This has been accelerated by the introduction of the Financial Services Legislation Amendment Act of 2019 which came into full effect in 2023 and imposed a regulatory advice regime on insurance brokers.
Whether you’re a vendor or a purchaser considering consolidation as a viable option for your brokerage, there are industry-specific challenges and considerations you’ll need to overcome to deliver successful outcomes beyond the completion of the transaction. Here are some key considerations to keep in mind based on our transaction experience with insurance firms across New Zealand.
Differences in accounting practices
Smaller insurance brokerage firms often recognise revenue on a cash-basis by only capturing the revenue and working capital components associated with fully paid client premiums. However, under generally accepted financial reporting frameworks, revenue may need to be recognised based on when the business has discharged its underlying performance obligations to the client - which differ to those of the insurer - and typically occurs at the point where the firm has provided the advice, sourced the appropriate policy and issued an invoice accordingly.
It's also common practice for smaller brokers to keep other balances completely off their balance sheets. These can include the recognition of receivable balances due from clients, liabilities due to the insurer, and the associated trust fund obligations relating to premium payments received from the client but not yet transferred to the insurer.
The acquiring company should pay careful attention to the likely impact of these practices during due diligence. Using certain accounting approaches can lead to revenue recognition timing differences and an inappropriate working capital target or peg. Post-acquisition reporting changes to align accounting practices also need to be considered.
Trust account reconciliations
As an intermediary, insurance brokers hold funds on behalf of insurers for paid policies until they are legally required to transfer these balances. Yet, despite the strict requirements for maintaining insurance broking client accounts, we often encounter companies that don’t have proper reconciliation procedures in place to ensure the accuracy of these balances.
As part of the due diligence process, the acquiring company should consider the appropriateness and completeness of any reconciliations to ensure it doesn’t assume any undisclosed obligations at acquisition.
Similarly, a potential vendor should ensure strict controls are enforced, as well as regular reconciliations to easily demonstrate the accuracy of the balance of funds held on trust.
Client relationships
The strength of local relationships is a big asset for smaller firms. Often, a small number of key employees will hold deep-rooted client relationships and connections within their communities which can create significant competitive advantage.
An important consideration during due diligence is how these relationships will be maintained or transferred to the acquiring company post-acquisition to maintain the value of the business.
There are a number of ways acquirers can retain these client relationships; this often includes ongoing equity participation with the vendors through a staged-acquisition process, lock-in periods, retention bonuses, earn-outs and restraint of trade agreements.
The preferred combination of these mechanisms will depend on the circumstances and objectives of the parties. However, it is crucial that they are designed to provide the acquiring company with sufficient time to transition key customer relationships.
Remuneration structures
The acquiring company will often include a condition that key employees commit to a minimum employment period post-transaction. In most instances, the proposed remuneration package will be based on the acquirer’s current remuneration structure.
However, this often means the vendor, along with key employees who are often minority shareholders, may be moving from a position of remuneration supplemented by dividends to a very different package. This needs to be worked through carefully and considered part of the wider consideration of pricing by both parties.
Investment in technology
The insurance brokerage sector has historically been capex-lite, with minimal investment required in capital expenditure. However, the increasing need to invest in technology and systems is putting pressure on smaller brokers. This investment is necessary to stay competitive, meet regulatory requirements, and enhance operational efficiency.
For smaller brokers, the cost of upgrading technology and systems can be prohibitive. This is where national brokers can provide significant value. By leveraging their resources and expertise, they can help smaller brokers implement advanced technology solutions, such as customer relationship management (CRM) systems, data analytics tools, and other digital platforms. This not only improves the efficiency of the merged entity, it also enhances the overall client experience.
Premium funding
While the role of premium funding in these consolidations is not always significant, it’s important to consider as it often adds complexity to the transaction. Premium funding income is often accounted for in a separate entity without any operating structure or allocation of costs.
The value of these separate vehicles is often limited because they depend completely on the flow-through of premiums from the brokerage company and cannot operate in isolation post-acquisition; this can lead to a disconnect which needs to be bridged during the transaction.
Due diligence procedures should be designed to establish the likely level of premium funding income post-acquisition which will inform discussions around value between the parties.
The key to long term success is assessment, not assumption
There are several factors for both the acquiring company and vendor to consider to successfully complete a transaction. Acquiring companies need to design a comprehensive and wide-ranging due diligence programme to identify any commercial or accounting issues early. For vendors, success lies in articulating the business’s key strengths and presenting clear financial records that provide an accurate and complete picture of the business.
