Good afternoon. For our next presentation, I'm very pleased to have Powell Brown, President and CEO of Brown & Brown. Brown & Brown is an insurance broker focused on the small to middle-market commercial insurance sector. With that, I'm pleased to turn it over to Powell.
Thank you, Sarah. Good afternoon, everybody. Thought we might begin by talking a little bit about what we do. Brown & Brown is a decentralized middle-market insurance firm that focuses on insureds that generate, to us, $2,500 to $250,000 in commissions. I think the important point there is commission-based, think $2,500 in commissions would probably be about $25,000 in premium to several million dollars of premium at $250,000 of commissions. Our biggest competitors typically are a local firm that's a fabric of the community. It's not necessarily a large publicly traded firm that focuses on fee accounts. We're not going after Barclays or Amex or Boeing. We're typically going after the local beer distributor in the town that you live in, or a friend of yours that owns three nursing homes, or the contractor that would actually put an addition onto your house.
We're operators of businesses that happen to do lots of acquisitions, we'll talk a lot about acquisitions in a moment. We're growth and margin focused, we're really a mirror reflection of the middle-market economy. This is really an overview of our business. 60% of our business is retail, where we come out to see you, the owner of a business, and talk to you about how you can transfer risk to insurance companies, really the solutions that you could work with to solve your insurance needs. In the last four years, the average piece of new business that we've written is $12,500 of commissions in that space. Think $100,000-$125,000 in premium. That is the average of the property and casualty and the employee benefits piece.
In this segment, we have $172 million worth of employee benefits revenue, of that, about two-thirds is health insurance. Just over half of that is large group. The next piece would be national programs. That's where we develop a proprietary product for insurance companies. Think homogeneous groups. That could be dentists, that could be lawyers, that could be high-rise condominiums in Dade, Broward, and Palm Beach County. It could be force-placed coverage for financial institutions. It's typically a homogeneous group. Those are our national programs. It's distributed through a network, typically of insurance agents. Some of them could be Brown & Brown. Wholesale brokerage, about $160 million of revenue. There's really two components to that. Wholesale brokerage would be transactional brokerage. Talk about that in a moment.
Binding authority business, where insurance companies give us the pen to assume risks that fit into a small box. That might be something that looks like a strip shopping center with a bar in it in your neighborhood. Something like that The Hartford or The Travelers or another large public company wouldn't want to bear that risk. These are all typically non-admitted risks, excess and surplus lines risks. On the brokerage side, it would be more, think larger accounts. It could be a $50 million cold storage warehouse in Dade, Broward, and Palm Beach County. No one carrier is going to write that entire risk because of the hurricane threat. It could be underwater demolition contractor. It could be the D&O or professional liability on a company, public or private.
The final component is a services component where we have four businesses, and the way I describe our services is if my fist would be an insurance company, they usually provide their outsourced services in and around insurance companies. For example, we have a work comp TPA in Florida that provides services or claims adjusting services in Florida and the Southeast. We have two Medicare Set-Aside companies, one in Florida and one in Colorado, and we have a Social Security disability advocacy firm. Knowing a little bit about what it is we do, where do we do it? On this map, you'll see, and I'll say this slowly, our seven largest states, Florida, Michigan, New Jersey, California, New York, Pennsylvania, Washington. Why are we in those states?
The response would be there were more high-quality firms that became available that fit culturally with Brown & Brown, Inc., and we did those transactions. It's not a we must be in such and such a state, or we need to go to Utah or Wyoming or Alabama and plant a flag. That's not how we operate. We operate. It's all about people. So we believe good people operate and run good businesses, and so we're focused on trying to find and acquire more businesses that are run by high-quality people that fit culturally with Brown & Brown, Inc. The other reason I mention that is, if you think about that, several of those states have been hit probably harder by the downturn in the economy than others. Florida, Michigan, California come right to mind.
Obviously, the Southwest, as a general rule, has had a pretty challenging operating environment, Nevada and Arizona. Texas has probably performed the best, if you're going to just talk about a general statement from our view on the economy. That's where we operate. We have a small business in London as well. This is just a chart of our growth in terms of top line. We did not grow our top line in 2009, meaning it dipped and then came back up in 2010. In 2009, we did the fewest number of acquisitions in terms of annualized revenue that we had done in the past 10 years. We acquired just under $27 million of revenue that year. If you looked at the last 10 years, excluding 2009, we acquired typically somewhere between $45 million and $125 million of revenue annually.
