Mr. Hamilton: When we take a look at their earnings, I think they basically came in about where we anticipated. We saw that it was a difficult environment with flattening organic revenue growth, pressure on margins, yet at the same time there were tremendous opportunities for mergers and acquisitions. We saw all of those three factors having a significant impact in 2007, but overall the earnings came in about where we expected on the companies that we do cover.
TWST: Why the flattening revenue growth?
Mr. Hamilton: When you take a look at what's taken place in the insurance sector
over the last two to three years, you get an understanding. I look at the
earnings model of the insurance brokers as being a derivative of the insurance
model. The insurance companies have had unprecedented profitability since 2004.
We take a look back over history and we get a measure of their operating
returns, which is really the combined ratio. If you have a 100% combined ratio
of the losses and expenses equaling each premium dollar that you receive, that
is essentially zero underwriting margin; where they make their entire money then
is going to be on investments.
Since 2004, we've had combined ratios of 98.1% in 2004, 100.7% in 2005, 92.7% in
2006, and through nine months in 2007 just a little bit under 94%. So for the
last four years we've had really at par or profitable underwriting operations.
What does that mean? That means that the insurance companies then see that they
are making money on the underwriting side as well as on the investment side and
are willing to compete more to retain their current clients as well as being
more aggressive in acquiring new clients. So the insurance premiums will fall
and that also then, as the insurance brokers are paid largely on commission,
means that their top line will also fall absent any market share gains or
acquisitions.
Tickers included in this excerpt: AOC, BRO, MMC
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