The brisk pace of mergers and acquisitions among
brokerages over the last five years has stretched the old categories. Nowhere is this more
evident than in the evolving “tier 2.”

By Craig Harris

(reprinted from ci Canadian Insurance Magazine, Oct. 2001)

Here’s a simple question — who invented this
“tier” concept for brokers anyway? Most people are familiar with the term
(“oh, you’re a tier 2 broker”), but what exactly does it mean and does it
really hold any significance in today’s brokerage environment? The answer is yes and no.

Yes, in that as a rough rule of thumb it gives a sense of
broker demographics in Canada. The tier concept started about 20 years ago with the
now-defunct Trivest Insurance Network, according to Cookson Walker consulting group.
Insurance companies today still use the breakdown as a rudimentary dividing point when looking at brokers.

Indeed, many insurers, such as AIG, Chubb and ACE/INA, have
begun to pay more attention to certain tiers in their corporate strategies. Others, such
as Royal & SunAlliance, Lombard and Economical, are paying a different kind of
attention, seeking ownership or at least some kind of equity in larger brokers across the
country, according to sources.

The early measure of the tier system was commission income
– if you were over $5 million, you were tier 1; over $2 million, tier 2; and the rest
were tier 3, according to Eric Walker, partner in Cookson Walker. Today, the tier 1
brokers are still the alphabet houses, although consolidation has shrunk the numbers down
to the big two – Aon and Marsh (and to a much lesser extent in Canada, Willis). The
essence of their business is still the large risk management account. And tier 3 brokers,
although they too have become bigger over the past five years, still tend to be more
personal lines oriented, with perhaps a dabbling in standard commercial lines.

The “no” side on the relevance of the tier
concept is the clear fact that some of the old rules do not apply. Many of these
categories have become outdated as brokerages become larger. In Ontario alone, the number
of corporate licenses has declined by 18 per cent over the last five years (currently at
1,381), while the number of individual registrants per business has climbed steadily (now
at 10 per brokerage), according to figures from the Registered Insurance Brokers of Ontario.

The change has become most noticeable in the amorphous
category of tier 2 (most brokers dislike the term and prefer “mid-size” or
“regional”). Generally, these brokerages are over $30 million in premium volume,
with a significant stake in commercial lines. Some well-publicized mergers (Hunter Rowell
with Keilty Muntz & Beatty, Hargraft Wood Fleming with Schofield, McFarlan Martin with
Rowlands, etc.) have left dominant players in key regions. Their employee base is at or
near 100 (or above), and most offer particular areas of specialization. They can write
larger risk accounts, even multinational business. And many of these brokerages have
experienced rapid growth, often more than 15 per cent per year over the past five years.

But in this category, quick labels make less sense. One can
see a stratification in this grouping. Indeed, in the “elite” category, there is
but a handful of brokers who can truly compete with the alphabet houses on large accounts
and are comfortable targeting premium accounts of $225,000 to $1 million and above.

The most obvious of these is Toronto-based Hunter Keilty
Muntz & Beatty. With well in excess of $100 million in premiums and more than 150
employees, HKMB has carved up its mostly (90 per cent) commercial business into key
specialty “practice areas,” according to the firm’s president Greg Belton.
These include life sciences/ biotechnology, hi-tech firms and auto leasing & retail
outlets. The brokerage has also formed HKMB Capital Solutions to provide alternative
solutions, particularly in areas such as third-party credit enhancement.

“We are a very serious alternative for people to look
into for virtually any size account,” Belton says. Noting some big players as clients
– JDS Uniphase or Toronto’s Skydome –he says HKMB competes with the
alphabet houses on about 50 per cent of its business. Still “we want to offer the
personal service of a boutique with the sophistication of a large firm.”

Belton says his brokerage has sharpened its skills to
compete. Internationally, it is part of Assurex International, and is also the only
Canadian brokerage to belong to the Worldwide Broker Network, a 49-member partnership
based in London, England. It has established an in-house claims unit with eight full-time
staff and invested in technology to provide customized reports on claims and risk to clients.

Montreal-based Morris & Mackenzie also has a premium
volume in excess of $100 million, with 178 employees. President and CEO Maurice Sauve says
his firm has also made a significant investment in IT over the past 11 years and is now
starting to see the results.

Although weighted a little more to personal lines at 35 per
cent (mainly group home and auto), Sauve says the brokerage targets higher-end commercial
accounts, particularly in the construction sector. “We have seen in the last two or
three years, a number of large national firms coming to us as an alternative. We find that
the principal reason they are looking around is they are not getting the type of service
they want. And we have been successful on a number of these accounts.”

John McArthur, chairman of AMAC Consultants Inc., says the
alphabet houses “have little time for an account where the commission revenue is
under $10,000.” Some, he adds, are even sub-contracting parts of this business to other brokers.

