In early 2023, mergers and acquisitions (M&A) activity in Canada’s property and casualty brokerage space slowed. Some attributed waning enthusiasm for deal-making to an inflationary environment and higher cost of capital.
Not unreasonable given the Bank of Canada also feared stubbornly high inflation could trigger a recession, while other observers suggested a possible milder economic downturn. Following months of aggressive interest rate hikes, the central bank again raised its overnight lending rate in early 2023.
By mid-year, deal-making in the P&C sector picked up. About one year later, the Bank of Canada twice dropped the overnight lending rate by 0.25%, and then dropped it another 0.25% in early September 2024.
Inflation’s impacts
What did that mean for P&C brokerage M&A? Depends on whom you ask.
Some acknowledge higher capital costs slowed acquisition totals or materially impacted M&A strategies. Others say higher capital costs introduced new considerations into the M&A landscape. Still others highlight the industry’s relative resilience to recessions.
In other industries, higher interest rates caused considerable slowdowns in M&A activity and a softening in valuations, says Alex Wong, a partner at Smythe LLP in Vancouver. But this wasn’t the case in the insurance M&A market.
“Other than the minor slowdown in early 2023, deal activity and valuations weren’t negatively impacted by the increased interest rates, so I’m not anticipating a significant change in buyer appetite or valuation metrics as interest rates come down,” he says.
Jamie Lyons, president and CEO of Westland Insurance, agrees. “We don’t expect the current direction of interest rates to materially accelerate M&A activity or change the dynamic of the M&A landscape – both will continue to stay robust for the foreseeable future.”
What will be interesting, Wong says, is how brokerage profitability will shift as inflation impacts both revenues and expenses. “Valuations are tied directly to profitability, so a brokerage’s ability to adjust to the new inflation environment will impact its valuation.”
Inflation impacts brokerage expenses by increasing operating costs. Insurers are also facing cost inflation and may respond by increasing premiums. Since brokerage commission revenues are a percentage of premiums, if insurers hike premiums, brokerages will receive increased commission revenues, Wong explains.
“Depending on what increases faster, there will be an impact on profit,” he says. “If revenues increase faster than expenses, then profit goes up, and vice versa.”
Yan Charbonneau, chief vision officer and board chairman at Quebec City-based acquisition company Synex Business Performance, says the capital costs did slow acquisitions. But it wasn’t just about money, he suggests. Purchasers are also conducting more due diligence on acquirees and not accepting all the proposed adjustments that brought the price higher.
“In 2024, every acquirer has adjusted their model and is back in an acquisitive mode, but still digging way deeper in the data of the due diligence process,” Charbonneau says.
Brief downturn
Overall industry consensus is that last year’s dampened enthusiasm in brokerage M&A was short-lived.
“The slowdown was temporary at the beginning of 2023, as purchasers were adjusting to the new lending environment,” Wong says. “Since mid-2023, deal activity has been strong again.”
Last year, M&A activity in the Canadian brokerage space (largely P&C brokerages) fell 15% from 2022, confirms Andrew Mathias, senior vice president of investment banking at KPMG Corporate Finance. And during 2023, M&A was down between 25% to 30% compared to 2021, Mathias estimates.
But it appears to have rebounded. “We’re seeing good activity, frankly, good reception from strategic players, as well as new [players] wanting to jump in,” Mathias says.
He calls June 2024 one of the hottest brokerage M&A months in the past year-and-a-half and attributes this to a belief that interest rates will continue to drop.
“There is a belief we’re done with the high-interest-rate environment, and it’s going to come down,” Mathias says. “This new normal [has] people looking at the future, and they’re willing to get back into the market.
“And so that’s what’s fuelling…M&A activity to pick up.”
This article is excerpted from one appearing in the October-November 2024 print edition of Canadian Underwriter. Feature image courtesy of iStock.com/mathisworks
