The surge in M&A involving U.S.-based insurance brokers and agencies in the later parts of 2020 may not preclude another active year for consolidation.
With the Biden administration's reported reticence to retroactively implement tax hikes, prospective sellers may gain another opportunity to sell their businesses without facing a larger hit while robust buy-side interest in the sector continues.
Arthur J. Gallagher & Co. Corporate Vice President and CFO Douglas Howell during a Jan. 28 conference call said 2021 might emerge as "the most active year ever in the brokerage M&A space."
Such an outcome would be quite a feat.
There were 117 transactions with U.S.-based nontitle broker or agency targets announced in December 2020, which topped the previous monthly high-water mark of 94 deals in December 2012. Thanks to that surge, nontitle U.S. broker/agency M&A hit a new high of 678 transactions in 2020, up from the previous record of 641 in 2019. This was all the more impressive considering that deal volume was down by more than 20% from 2019's pace through the first five months of the year as the onset of COVID-19 temporarily stalled activity.
Expectations for meaningfully higher taxes on long-term capital gains in the aftermath of the November 2020 presidential election drove the acceleration in deal activity, reprising a scenario that unfolded eight years earlier.
In 2012, prospective agency sellers took action in anticipation of a 15% tax rate on long-term capital gains sunsetting at year's end and the subsequent reversion to a 20% rate for the next fiscal year. Though Congress did not pass the bill confirming the specific threshold until Jan. 1, 2013, it had been widely anticipated that the return to a 20% capital gains tax rate would prevail for higher earners for that fiscal year.
The rush to close transactions in 2012 led to an especially sluggish 2013. Year-over-year comparisons in deal volume were negative by more than 10% in 10 of 2013's 12 months. Full-year deal count slumped by 31.4% compared to 2012.
Preliminary S&P Global Market Intelligence data show 2021 has begun in a similarly subdued fashion, with sharp declines in announced transactions on both sequential and year-over-year bases. But there is reason to believe history is not poised to repeat itself.
For starters, full clarity regarding prospects for higher long-term capital gains tax rates did not emerge until two runoff elections for Georgia's U.S. Senate seats were concluded in January. Uncertainty remains as to whether forthcoming legislation mirrors candidate Biden's plan in scope and content.
Biden proposed taxing capital gains at the same rate as ordinary income for those earning in excess of $1 million. The tax rate for income in excess of $400,000 would be raised to 39.6% from 37% under the plan, which would imply materially larger reductions in net proceeds from many future agency divestitures. Biden's presidential win and the potential for Democrats to control both houses of Congress likely served as catalysts for agency owners to eliminate that risk by completing sales prior to year-end, given the potential that any new policy might take effect for the 2021 tax year.
But Bloomberg News recently quoted Mark Mazur, the deputy assistant secretary for tax policy in Biden's Treasury Department, as saying that a retroactive tax increase "tends to be not the first choice" for the administration.
M&A aspirations of several of the leading broker/agency consolidators are not limited to the U.S, but J. Patrick Gallagher, the chairman, president and CEO of Arthur J. Gallagher, specifically cited "possible [U.S.] tax changes" during the Jan. 28 call as a particular driver of his expectations for "a very active 2021." The company has up to $2.5 billion in capacity to pursue M&A between its amount of cash on hand, its revolving credit facility and the amount of operating cash flow it expects to generate over the course of the year.
Brown & Brown Inc. President and CEO J. Powell Brown, speaking during a Jan. 26 call, described the pace of M&A as being "as active as ever" with ongoing competition between private equity-backed acquirers and what he described as "long-term strategics."
S&P Global Market Intelligence data shows that private equity-backed acquirers accounted for a majority of the sector's overall U.S. deal volume for a second consecutive year in 2020. Their continued presence and a whole host of operational and competitive challenges facing smaller, independent agencies in the current environment add to the secular drivers of consolidation in the sector and promise to keep 2021 from becoming a repeat of 2013.
A year-over-year decline in activity on par with the retreat from 2012 to 2013 would drop 2021's deal volume to its lowest level since 2014. But that outcome seems implausible as the confluence of buy-side and sell-side interest that propelled activity to new heights in 2020 remains in place.
