Flat reinsurance revenue and post-Spitzer recovery continue to put a damper on the broking industry, with a few notable exceptions, finds Lindsey Rogerson

Roland Frank, analyst at Citigroup, has both Aon and Willis as "hold". In a note issued after first quarter results he said that flat reinsurance revenues at Aon and its peers meant that the uplift widely expected post-Katrina had been more than offset by softening markets elsewhere.

Frank had been more conservative than most when allowing for the Katrina-uplift in catastrophe pricing but admits that based on first quarter new business announcements even his conservatism over-anticipated the rate rises and their impact on brokers' bottom lines. Although he did offer a glimmer of hope for the next wave of renewals, saying, "Pent-up demand may lead to higher-than-normal July renewal activity for brokers".

Hiscox Insurance Portfolio (HIP) has retained its negative stance on brokers in the 12 months since Global Reinsurance last looked at the sector. In 2003, HIP held almost 20% of it assets in broker stocks, however, in 2005 the fund dropped all but one broker stock, a position it has maintained for the last 12 months. The stock in question is US company Brown & Brown which saw a 218% leap in revenue for fees and commissions last year. Aon and Guy Carpenter by comparison reported near flat fee revenue for 2005.

Nick Martin, investment analyst on the fund, is impressed by the Florida-based Brown & Brown's track record in delivering consistent high growth. In 1993 the company's management promised it would deliver growth of 15% a quarter or more. With the results in for first quarter 2006, it has now achieved this ambitious goal for 41 consecutive quarters. Acquisition has played a major part in Brown and Brown's success. In January 2006, it expanded its presence in the wholesale reinsurance marketplace with the acquisition of Axiom Re. In the last few months it has combined its existing reinsurance operations with those of Axiom Re, and all of the group's reinsurance activities are now conducted under the Axiom banner.

Further consolidation

Indeed acquisition is viewed as a key driving factor for growth across the broker sector. In its annual survey of UK-operating brokers, accounting firm Mazars, found that just short of 90% of brokers believed the trend for mergers and acquisitions in their industry would continue. The report said, "The impression that they operate in a consolidating market continues to be held by our respondents with 87% expecting the number of insurance intermediaries to reduce in the next 12 to 18 months."

The survey also revealed a desire to expand geographically. Which brokers will be the ultimate beneficiaries from any such expansion and consolidation however, is still a guessing game.

Jardine Lloyd Thompson last month announced it was expanding its brokerage into China by way of a joint venture with Guangdong Ricsson Enterprises. Speaking at the announcement of the deal, JLT's head of operations in Asia, John Hastings-Bass, said the new company - JLT Lixin Insurance Brokers - had been set up to take full advantage of the vast opportunities available in the emerging global powerhouse that China represents. The broker is not alone in throwing recourses at the Chinese market. The annual Lloyd's of London market survey found that more than 50% of those working in the London market believe China presents a significant growth opportunity.

Of course good companies need good people to grow and thrive. The Mazars survey highlighted a talent gap in the reinsurance industry which it said was driving up wage bills as companies competed with each other to attract the best talent. In all, 79% of brokers said they expected their staff costs to rise in the next 12 months. However, broker Benfield believes it has benefited from not being embroiled in the Spitzer investigations, when it comes to staffing costs. "Following these investigations, Benfield benefited from a temporary easing of upward pressure on people costs and increased opportunities to acquire high quality people," CEO Grahame Chilton said recently, adding that they had taken advantage of their rivals' troubles to capture key personnel in areas that the company has targeted for growth.

High hopes for fac

Chilton also said that the Spitzer enquiry had helped it pick up new clients as many brokers named in the indictment were dumped. However, Benfield is being proactive in looking to win new business in a post-Katrina world. Chilton said, "With more than 60% of reinsurance broking revenues derived from property catastrophe business, market leading expertise in the analysis and modelling of catastrophe risk and transactional capability in traditional insurance and reinsurance and capital market vehicles, Benfield is extremely well positioned to meet reinsurance customer needs in current market conditions."

One area where it has high hopes is facultative cover. In the tenth edition of its annual survey of the reinsurance market Benfield concluded that facultative cover was "fast coming of age as a product that could offer the kind of complex solutions that are becoming an everyday part of the overall management of risk."

The broker feels that the January 2006 renewals could well be viewed by history as the point at which facultative cover once again became regarded as a core element of reinsurance programmes and has positioned itself to take full advantage. Specifically, Benfield has decided not to repeat the special dividend given out to shareholders last year in order to target capital to such key growth business areas.

- Lindsey Rogerson is a freelance journalist.

Investment Benfield downgraded to neutral

According to Merrill Lynch (ML), Benfield shares have performed admirably so far this year outpacing the reinsurance sector by 14% and the global insurance brokers by 6%. The shares have also outperformed the European insurance sector by 4%. As a consequence, the shares now trade only a few pence away from ML's 400p fair value.

Admirably, outperformance was achieved despite a weakening dollar, which has led ML to cut its earnings per share (EPS) forecasts by 4% for 2006 and by 7% for 2007-2008. ML believes Benfield is entering a phase of rapid earnings growth. And unlike its peers, Benfield is virtually a debt free business, so increased leverage could improve EPS by up to 6%.

Benfield shares offer several attractions, including rapid earnings growth as the investment in the business begins to bear fruit, powerful cashflow generation, an excellent management team, the potential from up to £125m of buyback programme that could add a further 6% to adjusted EPS and Benfield's ideal position in the reinsurance sector (it operates in the most profitable segments such as catastrophe and retrocession). However, ML's neutral recommendation is a function of several factors, including little scope in upgrading its EPS forecasts this year since any revenue "beat" will likely be used to accelerate Benfield's recruitment plan. Also, after the recent market decline there are several other stocks in ML's coverage that offer substantially more upside than Benfield.