adopting a 1980s way of doing things and they haven't moved on. That's why we get miffed about the perception that we're just a consolidator and that we buy businesses and toast the people it's a nonsense. We don't buy businesses to try to turn them round and the only exception to that is BPS."

Cullum continues: "Up until a year ago, carriers may have been nervous about what will happen to Towergate because we had Royal Bank of Scotland private equity as a shareholder and venture capitalists traditionally have short time horizons. We bought out RBS in October last year, so we own the management of the staff, and we own 97.5% of the company. For some obscure reason RBS kept 2.5%. With that ownership we are not under any strictures to do an IPO or some sort of private equity deal. We can now decide the fate of Towergate without a vulture capitalist staring over our shoulders. That means we can go into medium-term planning and invest in the business without just looking for a short term quick buck which is very important to us as we build the model going forward. We are glad to be free of the impediment of having to talk at every board meeting about the exit strategy."

Speculation over the future

There has been much speculation over Towergate's future and more specifically Homer and Cullum's exit strategy. Cullum says: "We have just effectively recapitalised the company to the tune of £585m and the lead bank is now HBOS rather than RBS. That will give us £250m in addition to the £180m we've just spent on Paymentshield to spend on acquisitions. So that is new, new money. That allows us to plan for 18 months to two years."

This additional £250 will help Towergate reach its 2007 target of £3bn GWP. Cullum continues: "What I'd also say about the refinancing is about the size of it. Financial services is not a place where banks and institutional investors queue up to get involved. And if you look at its record they have every reason to feel less that totally confident about it as a market so £585m is a big number to have raised. Lloyd's TSB are there as well and what is significant is they are underwriting that deal because what happens is banks say they will lead it and hope they can find syndicated banks that will follow to spread the risk but in this instance HBOS and Lloyd's TSB have underwritten the £585m - it's guaranteed."

So that explains the short to medium term future and Homer and Cullum's involvement; but is floating still on the cards at some point?

Homer: "I think refinancing kills the speculation about are you going to IPO or who are you going to sell to. We've refinanced for the next two to three years and we can now plan for 18 months to two years and actually we like owning this business."

So you may float yet then? Homer: "Talking about floating is a double-edged sword. If we said we would never IPO, people would say we are lying and if we said we would consider it we would get every investment bank and his brother beating a path to our door. We have no plans to IPO in the next two years but that doesn't mean we have ruled it out either - we certainly don't need to float at the moment. We're also suspicious of the burden IPO brings. A lot of the entrepreneurs, businesses and businessmen that we insure that have gone to the AIM or a public listing have lived to regret it."

Cullum adds: "Covering that off in terms of IPO. A lot of people think it's an exit, it's not - it's just cheaper capital and if we believed we could get cheaper capital in two to three years time by doing an IPO - because we couldn't sell our shares, institutions don't allow it - so that would only be another pit stop for us if we need to raise more money and that was an effective way to do it rather than going to traditional banking sources."

Latest acquisition

Towergate's latest acquisition of Paymentshield has caused something of a stir not least because its owners (the Riding family) prior to HBOS, from which Towergate acquired it, have denounced the deal. This is due to the discontinuation of commission payments to dormant agents, which was decided four weeks prior to Towergate taking ownership. So, with such an incentive for agents gone, are Cullum and Homer concerned existing brokers will vote with their feet at renewal?

Cullum: "There was no preemptive strike on our part, I think the word collusion has been used in relationship to Towergate and Paymentshield in connection with payment reduction. They run this business autonomously and we had no influence while negotiating to buy it. However, we can't pay commission to non-regulated, dormant retired brokers - that's the problem. The strategy around what commission is paid to agents is in the hands of the Paymentshield management team. It's clear the product, the service, the commission that's paid to supporting agents represents a great package. A tidying up of payments made to dormant agents we regard as Paymentshield management's business, it's not something we will interefere with."

Cullum cites the unusual nature of the set up by using the example of an insurance broker that was no longer trading and what would normally happen, which would be that the agency would be cancelled and the commission would cease. Homer also argues that it would not be acceptable to the customer for an agent they never heard from, that did not issue the policy, give advice or is not qualified to collect a commission. However in terms of retaining its existing active agents Homer also says: "There is nobody in the market, and we know this for a fact, that pays the same level of commission that Paymentshield pays. It's just a great deal for mortgage brokers and we feel there are some isolated bits of bitching going on. They have great relationships with outfits like Sesame and St James Place and you don't win their business by paying substandard brokerage because they'd vote with their feet."

A class action

However, a press release issued by the Ridings in mid-November indicated their involvement in a class action of some 4000 brokers. So are Homer and Cullum ready for that? Cullum: "Our position, as I've said, is we can't pay commission to non-regulated, non-FSA approved intermediaries, in addition to the fact that they are giving absolutely no value whatsoever to the customers and I think they've got a pretty weak case. However, if there is going to be litigation we can't really make any overt comments about that."

