Business Breakdowns
· Matt Reustle, Aaron Cohen
[00:00:00] S0: Yes. And acknowledging the dynamics that are causing it and just putting those to the side to focus on the impact that that would have for an insurance brokerage business. Is it right to just think if premiums are growing, the brokers are capturing a percentage of those premiums, therefore that is top line growth? Is that the most simplistic way to think about it? [00:00:00] S1: That is fair and that's for the small and mid-sized world. So I'd separate that from if you think about the Fortune 500, they have really smart actuaries and insurance experts who are determining what type of insurance they need. They're going to the large broker houses and they're paying a fee, and the broker house is getting a fee. The traditional mid-market SME, et cetera, PNC World, where private equity has been incredibly successful for the last 20 years, that is commission. Yes. So as premiums go up, the revenue of that insurance broker goes up. So it's a wonderful business because we don't have to ask our clients for raises, we don't have to change our price. We just get a percentage paid by the carrier back to us of their premium. [00:00:00] S0: Out of curiosity, is there a threshold where you move from the percentage to the fee? Is there a number that's involved there that you have mentally?
· Matt Reustle, Aaron Cohen
[00:00:00] S0: Out of curiosity, is there a threshold where you move from the percentage to the fee? Is there a number that's involved there that you have mentally? [00:00:00] S1: There's not a number, but it's big. If you think about any type of growing business and a management team and a board of directors who are trying to set strategy and allocate capital, you have to be pretty big to say the next $5 million. I want to build an insurance department at this organization. So it's truly the largest of the largest corporations. [00:00:00] S0: And you mentioned some of the new risks coming into the system. One of the things that I often think about is cybersecurity and whether it's just the trend line of what's happened in the cloud and now we have AI, but it's something that in theory should be more and more in focus going forward. Does that category fall under this bucket as well? Does it tuck into a large insurance broker's operations, or would that sit outside?
· Aaron Cohen
[00:00:00] S1: No, this absolutely tucks into all the insurance brokers that we've been talking about today. If you have a business, you need cyber insurance. Absolutely. And the irony is this is the first type of risk that I believe is very different than any other risk in insurance, which is why it's really hard for carriers to underwrite it. And I love talking about this, and I get up on a little bit of a soapbox. Most other risks that you think about, property damage, slip and fall, et cetera. Once the carrier or the insurance broker hears about the risk and the event, it's done, it's behind you, the fire happened, your manufacturing facility burned down, it's done. Cyber is real time. You call your insurance broker, you call your carrier, and you say, someone is in our systems, we've had a breach. So carriers who obviously have to minimize their loss exposure, they have to be proactive and be prepared to move very quickly to help the insured exit or end this breach situation. So it's a very, very different risk than any other risk this industry has ever seen, which is why people are struggling with underwriting it, pricing it appropriately. And you're seeing some carriers have pretty adverse loss ratios because it's a very, very different outcome than any other risk in this industry.
· Matt Reustle
[00:00:00] S0: I think again, it proves your point on why brokerages are the interesting niche within here where you don't have the carrier underwriting risk that sits on your balance sheet, but you still get to capture the upside of the growing market. So probably came across in all of your previous answers, but just to spell that out again, I think that one certainly proves the point.
· Aaron Cohen
[00:00:00] S1: Yeah, I mean, the best part about this industry, insurance brokerage, is insurance brokers do not take risk. Now, of course, people could argue over the long term, they may, if they keep on placing bad risk with the carrier, the carrier may cut them off. But that would be adverse selection, which you don't see. If you have general loss ratios consistent with the industry and other brokers that are placing premium with that carrier, you are not taking any risk. And I mentioned it earlier, I do believe in insurance and broader financial services that if you own that customer relationship, you should increase your percentage of the ecosystem profits that you derive. And that's because you're helping the insured decide what carrier to go with. And what's interesting about that is if you think about it, most people, and when I say people, I'm talking businesses here, but people as well, they don't really care who their insurance carrier is. As long as they're A rated and they're known to pay claims, they're happy to go with any of the top wonderful carriers out there. So their broker has a tremendous, tremendous impact on their decision. And when you think about an insurance carrier, they're large companies, they're capital intensive and that's really what drives their value proposition. They bring capital and capital is a wonderful thing, but it is a bit of a commodity. Sometimes it's more scarce than others. And commodities don't get the same value proposition as driving customers to decisions.
· Matt Reustle, Aaron Cohen
[00:00:00] S0: On the difference between brokers. When you get down to the profitability metrics and I think EBITDA margin to your point, EBITDA translating to free cash flow, I would imagine that is the metric that tends to get a lot of focus. What does that range typically look like for these businesses in terms of somewhat mature insurance brokerages? How much variance is there from one operator to the next? [00:00:00] S1: I think the financials of these brokers of similar size are very similar. Their EBITDA margins are all within a couple hundred basis points of each other. And that difference usually is organic growth. You can look at that over the course of the last 20 years and a broker with 3% higher margin probably has 1% less organic growth. But they are very similar within bounds. And of course as they get larger they do have the ability to increase their margins because there are scale advantages and operating efficiencies. [00:00:00] S0: Is there a range, out of curiosity that you could put numbers around? [00:00:00] S1: Just EBITDA margins, Matt? [00:00:00] S0: Yeah. [00:00:00] S1: A solid insurance broker could be in the range of 28 to 35%. [00:00:00] S0: Certainly healthy when you factor in what that means for free cash flow in terms of the investments or anything below the line that would be required. Putting aside leverage and the capital structure, what would go into other investments that need to be made, whether it's now or in the future that you think about as an investor.