Many of the “up-and-comers” in the tier 2
commercial broker category have tapped into the skills of ex-alpha house employees.
BF-Lorenzetti, which is based in Montreal, has made a big push in the Ontario market. As a
brokerage with a 95 per cent stake in commercial lines, about $100 million in premium and
109 employees, it lured ex-Aon employee Jack Lee as managing vice president.

The goal, says Lee, is to compete aggressively on the
mid-market accounts, where service is often the difference. “Clearly, on the risk
management business, that is where the global network of the alphabet houses comes into
play. But on the mid-size account, a lot of times these clients have been with a large
broker and realize they are just a little spot on a broad canvas. To the mid-size broker,
this is a bread and butter account, and he will service the heck out of it.”

Lee, who worked with Aon for three years and, prior to
that, with Johnson & Higgins for seven, says there are pros and cons in both the large
and mid-size brokerage environments. But the flexibility of mid-size brokers can translate
into more opportunities. “If you are a broker specializing in, say, long-haul
trucking, you can compete in the larger accounts and run circles around the alphabet
houses in terms of service. That is your specialty.”

Specialization and service were the main reasons for
starting Toronto-based Jones Brown & Associates in 1997, according to its president
Brian Jones. After 21 years with Johnson & Higgins, he and chairman Don Brown formed
the brokerage to target key industries, such as entertainment (film, event cancellation)
and financial services. The aim is to be a “category killer,” Jones says.

Jones Brown boasts some pretty good size clients, including
the worldwide operations of Atlantis Alliance, underwritten by Chubb. Last year, Jones
says his firm wrote the directors and officers liability for a Canadian bank’s IPO on
the NYSE – one of the largest in the exchange’s history.

The brokerage is intent on forming “deep and intimate
relationship with clients,” according to Jones. “The focus on client service has
been lost in the consolidation and restructuring going on at the alphabet broker level.
For us, it’s a bit of a David vs. Goliath struggle. I know that they (alphabet houses)
certainly don’t like to lose accounts to a tier 2 broker. But in some cases, they are.”

A West Coast firm based in Burnaby, B.C., CMW Insurance is
similarly eager to grab the mid-size accounts that have fallen from the books of alphabet
houses. President Chris Waters, who worked as a vice president at Aon for 14 years, says
in the past seven years, his brokerage has built up a solid stable of mid-size clients in
the manufacturing industries.

“I can cite dozens of clients who have moved their
business recently because they say they say they haven’t received the serve from
larger brokers,” he says. “This is a real growth area for us.” Like HKMB,
CMW is part of Assurex International and Waters says, although the brokerage just started
earlier this year, he anticipates the network will be particularly useful for
manufacturing clients expanding into the U.S.

In addition to the mainly commercial
“up-and-coming” brokers, there are the large regional brokerages within the tier
2 category. There are several in Ontario — Blonde & Little (Windsor), Cowan Dalton
(Kitchener), Dan Lawrie (Hamilton), Hargraft Schofield (Toronto), KRG (Toronto), McFarlan
Rowlands (London), Stevenson & Hunt (London) and Sinclair Cockburn (Toronto), to name a few.

There are also plenty of regional players in other areas of
the country, such as Capri (Kelowna, B.C.) Johnston Meier (Maple Ridge, B.C.) and Renfrew
Thompson (Calgary, Alberta) also just to name a few.

Many of these brokerages have specialty offerings as well,
whether agriculture, construction or professional liability. Paul Martin, president of KRG
Insurance Brokers, says the increasing specialization of mid-size brokers will likely
continue. “I think many are moving away from being general practitioners, moving into
the realm of specialists,” he notes.

Others are seeking to capitalize on cross-selling in
financial services. Jim Aston, president of Sinclair Cockburn Financial Group, says his
brokerage changed its name three years ago to reflect the growing importance of multiple
product offerings. “We have 15,000 clients and we think there is a lot of potential
to be tapped in cross-selling and referrals,” he says.

For Stevenson & Hunt (another Assurex member),
cross-selling in employee benefits has been a competitive advantage for decades, according
to president Ed Holder. “We have been very successful in providing employee benefits
because we realize that specialists are needed; you can’t just dabble in it,” he
says. “Once you do it right, it doubles the opportunities.” With a 70 per cent
focus in commercial lines and specialization in commercial agriculture, larger
manufacturing, surety and hi-tech business, he says the opportunities are there to provide
personalized service in a broad spectrum of products.

Regional brokerages also tend to have more of an emphasis
on local clients and a greater stake in personal lines (often 30-50 per cent). Tom Meier,
secretary-treasurer for Johnston Meier Insurance Agency Limited, says his brokerage has
seen “a bit of business” from ex-alphabet broker clients, but the emphasis is
more on local customer relationships. “We are a strong regional tier 2 broker,” he says.