This year, you'll see later, we've acquired $52 million annualized revenue year-to-date. This is the one that you want to talk about, and this is the internal growth schedule. Our business, as I said earlier, is a mirror reflection of the middle market economy. In places like Florida and California and Michigan and other places around the country, we've seen significant shrinkage in exposure units, and you'll see in a moment, the next slide, rate pressure. Rates are not under as much pressure today as they have been, but they're still shrinking overall. If you're a owner of a risk bearer, depending on the risk bearer, you may hear them say that their rates are going up on certain segments of their book, and that may be the case on the renewal book in, let's say, commercial middle market.
That is on the accounts that they typically renew. I would challenge you to think about, one, what the pricing is on new business or the accounts that they lost, and more specifically, we would not do this, but if you took an account that somebody wanted to renew at up 2% and you change just the name, that same account to that same risk bearer on a new piece of business, the rates would be down 10%. There's this discrepancy in pricing. What you have, meaning new versus renewal. What you have in basically all segments of our business, some more so than others, is you have pressure on rates, slightly down, and still pressure slightly down on exposure units. Exposure units, think payroll and think sales.
As you can see, in the first four quarters of last year, we incrementally got better, and then we continued to get better in Q1, and then Q2, we fell down a little bit. We're a little surprised ourselves, if you heard our second quarter call. We would tell you that we've said that we believe that our results will continue to operate in the range that we've historically seen, if the economy stays like it is. We don't have a crystal ball. I can tell you that we are continuing to renew and try to do what's in the best interest of all of our customers each and every time, and we continue to write a lot of new business, but we continue to see challenging operating environments in the states that, particularly some of our largest states.
I would mention one thing while we're at this slide that you might find interesting or you need to be aware of. Believe it or not, 17 years ago, it's hard to believe, 17 years ago, we were involved in a situation where periodically in our business, if you make a mistake, and hopefully you don't make a mistake, it's called an error or omission. We have insurance typically for that. We had a situation in the state of Texas where it involved a Certificate of Insurance. When we went to court, the first court that we went to, we had a summary judgment in favor of Brown & Brown, which we did everything we thought was correct, and the court, in the first court, found in favor of Brown & Brown.
Subsequent, there were appeals. Some of those other courts overturned that, and it was weaving its way through the court system in Texas, which we thought was very unusual because we'd had a summary judgment in our favor. 17 years later, the Supreme Court of Texas did not choose to hear our case, and we were given a $2.6 million judgment for something that started 17 years ago. You need to be aware of that. It'll come out. It's not in our normal course of operations, but it's an unusual event that we've just become aware of in the third quarter of this year. We try to endeavor to do the best for our customers.
Apparently, the court has found, in this particular case, there was something that we don't still think we did wrong, but the court found it, and therefore, we have a $2.6 million penalty that we have to pay this quarter, or has been paid this quarter. This right here is a chart based on rates. If you look at in the beginning of 2008, rates were under the most intense pressure, down, that's on average, 15%. That includes all lines of business. Today, that shows that rates are down about 2%. Once again, that's just an average. Averages can be a little misleading. As I said, if you own risk bearers, particularly middle-market risk bearers, you may hear about upward pressure. We see upward pressure in certain segments of the business. Overall, we still see negative or downward pressure on rates.
That is not a negative situation, I believe, for Brown & Brown or any middle-market broker. What it is that is the normal operating environment. We are in a normal pricing environment today. We believe there's always downward pressure on rates. People sometimes say, "Well, when's the market going to change?" We don't know, but we still think that there's a lot of excess capacity in the market, and so therefore, that rates will continue to be soft for a period of time into the future. A lot of people ask about workers' compensation in particular. It's absolutely running a temperature. 120% combined ratio this year, probably at a minimum, but that doesn't mean that we're having a problem placing workers' compensation for our clients. There's not a shortage in states, and there is rate pressure, but modest in certain states, but not a huge deal.
