Focused Insights: Is Debt Still Your Friend? June 2022

Global unrest, ongoing supply chain issues, and an extremely tight job market are leading to concerns that inflation may continue to rise. The Federal Reserve (Fed) is raising interest rates to manage rising prices that are near 40–year highs. Although higher rates will impact borrowing costs for buyers in the insurance distribution sector, there are other factors influencing deals in 2022 and beyond.

Demand continues to be strong for acquisitions in insurance brokerage, and today’s credit market continues to be constructive. Equity markets have been volatile year–to–date but according to MarshBerry’s Broker Index, public brokers are outperforming both the S&P 500 and the Dow Jones indices through May 30, 2022. During second quarter earnings updates, most public brokers spoke of expected increases in deal activity for the remainder of 2022 noting a robust merger & acquisition (M&A) pipeline of prospects.

Today’s Credit Market Constructive for M&A

In past periods of rising interest rates, there was impressive M&A volume in the U.S. insurance brokerage sector. After the 2008 recession, the Fed raised rates for the first time on December 16, 2015. This was followed by a 0.25% increase in December 2016 and another 0.25% increase in March 2017. Following the March 2017 rate hike, there were two additional 25 basis point hikes in 2017, and four 25 basis point increases in 2018.

2017 broker deal volume set a record, with 537 announced transactions, the most active year on record at the time. 2018 was another boom year for deals in brokerage: 594 transactions were announced that year, making it another record–breaking year.

---

---

Several factors contributed to increases in deal volume. The U.S. economy was improving following the prior financial crisis, and capital was near all–time highs with private equity and venture capital investors eager to invest.

Private equity fundraising in North America saw an 18.6% increase (+$36.6 billion) year over year in 2017, following the 6% increase in 2016. Interest rates were slowly climbing from the historical low levels coming out of the Great Recession, where interest rates were kept near zero for a period, with investor and consumer confidence levels rising.

While the Fed is raising interest rates in 2022, with all else being equal and absent ongoing rate increases, a pure increase in rates shouldn’t suggest a strong tapering in M&A activity.

After raising the federal funds rate by 50 basis points on May 4, 2022, the Fed announced on June 15 that it was raising the federal funds rate ¾ points to a target range of 1.5–1.75%. This is the first time the Fed has raised the target range by ¾ of a percent since 1994 and was higher than the half percentage point increase they previously hinted at.

Are we poised for another recession?

Beyond interest rates, additional factors will influence M&A volume in insurance distribution this year. While we still see healthy deal volumes in the sector this year, boosted by continued broker consolidation and availability of capital, lower investor confidence and high inflation are two current issues that we will monitor.

There are also concerns around a slowing economy after first quarter GDP decreased by 1.5%; however, predictions for recession among analysts and economists remain low.

According to Pitchbook’s recession model (using data at the end of April 2022), there’s roughly a 20% chance of a U.S. recession over the next 18 months.

Overall, an active M&A environment is still expected in insurance distribution over the next few years. There is still an appetite for high performing firms and many buyers remain flush with capital to continue an aggressive acquisition strategy.