These brokers have the capacity to compete on national
business, and sometimes find themselves squared off with the alphabet houses on a
particular account. Renfrew Thompson’s CEO Doug McIntosh says a large national client
may be headquartered in a city like Calgary and often wants the broker to be there as well.

But the international part of the business has been a
tougher nut to crack. “This area has been much hyped recently, but the successful
examples are few and far between,” says John McArthur. “One of the problems with
counter-signing authority or even broker networks is the relative size of the Canadian
account. Here, we don’t have workers’ comp nor the relative premium size brokers
in other countries are accustomed to. Most U.S. brokers are going to focus on what is
going to make them money.”

These brokerages do not necessarily seek out international
business, but insist they can write it for key accounts. Wanda Thrush, vice president of
Cross Border Underwriting Services, says there is more education among brokers that they
can find missing pieces of the puzzle for a client. That piece is often workers’
compensation or product liability for a customer expanding in the U.S.

“I think brokers today realize if they leave that one
piece missing, they are vulnerable (to competitors),” she says. “But the
business is there for those who want it. We see lots of business coming from clients of
larger brokers who are not happy about the level of service.”

Whatever the category in tier 2 (elite, up-and-comer or
regional), these brokerages increasingly wield greater clout with carriers and clearly
have become big players in their respective markets.

Says Paul Martin: “Size is a big issue. If you are
just ABC broker down the street your submission tends to go to the bottom of the pile. But
if you have a certain volume, you get the attention.” For Jack Lee, one indicator of
clout is how many markets a brokerage truly represents. “You need to have multiple
markets to place some of this business, but the question is how many actually do?”

For insurers, there is recognition that tier 2 brokers
account for an increasingly significant portion of their business. Gary McMillan,
AIG’s CEO in Canada says we “have always been seen as a larger broker company,
but we have been trying to rebalance. We have gone from 80/20 (in terms of alphabet/tier
2) to more like 60/40,” he says.

Jan Tomlinson, president and CEO of Chubb Insurance Company
of Canada, says some of the specialty brokers in the mid-size category have provided
business tailored to some of her company’s niche products. “That has been
beneficial for us,” she says, adding that the company sees a lot of business in the
standard commercial lines from tier 2 brokers.

Sources say there are many challenges ahead for tier 2
brokers and these vary in priority depending on whom you talk to. One hurdle is dealing
with the obvious increase in size, particularly the number of employees.

“I think when brokerages of a certain size become
larger organizations, things obviously change. And the management skill in dealing with
this change requires a different kind of expertise,” says consultant Eric Walker.
“The old sales-driven models don’t work anymore.”

His firm is regularly called in to do audits or assessments
of brokerage operations. He recalls one case of a larger brokerage where it was obvious to
all, except the principal and producers, that a general manager position was needed to run the operation.

Another frequently mentioned hurdle for brokers is what
many refer to as the “thin” level of emerging management and a general lack of
talented young professionals in the industry. This applies especially to producers.
“In the past, there were some insurers that had training programs and many ex-company
employees were hired by brokerages. With those programs cut, there is a big gap.
Essentially, we have wasted a whole generation of expertise,” says John McArthur.

“There is a vacuum out there right now,” says
Maurice Sauve. “We need to do a better job of recruiting and attracting bright,
talented people to this industry.”

Another obstacle could be raising enough capital to feed a
growing operation. “Our biggest problem is twofold and both relate to capital,”
says Robin Durrant, a senior partner with Capri Insurance, a brokerage that, with 206
employees and more than $100 million in premiums, stands out as a big player in the
relatively small Okanagan marketplace. “One, we need the capital to invest in
information technology. And two, we need capital to market ourselves effectively.”

McArthur says a major source of capital over the years has
been insurance companies. “It is hard to find brokerages over $20 million that
don’t have a significant level of financial commitment, whether through loans or
partial ownership, from insurers,” he says. Others, such as Cookson Walker, say there
are more brokerages owned by insurance companies than most people realize. If not direct
ownership, then financing and loan covenants play a distinct role in brokerage equity, sources say.

Several brokers contend that the opportunities for the
typical mid-sized firm far outweigh the challenges. Many claim satisfaction that they are
“where they want to be” in the market.

Jack Lee says he foresees a “plateau” in the
Canadian risk management business, but growth in mid-market accounts. “I don’t
think there is a huge number of seven figure risk accounts in the Canadian market. There
are many more six figure premiums out there. And I see tier 2 brokers excelling to meet
that market.” Adds Brian Jones: “We are coming right up the middle and the one
thing that surprise me is that there aren’t more brokers doing this.”

Perhaps with all this growth, many brokers can shed what
they consider to be the pejorative “tier 2” label. Or maybe it’s just time
for a new mode of classification,

Says Jan Tomlinson: “I always apologize when I visit
with a ‘tier 2’ broker and clarify that I don’t mean the term as an insult
or anything. It’s just what people refer to. I’m sure if a better system was
developed, we would all use it.”