My point is, this particular graph, I believe, just shows you that rates, we believe, are always going to kind of be under a certain amount of slight pressure. When rates do change, it will probably tick up for a period of time, short in nature, and then there'll be continue to be pressure on rates. That's not the issue that is the biggest challenge for Brown & Brown. The biggest challenge for Brown & Brown is our clients as they shrink. Those payrolls and sales on our clients as they shrink, it is hard to fill in that hole. We have not been able to write enough new business to fill in that hole with rates shrinking and exposure shrinking to grow our business organically. Final thing, and we'll open it up to questions, is acquisitions.
We get asked a lot of questions about how do you find them, how do you price them, where do you do them, and how does it all work? Really, it's a combination of two things. We talk to people all over the country all the time. We sometimes call that the farmer's theory, where we actually are planting seeds, and we're trying to talk to insurance agents everywhere, all over the country, because ultimately, they will sell. Every independent firm will sell. They're either going to sell to a larger firm, like a Brown & Brown, they'll sell to a bank or another financial institution, or they'll sell to their cross-town rival. The average independent agent today is 57 years old. He is a he, and it is typically his largest single asset.
He and his wife typically have two children, and if they're not already in college, they're going to college soon. They're thinking about do, and when do they monetize this asset? We can be an answer for that. We're not the answer. We're an answer. We try to learn about them and therefore give them an opportunity to learn about us to see if there is a cultural fit. We believe there's somewhere between 20 and 24,000 independent agents in the U.S. That roughly makes up about $40 billion of revenue. Those numbers I just gave you exclude the top 100 independent and publicly traded agents and brokers in the U.S. The 100th largest firm is about $25 million of revenue. That $40 billion I'm talking about is everybody that's under $25 million in revenue in the U.S.
We either meet these people by cold calling them, meeting them through an insurance company event, or some way or another, or we have business brokers. There are business brokers which are kind of like smaller investment bankers for these smaller transactions that bring potential transactions to Brown & Brown. We, in turn, talk to them, see if there's a cultural fit, and then figure out if we can price these transactions. Transactions typically are on two and three-year prospective earn-outs. You'd say, how does that really work? You take EBITA. EBITA is there's really not much D in our business. We call that operating profit, and typically, depending on the operation, it's six to six and a half, maybe seven times an operating profit on a prospective basis.
For sake of this discussion, if you had a $4 million business and it generated a 25% EBITA margin, that'd be $1 million. We said to you, Rob, that your business is worth $6 million. Six times $1 million is $6 million. We would pay you, Rob, $4.5 million down. That's the minimum. If the whole world goes to hell in a handbasket, you keep your $4.5 million in revenue. That's the bottom of the collar. The top of the collar is $7.5 million of revenue. Think 75% of $6 million, 125% of $6 million. That's your collar. Rob goes forward and grows his business over the next two years, and the average operating profit, the average EBITA over the next two years is $1.2 million. At the end of the earn-out, we take six times 1.2, that's $7.2 million.
We take away what we've paid him, which is the $4.5, and that's the remaining true-up on the acquisition or monetizing his asset. That's how we typically buy businesses. We've done, as you can see, 18 acquisitions this year with $52 million of annualized revenue. The largest of which is about $15+ million, which coincidentally we bought from the financial institution that gave a presentation in this room right before us, right? Wasn't it First Horizon? Yeah, First Horizon Bank. We bought an insurance agency that they happened to own that was in Nashville and in Chattanooga, Tennessee. With that, I'll open up to any questions anybody has. I try to touch on acquisitions, organic growth, revenues. We can talk on margins, whatever you'd like to talk about.
Powell, I'll kick it off while we get the mics set up. You had pointed out how the organic growth slipped in the second quarter, reversing the trend that we've seen over the past year of an incremental slowdown in the rate of decline. To what extent do you think you can improve upon that result if you don't see any further pickup in the economy in the near term?
Well, we, as I said earlier, think our business is a mirror reflection of the middle market economy. We said on Q2 earnings call that we think that we continue to operate in a historic range based on the economy as we've seen it. Depending on your perspective, I don't know if you'd say the economy has ticked backwards or is flat. There's nothing that we're changing as it relates to addressing, meaning we're not trying to change the way we go after new business or change the business model. What we're trying to do is do everything in our power to retain every client that we've got. We're trying to sell as much new business as we can. We're trying to hire more good people, meaning good producers, and retain the existing teammates that we have.
