Insurance is generally sold “direct” by insurance companies’ paid employees or sold via agents/brokers also known as third party distributors. The economics of an agent/broker are very attractive. They charge a commission/fee for their services (typically a percentage of the premiums) and do not assume underwriting risk – they are only middlemen in the insurance placement and sale. Insurance industry premiums are correlated to economic and population growth, and agent/broker client retentions are typically > 90%. These factors yield steady, predictable revenues and margins, with only modest capital needs.
There are thousands of agents/brokers in the U.S. The attractive economics of the business, combined with readily available and cheap credit, have fostered a robust M&A environment in recent years. This consolidation has left public investors with fewer options to invest. However, publicly traded agents/brokers remain active buyers of private properties, adding another layer of growth to the long-term business model.
There is some cyclicality in the business. Insurance industry premiums reflect exposure (economic activity) and price (actuarially determined). When economic growth accelerates, the exposure piece of the premium equation increases, which tends to increase commissions and fees for the agents/brokers. The converse is also true. When property-casualty prices are increasing (to offset increases in claims/reserves), the price piece of the premium equation contributes similarly to the revenue model. Interestingly, the current COVID-19 environment is contributing to both exposure declines and price increases – the net impact to agents/brokers remains to be seen. However, we expect the business models to prove their resiliency.
We maintain long-term investments in this group. The valuations attributed to the publicly traded agents/brokers remain attractive, given the capital-light business models and long-term growth (organic and M&A) opportunities. We view these stocks as conservative investments in uncertain times.
Everyone uses insurance, but few people realize how attractive these companies can be from an investment standpoint.
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