Public brokers continued to lead the buying segment, representing nearly half (106) of the announced transactions, followed by 62 categorized under the “insurer and other” segment (other financial services and specialized companies) and 48 by banks.

Before analyzing the activity in more detail, it is helpful to step back and review the market with more of a macro perspective. When doing this, two trends become very clear–organic growth has stagnated, and the basic rule of supply and demand is clearly in force.

Organic growth rates are beginning to inch upward only slightly from 2004 levels. The net growth among public company brokers during 2005 was far below 2003, and is not projected to make any dramatic improvements in 2006. This places enormous shareholder pressure on many public brokers, who have no choice but to augment flat or anemic organic results with acquired growth.

In the last few years, acquisition demand has resulted in a number of high-performing agencies being acquired. In 2005, demand created more of a seller's market, as many buyers were chasing fewer high-quality and average-performing agencies. There is no doubt this trend will continue. Declining organic growth rates and fewer high-quality agencies for sale will continue to have a ripple effect on industry M&A pricing.

The fact that many large brokerages have ceased accepting contingent commissions due to New York Attorney General Eliot Spitzer's investigations into bid-rigging and steering of accounts has made a marked impact on many major brokers' results. Without this revenue stream, the industry leadership has turned even more solidly toward acquisition strategies to augment their growth.

Wholesale business has been affected by the change as well. Leading acquirers–namely, Arthur J. Gallagher, Brown & Brown, Hilb Rogal & Hobbs and USI Holdings–acquired wholesale businesses last year, while Marsh, Aon and Willis all sold off their wholesale operations (presumably to address perceived conflict-of-interest issues).

Brown & Brown was, for the fifth year in a row, the leading acquirer of announced transactions. Fifteen deals were announced by the company in 2005, while Arthur J. Gallagher and Willis each had 11. Willis continued its international market approach, with eight of its 11 acquisitions being outside the United States.

USI and Hub International, both new entrants into the market in 2003, continued to prove to be formidable in their acquisition abilities. Their aggressive approaches resulted in 10 acquisitions for Hub and nine for USI during 2005.

HRH was the least active during 2005, with four acquisitions. Marsh and Aon were not active participants in agency consolidation due to well-known regulatory issues and their focus on reorganization and realignment of marketing and services.

The continuing low cost of capital worked in the favor of privately-held brokers and banks, fueling their acquisition appetites. Low interest rates reduced the barriers to entry for many regional and super-regional brokers, thus offsetting low organic growth rates with acquisitions.

Property-casualty brokerages continue to dominate the volume of announced transactions with 106 deals (49 percent of the total), while nontraditional outlets (insurance and others) represented the second most active category, amounting to 62 acquisitions (29 percent) in 2005.

Banks remained the third most active category among acquirers, with 48 announced transactions (22 percent). Although banks remained down significantly from 2000, when the banking industry's 84 announced transactions accounted for 45 percent of the total, they still remain a viable component to agency consolidation.

Although the number of announced bank transactions decreased in 2005, financial institutions remain highly committed to the insurance distribution industry. Recently, banks have been retrenching and integrating prior acquisitions, which is a precursor to the next round of focused deal activity.

Softening product rates have contributed to this defensive strategy. However, banks will continue to grow into their role as a major influence in insurance product distribution.

According to the 2005 edition of “Who's Who in Bank Insurance” by The Bank Insurance Market Research Group, 25 of the nation's top 100 insurance brokers were bank-owned–which makes a pretty significant statement on the penetration these institutions have made into the brokerage market during the past six years.

While the days of being a platform agency acquisition are dwindling for large, high-performing agencies being acquired by a bank at a lucrative multiple, the lure still exists in certain segments and geographies.

Recently, private equity groups have shown increased interest in insurance distribution. PEGs have largely been focused in other industries during the past 10-to-15 years, investing in and partnering with technology, manufacturing and risk-bearing businesses.

Now, however, many large groups seem to be drawn to the opportunities that have been developing within the insurance and financial services distribution consolidation, which has strong continued growth potential. It is very likely you'll see a PEG partner with an emerging management team of industry professionals attempt to “roll up” the next leading firm in 2006-2007.

The first matter that most insurance agency professionals want to know about a potential M&A is what an agency is worth or valued at.

This, of course, is most influenced by supply and demand. Despite rate softening cutting into revenue growth and the damage to the brokerage industry's reputation caused by the Spitzer investigation, the dwindling number of high-performing agencies and brokerages available for acquisition–and willing to be acquired–drove average transaction prices higher across all market segments during 2005.

Notably, the most desirable firms being acquired by public brokers recognized an increase to 7.25-times earnings before interest, taxes, depreciation and amortization (EBITDA) in 2005, up from a 6.75 multiple in 2004.

When reviewing all announced transactions, the percentage that commanded a multiple of greater than 7-times EBITDA increased from 20 percent in 2004 to 45 percent in 2005. While this presents a significant trend, it also is important to note that 2005 transactions evolved more heavily toward earn-outs, which allow buyers to structure higher valuations but still moderate their pricing risks.

Multiples in some cases have gone even higher–the industry witnessed a 10-times multiple and higher during 2005. But use of the earn-out mechanisms shows that buyers are using more caution by hedging their bets against future growth and profitability, post acquisition.

Regardless, the demand for high-performing firms is at the highest level yet. If they perform well, post acquisition, they will be handsomely rewarded, and at record multiples.

o High-performing, middle-market agencies–those few that are still independent or acquirable–should be able to command a premium, especially from public brokers and banks. As independent, top-tier agencies of all segments become fewer and fewer, competition will intensify among top organizations looking to absorb those firms.

o Employee benefits agencies are also in a good position to receive premium multiples, as consolidating brokerages and banks seek to extend cross-selling opportunities.

o The small-to-midsize broker who seeks to remain independent should be able to capture a significant amount of fallout from the larger brokerage firms trying to purge their middle-market clients due to cost constraints. Expect a number of top, privately-held brokers to emerge as industry leaders during the next year or two.

In the short term–assuming flat product rates result in continued lower organic growth–agency valuations should not vary significantly from the current multiples being offered. Earn-outs will remain a significant part of transactions, with the possibility of more variable purchase price being placed on future industry transactions.

With a dynamic marketplace, M&As continue to be a fascinating aspect of the insurance agency and brokerage world and its continued consolidation.

Most leading public broker acquirers have indicated their acquisition pipeline is full, and banks seem to be concentrating on integration issues rather than expansion. However, I fully expect both of these leading segments to continue to increase their portfolios in 2006.

Banks very likely will try to leverage their low cost of capital, while overcoming previous integration issues. Public brokers will be driven by low organic growth to feed the bottom line through M&A growth. Private equity groups will continue to seek to be part of the system.