We're trying to look for new quality acquisitions that can help us grow in the future. That's what we're really doing. Yes, sir. Rob.
Sorry, one more time.
Yeah.
Do you feel a need to grow internationally other than the U.K.?
The question is international growth. The short answer is we don't like to say never or always. Up to this point, we've really felt that there were great opportunities to invest right here in America. We started the business in the U.K., de novo, with a London broker. We think that we can continue to grow organically in London. There may be some additional people that will, or teams that would join us. We don't know. We haven't seen the right opportunity yet. I think that there are all kinds of opportunities out there, I think a lot of them are right here in the United States, and they are a lot closer to get to. For right now, we've been focused really on the United States and the middle market in the United States.
I have two questions, please. The first is, I would agree that insurance prices are falling most of the time. They go up very sharply and then fall for 15 years. The last time they troughed out in the late '90s, Brown was able to grow its revenue, and this time around it hasn't. I'm just wondering, when you add it all up, what do you attribute that to?
Could you repeat the part on the trough in the late '90s and when it grew from that?
Sure. The last time the soft market and insurance pricing troughed out was '99, 2000.
Yeah. Sorry.
It was bad in '97, '98, '99, 2000.
Got it.
Brown grew its revenue that whole time.
Yeah.
This time around, maybe we're near the trough, maybe we're not, but revenue's been flattish for five years. When you add it all up and look back, what do you think is the difference there?
Yep. First question. In the late '90s, what you see, by the way of comparison, if we go back to this slide, I would tell you that rates in the end of the '90s, before the market started to firm up in 2000 and 2001, rates were down 5%-8% on average. If you think about that time in the economy, the economy in the late '90s wasn't great, but it wasn't bad. I'm just going to speak from personal experience in Florida and knowing what was going on in Florida in terms of the construction environment and just the overall economic environment.
As it relates to our growth, and more specifically our internal growth, in 2007, it was the first year of our negative internal growth, and that was directly as a result of the governor of the state of Florida taking the market of last resort and making it the most competitive property market. He took the property rates with the market of last resort for those individuals, for homes and condominiums and apartments that can't get insurance anywhere else, and made it the most competitive market. That action, if you took that out, which you can't, we would have had positive organic growth that year. 2008 forward has all been economic.
I have only been in the insurance business for 21 years, so I can only rely upon those that have done this a lot longer than most of the people in this room, but our chairman's been doing it for 52 years. For the entire time he's been in the business, he said he's never seen it this bad. For those of us that live in Florida, and there may be some others in the room other than Corey and myself, it's been kind of challenging and bumping along in certain states, particularly in a place like Florida where we've operated. In terms of that growth, I think it's all driven by exposure units, and that doesn't make it right. It just means that's what it is. It's not something that we're happy about.
When Sarah asks, "Is there something that you're going to do?" like we've got something to pull out of a hat, not making light of it, but there is not a rabbit to pull out of a hat. It is, we have a not a very sexy business that we sell and service insurance. We think we do it really well on behalf of our customers, and we're kind of been flying in the face of kind of a tough operating environment where our middle market, small, medium-sized customers are still shrinking. You had a second question.
Second question. As the carrier's results deteriorate, you have some exposure to that through your contingent commissions.
Yep.
Question is, looking forward the next 12 months or maybe just into 2012, what kind of negative impact could we be looking at in terms of your participation there?
Hard to answer exactly. What we've always said relative to profit sharing and contingencies is it is a fair statement for you to say if loss ratios deteriorate with insurance carriers, the contingent payments will come down. Broad statement. Having said that, you cannot say that our Nashville office, even though they do business with some of those carriers that have deteriorating results, are going to get less contingencies because you don't know how their book of business performs. It is conceivable that there are offices in our system that will do business with those carriers that have poorer results next year than they did this year, and they will get higher contingencies.
In an overall magnitude, I think it is fair to say that it is down, but I don't think Corey or I have been able to give you, and wouldn't be able to give you, an exact number because we just don't know how our book of business will perform relative to for those carriers. Did you have a Yeah.
Thanks. A more general question about why you use the acquisition earn-out structure.
Yeah
that you do. Is that industry convention, or is it specific to your company, or?
Typically, in the industry, there are earn-out periods. We're not unique to that.
