Moving with the tide

In the past it has been difficult to determine exactly what has been taking place in the broker market and how many firms it was served by. Practitioners have been able to gain a good feel of market trends, and there has been much anecdotal evidence of what is happening, but little in terms of definite numbers.

The Financial Services Authority states that 7940 primary insurance brokers were regulated in the UK as of 14 January. On top of this, there are a further 4839 firms that have extended their scope of permission to include general insurance. This is all before taking into consideration those that have been registered as secondary insurance brokers.

Many practitioners in the market freely question these figures. Not so much because they believe the FSA has made an error in its sums but, rather, in its classification of firms, the business they do and the reliance they have on general insurance business.

Grant Ellis, chief executive of The Broker Network, puts it bluntly when he states: "I do not believe the figures. I am sure there are many that registered with the FSA, but what I am questioning is the number that are actually primary brokers. I think there are closer to 5000 brokers that are earning their main income from general insurance and about 1000 of those are absolutely tiny."

However, debate over numbers is in many ways irrelevant and, for those in the market, the real importance will be in monitoring how they change and how the line in the sand moves with the tide of the market.

There is little doubt that the number of brokers operating in the market is set to shrink. Consolidation has been on the agenda for many years and there is no reason why it should now become unprofitable, unfashionable or unworkable. But what is driving it and how it will affect the dynamics of the market are important issues to be addressed.

It is likely that recent regulation will act as a spur for further consolidation in the broker community. For many, the prospect of FSA regulation was, at best, unwelcome. However, many firms that had considered selling up as their principals looked to retire decided to hold off until they had been authorised.

Simply put, the logic was that, before regulation, it might have been easier for a prospective buyer to force down the sale price due to the unknown costs and liabilities of regulation that would have to be addressed.

For the smaller firms - those generating commission of less than £1m - it was also relatively easy to become regulated and, therefore, no great burden to hold off on a sale and go through the process.

However, being regulated and operating compliantly are two very different things. For some small firms that have become regulated but have not been able to meet the requirements of the new rules, a sale may still go ahead, but the poor operating procedures will negate any benefit that was to be had from waiting for FSA sanctioning.

Paul Meehan, chief executive of Smart & Cook, explains: "For those that have been regulated and then decided to sell, the buyer will come in and lift the carpet to look at the business and see that there are no floorboards, thus, their aspirations for a better cost will not materialise. It really depends on how well the firms have been able to put regulation into practice and comply with the rules."

There is also likely to be a number of businesses that had not planned on selling up but find the whole burden of regulation more than they had bargained for. Kevin Young, managing director of Argyll Insurance Brokers, comments: "As the FSA regime starts to take effect, there may also be more businesses coming onto the market. At the moment, a lot of people have answered all the questions correctly but it remains to be seen how many of those people can actually operate within the regime. It is a costly exercise and it requires a lot of work, effort and time. As the FSA regime goes forward, many people will decide that this is not for them after all and further consolidation will be the result."

The acquisition trail

Argyll, like many other medium-sized brokerages, is certainly prepared to snap up brokers that become available, as long as they are relatively close at hand geographically. He says: "Argyll is still on the acquisition trail. We have completed three in the last three years in Kent and we are hoping to complete another very soon. It is firms like Argyll that are looking to bolt on acquisitions and I think bolt-on acquisitions are the secret.

"If you start going out into a brand new area, trying to achieve growth that way, then it is very difficult but, if you have a presence in Kent or Sussex, as we do, and a broker in those areas comes on the market, then clearly, as you already have the infrastructure, it is a relatively easy thing to bolt that business onto your own. I think that is where a lot of the consolidation will happen."

Acquisition of the smaller firms is also being driven by some of the networks in the market, with the likes of The Broker Network offering an exit strategy to members once they feel they wish to retire and leave the business. Ellis says: "I would expect to see a flurry of people wanting to sell their business and retire or at least see what the options are. We are here to help brokers who want to retire by acquiring their businesses. In 2004 we acquired 10, all of which were members, and that is obviously a target market for us."

Elsewhere, some of the larger national brokerages look set to continue their growth and create genuine heavyweights in the market. For these larger firms, the target market is the medium-sized brokerages that will add further volume and economies of scale to their operations. Such acquisitions are not cheap and much of the funding is coming from the venture capital market with firms like Smart & Cook being owned, in part, by 3i (almost 40%). Such backing means there is capital available to finance acquisitions, but the real question is what will happen when these firms run out of targets? The venture capitalists are still looking for either growth or an exit strategy.

Ellis says: "Venture capitalists want quick results. There has been a lot of competition for the £1m-plus deals, but there are not enough of those to go around to satisfy demand so I would expect to see the big firms start to come together. I can envisage a situation where some of the consolidators may end up coming together as a natural progression.

"If you ignore the nationals, there are only 50 brokers that have revenues of £4m or more, and only 250 with a revenue of £1m or more and so there is a finite number of targets. An even smaller number of these will be in a position where they want to sell."

It is this type of consolidation that created the global brokers in the market today and so it should be no surprise that others are trying to emulate their success. What is worrying, however, is the lack of new blood coming into the market.

The introduction of regulation has undoubtedly made it more difficult for firms to start up in terms of the base level requirements, but there is also an argument that this will ensure those who do look to enter the market are more professional, more thoroughly thought out and better financed than start-ups at any other time in the market's history.

Ellis comments: "The barriers for entry are greater than when I started, but the entrepreneurs have not gone away and I think you will see, as the gaps are left, new businesses coming in to fill them. The entrants will be more professional than they were 30 years ago and they will have to have funding and a business plan - the opportunities to start up and bumble along are just not there."

Not only is it more difficult to enter the market but there are also fewer looking to do so, with less entrants coming from the old training ground of the insurance market.

Phil Boothroyd, product manager for general insurance business at Sesame, says: "Traditionally, independent financial advisers are aged 50 plus, so many are winding up their businesses and we are not seeing as much new blood come into this area to make up for those losses. However, I think a lot of people are looking at how they can encourage more and younger people into this arena and offer them a career path. Certainly it is something that we are looking at and plans are beginning to take shape, so I think you will find people offering better training, help with regulation and assistance with funding."

Young agrees that work has to be done to help encourage training in the market and that the burden of this has fallen onto broking firms themselves.

He says: "The insurance companies were traditionally the training ground for brokers but nowadays we are having to do a lot more training at the lower levels to bring people through from when they leave education. We have a regular intake of people from school and university and we hope to train them up. I think that has been happening a lot more in the last five to 10 years, with brokers training from the cradle."

Eric Galbraith, chief executive of the British Insurance Brokers' Association, is aware of the problems the broking market has experienced in attracting people through its doors. He says: "We do not have the right image or reputation to attract the right people into the business and there is a huge opportunity that we are missing here. It is something that we as an industry have to do more about."

New blood

Galbraith says the industry has to work together and the trade associations have to work harder to attract new blood and ensure that they know how large the industry is and how numerous and varied the opportunities are.

He admits that there is not an initiative in place to deal with this at present, but says there is momentum growing across the industry.

He says: "I would like to think that we are about to light some touchpaper and that activity will be created in a number of areas within the industry both with the Association of British Insurers and The Chartered Insurance Institute. BIBA is certainly willing to play its part."

Consolidation is affecting the industry in many ways and, despite the press it has had, not all are bad. If brokers and insurers can get their act together to encourage and train junior staff and develop channels to bring new workers into the sector, there is no reason why consolidation should not act as a pruning of the industry that will allow for further and stronger growth. It may take time to blossom but the effort will be worth it.