Homer continues: "If there is going to be litigation then Paymentshield's lawyers will advise them and we look at the agency agreements but I think the important point is it's not something that Towergate have been driving - it's a Paymentsheild view of the way they manage their agency relationships. If it comes to it, the whole area of agency relationships and regulatory status amongst those 4000 agents will have to be picked through and what the nature of the particular contract that they're signed was in relation to what their current involvement with the client is."

So, following the acquisition of Paymentshield how much debt does Towergate carry and does the figure cause concern?

Cullum: "With our recapitalisation we will have, but not at the moment, around £250m."

Is that because the deal hasn't gone through?

Cullum: "It's because we have a draw down facility and we will only draw it down when we actually need it."

Homer adds: "So in terms of leverage it's nowhere even close to being a concern. Our business has just been valued by a group of investors who wanted to get the value to the lowest possible number for obvious reasons and the number was £1.3bn. Debt is always related to profits and our profits are strong, our cash flow is strong and our acquisitions tend to be successful and add and create value, which is why the banks are happy to underwrite it. So we're not stupid, we wouldn't overstretch."

Cullum: "Our run rate is well north of £100m, I mean well north of that EBITDA. So we could run at £400m to £500m debt if we wanted but we're no where close to that."

So, having recapitalised, derisked and set a succession management team in place - finance director Ian Patrick, Amanda Blanc, Clive Nathan plus Stuart Pender and his management team from Paymentshield - Towergate is now ready to seriously up the ante.

Homer explains: "We've got Towergate Healthcare just about ready to go. Norwich Union Healthcare is the main carrier on that. It will be small to start with - about £10m in premium but we will grow that by acquisitions and we have some strong organic growth prospects in selling healthcare to SME businesses within Towergate."

It is an irony about Towergate that as Homer and Cullum become increasingly 'miffed' by the tags and pigeonholes that get attached to their firm they make is increasingly difficult to define. Enter Towergate Financial Services.

Homer explains: "We will enter the IFA market in 2007 with TFS - the strategy has been determined and execution will be dependent on us having a management team to run it. The reason is we think there is room to consolidate the best of the best in the IFA market." Cullum also says: "We think the current distribution model in financial serves is bust - with high indemnity commission at the front end - its horrible and the churning is terrible. The whole industry makes it almost inevitable that there will be a high level of churn among IFAs and it's crazy for the customer so we've got a different model that we want to introduce." Can you say anymore about it? "Not yet but it will be innovative and as with all innovation it has a high risk of failure. We're not blind to the fact that we could get blackballed by the main life assurers that are wedded to their traditional model. We do know one that is going to run with it, which is important but we're not going to go head to head with our paymentshield Partners like Sesame and Open Work."

ARROW visit

Homer also mentions Towergate Law and the intention to consolidate solicitors firms but would not go into any detail beyond its planned 2007 introduction.

Another little known fact about Towergate is that in April it had its ARROW visit, and the FSAs inspectors stayed for eight days. Homer says: "The risk mitigation programme the FSA have asked us to adopt is sensible - this is a standard thing everybody gets and it says what you need to watch or tighten up on and the FSA treats that as the agenda for future meetings." So was there any fundamental change required? "No, actually what they were most concerned about was the governance at the top, the way the board receives reports and audits - the internal audit strength, the way that compliance fitted in with audit. It was that sort of corporate governance they were very interested in."

Cullum: "And can I just also say the ARROW visit was not a tick-box exercise; that was a seriously, seriously thorough examination."

In conclusion Homer says: "We are planning ahead so sadly we are going to be around for a while." Cullum adds: "If we got bored and didn't want to get up in the morning then we'd stop but we have got a lot of ambition still, not to do the same things again we to push the envelope and innovate."

Read the full length interview to hear Homer and Cullum's views on CCV, the commission debate plus technology and the commoditisation of commercial business at www.professionalbroking.com

CV - PETER CULLUM

2005: Chairman, Towergate Partnership

2002: Established Folgate Partnership

1997: Formed Towergate Underwriting Group as chief executive

1996: Group marketing director, Hiscox

1991: Chief executive, Economic Insurance Company.

1982: UK marketing manager, ITT London and Edinburgh

1979: Marketing executive, Commercial Union

1975: Joined Commercial Union

1969: Trainee underwriter and new business executive, Royal Insurance Group.

CV - ANDY HOMER

2005: Chief executive, Towergate

2003: President of the CII

2002: Chief executive officer, Folgate Partnership

1999: Chief executive of Axa Insurance, following the acquisition of the GRE Group

1998 and 2000: Executive director of Sun Life and Provincial Holdings

1998: chairman of the MIB

1998: chief executive of Axa Provincial

1998: General manager, corporate and London Markets upon the merger of Commercial Union and General Accident

1998: Trustee of the Insurance Ombudsman Pension Fund

1996: UK general manager, CU

1976: qualified as a chartered insurer

1971: Management trainee, CU.