Insurance Brokerage Industry: The Impact of Rising Expenses on Earnings

Current Trends in Insurance Brokerage Expenses

Rising insurance costs are a significant trend, with brokers like AJG working to mitigate these increases for clients. Larger firms like Marsh have an advantage in managing these costs compared to smaller, fragmented brokers. Additionally, fee revenues from various segments and revised estimates for earn-out payable expenses are influencing current expense trends.

"So overall, our clients continue to see insurance costs increase, but our job as brokers is to mitigate these increases and deliver comprehensive insurance programs that align with their risk appetite and fit their budget." --- (AJG, earning call, 2024/Q1)

"First, I'm wondering whether there is a difference in the market share gain potential when you're in a rising rate environment and the enormously fragmented brokerage world includes a lot of companies that just don't have the resources to help clients manage higher insurance costs as successfully as a company with Marsh's resources." --- (MMC, earning call, 2024/Q1)

"Fee revenues are generated by: (i) our Programs and Wholesale Brokerage segments, which earn fees primarily for the issuance of insurance policies on behalf of insurance carriers and (ii) our Retail segment in our large-account customer base, where we primarily earn fees for securing insurance for our customers, in our automobile dealer services (“F&I”) businesses where we earn fees for assisting our customers with creating and selling warranty and service risk management programs and fees for Medicare Set-aside services, Social Security disability services and Medicare benefits advocacy services." --- (BRO, sec filing, 2024/Q2)

"2nd, on non cash expenses. We have revised our estimate for earn out payable expense within the brokerage segment." --- (AJG, event transcript, 2024/06/25)

"First, I'm wondering whether there is a difference in the market share gain potential when you're in a rising rate environment and the enormously fragmented brokerage world includes a lot of companies that just don't have the resources to help clients manage higher insurance costs as successfully as a company with Marsh's resources. How much of a difference does that make?" --- (MMC, earning call, 2024/Q1)

Impact of Rising Expenses on Profit Margins

Rising expenses, such as increased medical plan costs and the overall cost of risk, are putting pressure on profit margins. Contingent revenues, a pure profit source, are also facing downward pressure, impacting profitability. Despite these challenges, some companies like MMC are managing to expand their operating margins.

"But the first question is, is it fair to say that contingents for you are like many others and that it's kind of a pure profit source of revenue and so it does have a little bit of a disproportionate impact on margins if it changes." --- (AJG, event transcript, 2024/06/25)

"I know we talked about programs. Just other thing, keep in mind, in Retail, and you saw it in the numbers and everything, contingents were down in the Retail business and year-over-year, about $1.4 million or so is -- and we've had downward pressure on the contingents that we earn within personal lines just based upon overall profitability within personal lines in that -- just that sector right now." --- (BRO, earning call, 2024/Q1)

"Our adjusted operating margin increased 80 basis points to 32%, and we expect higher margin expansion for the rest of the year, particularly in the second half." --- (MMC, earning call, 2024/Q1)

"2024 medical plan increases reflect these rising costs and with some carriers suggesting profitability pressures this year, we believe elevated price increases are likely here to stay for the near to intermediate term." --- (AJG, event transcript, 2024/06/25)

"The overall cost of risk continues to increase. And demand remains very strong." --- (MMC, earning call, 2024/Q1)

Role of Technology in Cost Management

Investments in new tools and technology at Arthur J. Gallagher & Co. are enhancing claims resolution and improving outcomes, demonstrating technology's critical role in managing costs effectively.

"That would be another fantastic year. As I look ahead, the business is in great shape and should continue to benefit from our investment in new claims resolution managers, the addition of new tools and technology that enhance and further improve the claims experience." --- (AJG, status update, 2024/06/25)

"I believe we have the best team in the industry with leading edge technology to achieve the best outcomes." --- (AJG, event transcript, 2024/06/25)

Regulatory Impacts on Expenses and Earnings

Regulatory changes are driving increased project work and expenses across the insurance brokerage industry, impacting earnings. Companies like AJG, AON, and MMC are facing higher costs related to regulatory filings, legal services, and compliance, while also experiencing revenue growth from advisory and risk transfer projects necessitated by these regulations.

