Top three insurance brokers are likely to persuade regulators to reinstate contingent commission that was banned in 2005 for conflict-of-interest concerns. Moreover, operating conditions in the insurance industry are improving. In my view, the tide is at least turning in favor of the top three insurers.
Likely reinstatement of contingent commissions
Regulators are conducting negotiations to revise, or even lift, the 2005 ban on so-called contingent commissions for the three largest brokers namely Aon Corp. (AOC), Marsh & McLennan Cos. (MMC), and Willis Group Holdings Ltd. (WSH). Contingent commissions are paid by insurers to brokers and are based factors such as how much business a broker brings to an insurer and how profitable it is.
Arthur J. Gallagher & Co. (AJG), the fourth largest broker, has succeeded in negotiating an end to its own ban on contingent commissions in October 2008. Arthur Gallagher estimated that contingent commissions will add $10 million to its annual revenue by 2011. Barclays Capital analyst Jay Gelb estimated in a note Tuesday that the commissions could add an additional $254 million in annual revenue for Marsh & McLennan Cos., $51 million for Aon, and $40 million for Willis. However, this compares poorly with what these top three insurance brokers collected in 2003. For instance, Marsh collected $845 million in contingent commissions in 2003, out of $11.6 billion in revenue that year. Moreover, customers may resist paying the fees.
Regulators are likely to reinstate contingent commission as the New York State Insurance Department is proposing new commission disclosure rules. Insurance brokers would be required to tell customers whether they represent the purchaser or the insurer in the sale and whether they receive commissions; buyers can request more information.
Improving operating conditions
In the first half of 2009, despite the challenging market conditions, reinsurers have been able to regain much of the capital that was lost as a result of the financial crisis and 2008 windstorms. According to Chris Klein, Global Head of Business Intelligence for Marsh & McLennan Cos, "Fears of a capital famine, not to mention the shortage itself, appear to have passed. By every measure - earnings, shareholders' equity, volatility, book value - a recovery is in progress." Moreover, as part of their risk and capital management strategies, major issuers are using cat bonds to complement and diversify their core placements. There is a possibility that cat bond issuance activity could reach $3 billion this year, especially with increased sponsor interest due to the reduced clearing spreads on the July transactions. Over the next two years, M&A activity is likely to be robust. Moreover, Solvency II legislation could free up capital that might boost M&A activity. Insurance companies and brokers may also realize some hidden revenue opportunities due to the Solvency II legislation.
Overall, the top three insurance brokers are likely to benefit from the likely regulatory changes and improving operating conditions. Therefore, I clearly see an upside in these stocks. In my view, MMC looks to breach $25 soon, while AOC and WSH could breach $45 and $30 respectively.