Okay.
The way that really came about is historical valuations of agencies. When you go back 25 years, if you said, "How did you value an agency or a book of business?" The answer is it was 1.5x the revenue. You said, "Okay." Well, we started thinking about that 1.5x revenue, if you operated that business at a fairly efficient basis, what would your margin be? 25%. 25 times six gets you 1.5x. You could actually have a business that operates more efficiently in margin, and so therefore pay a higher multiple on it, and it kind of evolved from there, but it's not unusual.
If you were to talk to a bank that acquires a business, if you're talking to a private equity firm or a firm across town that's buying an insurance agency, typically there's a prospective earn-out based on a multiple of either revenue or operating profit. Common practice. You had a question right here.
Just a quick one. Do you use cash or stock or some combination of the two for acquisitions?
We buy with cash.
Okay. How do you solve the succession problem? If your average guy is 57, presumably he's going to retire in five or six years. Do you have a deep bench of folks who are coming up through the ranks that will eventually replace the gentleman that's the head of that brokerage?
Yeah, we talk a lot about that upfront. The first thing that we talk about is, do you have somebody that you think can lead this firm after you want to retire? First off, what do you want to do? We don't typically, and we've had pretty good success with this, we don't want people to just outright tell you a lie or something that's an untruth to begin with, sometimes things change, meaning health, family, whatever the case may be, they say, "Okay, I'm 57. I want to work till I'm 63. I'd like to run it till I'm 63, then I'd like to phase out and just handle some accounts." That's a very typical scenario. Okay? The question is, if you got smacked by a Mack or something happened to you, God forbid, what would happen?
Well, this gentleman John here or Anne can run it. Okay, we're looking at Anne or John or both during the earn-out to see if they can run it. If in fact they can, we want to get them to be able to run it after this individual, in this case you, wants to retire or not run the day-to-day operations. If they can't, we have to find somebody to bring in there with your so-called blessing to shepherd that individual in to run that business. We're in the people business in terms of cultivating talent and getting people in positions to go and ultimately, if they show that they have the skill set and ability and desire, to go and run businesses. We provide a lot of upward potential mobility and responsibility for individuals that want to do it.
Let me take the other scenario. The other scenario is if in fact, and this doesn't happen that often, but it does happen, you have two people that can run your firm. Anne and John both could do it. Well, if they're both really hardwired to run the firm, one of them's leaving because you're going to pick one to run it and the other one's going to leave because he or she didn't get a chance to run it. In our firm, we offer the opportunity for both of those people to run a business. It just may not be your business, it may be somewhere else.
Is there a general shortage of people who want to run these businesses? One of your competitors often cites that as-
Yeah
an issue, there's not enough.
Let me put it this way. There's always an opportunity to find more people. We have 5,400 teammates on our team, and there's always an opportunity to get more producers, good producers, and more leaders on the team. We feel really good about the leaders that we have today. We believe that we've been pretty successful at not only identifying, but recruiting and retaining and training quality insurance professionals, and then identifying those that can take on additional responsibility, be it sales management or running offices. Might be just a stylistic difference.
Hi. Do you typically achieve synergies on the acquisitions? If so, could you quantify them and distinguish it from revenue and cost?
Basically, when we do an acquisition, we tell the team that we're talking with or the acquisition group that we have 187 different offices, operations. We're not going to tell you how to run your business, but we're going to share with you ideas, and then you can pick up the phone and talk to people about how they run their businesses, and that may in turn make you more efficient. You'd say, "Like what?" Well, every quarter, if we acquire your business and you're the head of that operation, you'll be invited to a Leadership Council meeting where all 187 of those leaders are, where we're sharing ideas about growing our business. In that, you'll get a book which shows everybody's results, every P&L, every line item, every everything.
We rank everybody relative to their performance, relative to all the others in that segment of the business, the four segments I referred to earlier. In your office, let's say that you pay, for example, 6% in rent and 2% in telephone. You look at my P&L and I pay 3% in rent, and I pay 80 basis points in telephone. Well, there's a 4.2, 420 basis point improvement right there. Now, the rent thing is probably not fixable overnight. I don't know when your rent comes up, but we'd be looking at it, and we have a goal, and it's a good time to be renegotiating your rent right now.