"These include costs related to regulatory filings, legal and accounting services, insurance and incentive compensation. Workforce related charges, which primarily include severance costs (either accrued or paid) related to employee terminations and other costs associated with redundant workforce. Lease termination related charges, which primarily include costs related to terminations of real estate leases and abandonment of leased space. Acquisition related adjustments principally relate to changes in estimated acquisition earnout payables adjustments and acquisition related compensation charges. In addition, from" --- (AJG, press release, 2024/04/25)

"In Wealth Solutions, organic revenue growth of 4% reflected strength in retirement as our teams continue to help clients reduce risk through pension risk transfer and manage the ongoing impact of regulatory changes as we continue to bring leading capabilities to help clients match risk and capital." --- (AON, earning call, 2024/Q1)

"We see DB plans funding statuses continue to benefit from elevated interest rates that's driving an increase in risk transfer over the last couple of years, as well as we have some regulatory requirements and demands that are creating some project work." --- (MMC, earning call, 2024/Q1)

"Organic revenue growth was 4% in the first quarter of 2024, reflecting strong growth in Retirement, driven by advisory demand and project-related work related to pension de-risking and ongoing impact of regulatory changes." --- (AON, sec filing, 2024/Q1)

"It's driving an increase in project work, predominantly revolving around risk transfers as well as certain regulatory requirements that are out in some of the jurisdictions around the world." --- (MMC, earning call, 2024/Q2)

Competitive Dynamics in the Face of Rising Costs

Clients are adjusting their budgets and coverage due to rising premiums, impacting competitive dynamics. The rising cost of risk affects the entire ecosystem, leading to potential client dissatisfaction and search for alternatives. Higher interest rates may influence industry returns and pricing, further shaping competitive dynamics.

"They just work off a budget. And if the primary premiums are rising, they're taking bigger retentions, they're dropping limits, and they don't – they're not necessarily comfortable with that." --- (AJG, earning call, 2024/02/28)

"There's lots of emerging data that's troubling for our entire ecosystem, for our client, and it contributes to that rising cost of risk that I mentioned earlier." --- (MMC, earning call, 2024/01/31)

"So, if you have gotten a price increase on your condo or your properties or whatever for the past four or five years, you're just over it." --- (BRO, earning call, 2024/01/09)

"And I guess, would do you think that old dynamic of if the traditional industry does do what they're expected to do and throws off double digit ROEs, mostly due to higher interest rates in the coming years, operator: Is it right for us anonymous: to think that there will be a continued deceleration in flow and our price?" --- (AJG, status update, 2024/06/25)

Customer Impact and Response to Rising Costs

Customers are adjusting to rising costs by opting out of coverage when rates increase and buying more when rates decrease. They are also reducing deductibles, pushing for better terms, and leveraging captive management to handle risk. However, finding coverage for cat-exposed risks remains challenging, impacting overall market conditions.

"The second thing is, remember, if the rate moderates, our customers are very good about opting out of coverage or as much coverage as rates go up and then opting back in for coverage to buy more when rates are coming down." --- (AJG, earning call, 2024/Q1)

"They're driving 20% plus ROEs in this market given the rate increases of last year and the higher attachment points our clients have been forced to absorb with greater volatility." --- (MMC, earning call, 2024/Q2)

"Accordingly, we are seeing clients leverage this to reduce their deductibles, push for improved terms and conditions or even buy more limit. Price increases on property classes, particularly North American cat exposed property have moderated, but that can be short lived if there is an active U. S. Wind season as predicted." --- (AJG, status update, 2024/06/25)

"I mentioned earlier, our captive business. We're the largest captive manager in the world, and that's been a meaningful outlet for our clients to manage risk and the rising rate environment over the course of the last several years." --- (MMC, earning call, 2024/Q1)

"Carriers are managing their cat exposures, including wind, wildfire, flood and convective storms, so finding homeowners' capacity for cat exposed risks continue to be very challenging. Despite property renewal premium increases moderating, we continue to characterize the wholesale market as difficult." --- (AJG, status update, 2024/06/25)

Future Outlook and Predictions

AJG remains optimistic about the future, citing a strong pipeline of opportunities and bullish outlook for 2024. The company is positioned for attractive growth, leveraging its Gallagher Better Works value proposition to address clients' needs, indicating confidence in sustained success.

"Was that a pull forward from future quarters? Or I guess, sort of outlook on the pipeline of the life sales and just how that – how you’re thinking about that throughout the rest of the year." --- (AJG, earning call, 2024/Q1)

"But ultimately the quarterly swings are really just timing. Looking ahead, we have a strong pipeline of future opportunities and remain bullish on full year 'twenty four. Shifting gears to outside the U. S, which is about 15% of our total revenues, here too we are seeing" --- (AJG, status update, 2024/06/25)

"Looking ahead, I believe we are positioned for attractive growth. Our Gallagher Better Works value proposition combined with leading experts, tools, insights and products will help clients navigate their most pressing organizational well-being needs. I am very excited about our future." --- (AJG, status update, 2024/06/25)