Acquisition fever on Lime Street

After a protracted period of inertia, it looks as if the Lloyd's broking sector could be in for a period of consolidation. The most startling announcement was that made by Willis chief executive Joe Plumeri, who said that the firm intends to pay a staggering $2.1bn for US retail broker Hilb Rogal & Hobbs, which includes Fenchurch Street-based Glencairn. If this deal completes then it would be the largest insurance broker deal for a decade.

Meanwhile, within the confines of EC3, Arthur J Gallagher International has acquired Global Business Solutions' wholesale business from Heath Lambert in a deal that has surprised observers; in April, Heath Lambert and fellow Lloyd's broker Cooper Gay stated that it was in talks to acquire all of the UK broker's reinsurance and wholesale operations, including the profitable GBS arm. Led by Martin Emkes, the GBS business has revenues of approximately £5m, employs 25 staff and includes mining, corporate risk, property and casualty and directors' and officers' capabilities.

More to follow

If Lloyd's brokers themselves are to be believed then we can expect such consolidation to continue over the next three years, according to the latest survey of the sector by accountants Mazars, even though the majority surveyed expressed concern that the credit crunch would impact broker valuations.

According to the survey, 52% of Lloyd's brokers thought that the increase in the cost of borrowing and restrictions in access to funding would impact values, while almost a third thought that it would not. However, the vast majority (89%) also predicted that the total number of Lloyd's brokers will diminish in the next year. A total of 54% of those surveyed cited whole-team acquisitions (and 27% mentioned whole-business acquisitions) as figuring in their strategic growth plans.

On the basis of this sort of evidence, can we expect some fairly frenetic acquisitional activity in the highways and byways of EC3 in the second half of the year? Well, not exactly. One of the most telling statistics in the survey was that, while most brokers want to expand, very few are thinking of selling: only 5% mentioned a sale and 7% a merger. Therein lies the rub: with few willing sellers, the offers will have to be very attractive and this looks unlikely for the time being while market conditions remain depressed.

According to Mark Grice, head of the broking group at Mazars, it is important to understand the idiosyncrasies of the Lloyd's broking market in this context: "The EC3 market is a bit different from the commercial market. You have a lot of smaller shops there with the names of the owners above the doors, so you have to deal with the thorny issue of egos.

"The pricing is different as well. A Lloyd's broker may see a commercial broker making three times their income and think they can achieve that, though it's not true. A Lloyd's broker is not like that commercial broker because they're getting the volume at the commercial end. There's probably an expectation gap in terms of the price that can be achieved for any sale. There are probably not as many people chasing Lloyd's brokers as commercial brokers either."

This is not to pour cold water over possible mergers and acquisitions among Lloyd's brokers, however; it is just that the time is not quite right at the moment in Grice's opinion: "I think in a year's time we will see more (acquisitional) activity in the Lloyd's broking sector, though not necessarily at the moment. After all, rates are against them, the dollar is against them and investment income is against them, so the pressure is there for Lloyd's brokers. If you're a lifestyle business and you can't maintain that lifestyle then you have a pressure to sell. There may also be a pressure to sell from the banks because of problems with debt."

Probable cause

Another factor that could intensify merger and acquisition activity among EC3 brokers could stem from the recently proposed changes to The Lloyd's Act, Grice adds. These changes would see a relaxing of the current rules barring ownership links between managing agencies and brokers, though once again such changes have yet to receive legislatory approval, which would mean that any activity along these lines would more likely be in 2009 than this year.

If we have to wait for the brokers to get their acts together, then, perhaps the more likely area for further consolidation at Lloyd's will be among the underwriters, who have not been shy when it comes to consolidation in recent months. The biggest deal of the year so far was that sealed in March, when Japanese insurer Tokio Marine & Nichido Fire Insurance Company completed its £442.2m takeover of Lloyd's heavyweight Kiln. The acquisition prompted speculation that further deals among some of the bigger players at Lloyd's are now in the offing to match the frenetic activity that has taken place at the smaller end of the syndicate spectrum.

In the last eighteen months, several of the market's small-to medium-sized players have been bought, with Bermudians Validus and Ariel Re picking up Talbot and Atrium respectively. German giant Munich Re acquired Beaufort, Caribbean financial services group Sagicor acquired Gerling's Lloyd's operation, while American Financial Group has taken a majority interest in Marketform.

According to analysts, buyers are being drawn to EC3 for a number of reasons, not least the Lloyd's platform that offers not only distribution through its network of global licenses but also the ability to leverage balance sheets using the Society's capital structure and, in some cases, access a wider range of business because of its higher security rating and location at the heart of the London market.

"Lloyd's represents an ideal platform for trading in the specialist P&C market for the financial returns it can generate, its flexibility and the access to customers," comments Chris Hitchings, an analyst at Keefe, Bruyette & Woods.

Limited options

In terms of market access, mergers and acquisitions may be now the only way forward, he adds. "It is interesting that a view regarded by many as heresy two years ago is now becoming conventional wisdom," Hitchings says, highlighting that, with tight controls now imposed by Lloyd's Franchise Performance Directorate on applications for new syndicates, "potential entrants have little choice but to buy existing ones".

As far as other market watchers are concerned, the recent Kiln deal could signal the start of further aggressive activity among the larger Lloyd's underwriters, which have been rather unresponsive to takeover approaches traditionally. "We had thought the most likely buyers into the Lloyd's market would be some of the smaller Bermudians that were set up in 2005; those that are now looking to diversify and find new income streams as they come into the soft market. We thought the most likely targets would be the smaller players like Hardy, Heritage and Novae," says Numis Securities analyst, Richard Gradidge, who adds: "The approach for Kiln suggests that potential bidders could exist outside the Bermuda 2005 startups, which could imply that bid interest is not limited to the smaller London insurers." Place your bets, please.