Telephone, if you called me, I might tell you that we use such and such a plan, and you might say, "Well, how do I get on that?" I can tell you how to get on it, but there's not a corporate plan. That's the case. As it relates to the system, we have wholesale. That doesn't mean you have to use our wholesalers, but they're part of the Brown & Brown team, and they're a very talented group of individual wholesalers. We may be able to help add value to you placing business there. Two, we've got these programs. In those programs, you may have access to a product that you heretofore have not either had or been able to write that business.
Three, we have these services which may or may not be able to help you either retain a client or write a new client. Conversely, you got all these other offices that may look like you, slightly larger, slightly smaller, that are successful in running their individual businesses, and they may be able to help you in a way that they're doing something. They're not going to tell you must. It's more of a, if you like it, we can help you. Just know in return, somebody may call you asking for help in the future. That's how we set it up, as opposed to, you join our team, this is how you do it. You get in the box because we got it figured out, and this is the only way we do it. It's not like that. The way we run our business is very individual.
You may, in your office, write contractors and property managers and nursing homes, those three things. You're doing better than anybody else in the country. That's great. We're not going to tell you you need to go out and write hospitals because they're in the medical field or you must do employee benefits like this. I'm not being critical of those that do it that way, I'm just saying ours is more decentralized, individualistic, and with the idea of sharing information across the platform as opposed to siloing.
Thanks. How often are you the sole bidder on acquisition versus going head-to-head with another bidder?
Interesting question. More times than not, there are multiple parties involved. When there's a business broker, it's typically 90% plus of the time there's another firm or more than one firm involved. Even whether there's a business broker or we've identified them and cultivated a relationship directly, ultimately it's people do business with people. You buy and sell emotionally and justify it intellectually, just like I do and everybody else in this room. Whatever car you have, you bought it because you liked it and you figured out if you could afford it. Just like the shirt or the blouse you have on or whatever the case may be. The same thing is with insurance, and the same thing is with insurance agencies.
Whether we're trying to solicit your insurance or trying to get you to join our team, ultimately, you want to join somebody that you like, that you trust, that you think is going to be there for a long time, and not only do right by you, but do right by your teammates. It's a thing where I think people ultimately say, we like the system, we like the people, we want to be part of you. Now let's figure out if we can get the numbers right. We may or may not be able to get to the numbers, but if we don't get the people thing right, we call that the Saturday afternoon beer test.
If I can't come over to your house on Saturday afternoon and we never talk a lick about business, we have a beer or two and we watch a football game and enjoy our company, if we don't enjoy our company, then we probably don't want to do the deal.
This will be our last question.
Could you just help me? I'm only marginally familiar with your business. I'm a little bit familiar with, just because I heard the presentation, that National Financial Partners, the contrast between those two businesses, and just help me understand the difference. You trade at vastly different multiples, and I'm just not quite sure what you guys do that's vastly different.
Okay. I'm not as familiar with that firm. You can correct me if I'm wrong. My understanding is it's a wholesale life insurance play where they buy 50% of agencies. They don't buy 100% of agencies. Is that correct?
Yeah. I think most of the business is actually health, middle market healthcare, and
Life insurance.
What?
They're life insurance. Is that right?
No. Again, I don't know if you cover them or
No, I do not.
All right. I won't make you-
Let me put it this way. I don't know that much about that business. Where it started, my understanding was it was life insurance, and specifically wholesale platform and direct sales of life insurance, I do think you're right that they've branched out into other segments of the business which we're in, number one. I thought that they bought initially, I don't know if that's the case anymore, 50% of agencies, and then the owners, so in this case let's say you retained 50% of the ownership. In our case, we are one, we buy 100% of the asset. We're buying with cash. We have a total platform of property and casualty and employee benefits, which would include personal lines and other related direct products to you. That's your home, your boat, your car, your business.
We can sell you life insurance or financial products, meaning 401(k) and types. All these other segments of the business may or may not add value to the person selling products to you, which would be wholesale. That's access to Lloyd's of London and the harder to place risks, the programs which are not necessarily harder to place risks, they're just homogeneous groups or a service. I don't know if I really answered the question, but yeah.
All right. Well, please join me in thanking Brown & Brown, and the breakout will be in the Madison Suite.
Great.