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Aon Q3: We’re going to need a bigger workforce

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We’ve all seen and heard the mantra that companies “put their employees first!” so often because it has appeared everywhere, from the cover of business management magazines to help wanted signs in fast-food windows.

One can reasonably assume that any random company would make this claim – whether it is accurate or otherwise. But for insurance brokers, the mantra is closer to a guiding principle.

The brokerage industry (arguably alongside the rest of the insurance industry) has had a longstanding talent shortage. The hard market has further exacerbated this issue.

Picture going to a business owner and explaining that her insurance rates are up 10%, the third year in a row of rate hikes. There’s a good chance the business owner would consider reaching out to a competing broker, particularly as she recalls the lag in response time she had when she requested those edits to the insurance certificates a few months ago.

The above is the scenario brokers would like to avoid - but retaining the customer relationship above all requires retaining the talent to manage those relationships.

While the industry has grown away from personal relationships and further towards institutional relationships, brokers must still pay careful considerations to their ability to have enough (trained) staff to manage accounts, particularly as brokers look to take full advantage of the economic recovery.

Understandably, this causes brokers to have relatively high employee compensation and benefits expenses – and with a hiring war heating up, some management teams are predicting that wage inflation will rise.

The Employment Cost Index (ECI), measured by the U.S. Bureau of Labor Statistics, showed that compensation costs in the third quarter increased 1.3% from the second quarter, and 3.7% YoY.

Companies are warning that wage inflation will outpace price inflation - which is already a point of major concern for the broader economy - into 2022. On Aon’s call, the company pointed to wage increases anywhere from 2-12% for their clients.

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In the last five years, Aon’s employee expenses as a share of total revenue have declined as a result of a years-long restructuring it underwent following the sale of its HR outsourcing business in 2017.

The chart below shows that the firm pushed its employee compensation and benefits as a share of total revenues down from its 2017 high of 60.9% to its 2020 low of 53.4%, the lowest of any broker covered at the time. Recall, the focus for brokers in 2020 was expense cutting (T&E, advertising, staff savings, benefits, and tech and consulting), an effort to deliver margin expansion in a recessionary period.

By Q2 2020, Aon was among the first to announce a return to “normalized” spending, an easier decision for a company with fewer pre-existing inefficiencies.

This quarter, employee-related expenses have jumped in 2021 YTD to 56.9%. While an increase was anticipated, we wonder how much would further expenses will rise into 2022.

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While the hiring war is beginning to affect retention and attrition, as well as employee-related expenses, for brokers, the super-cycle remains the dominant event impacting quarterly returns.

For Aon, specifically, the firm’s journey back from the attempted Willis deal has been a period of return-to-plan, including streamlining operations, just in time to take advantage of a beneficial brokerage cycle. It would appear that the company has been able to regroup and re-emerge from the abandoned merger with Willis.

This quarter company reported an adjusted EPS of $1.74 in line with street consensus at $1.70 (adjusted for the $1bn merger fee and accompanying expenses).

Investment in hiring has translated to accelerated organic growth vs. peers.

Aon’s consolidated organic growth rate, shown in the chart below, continues to improve even when most of the firm’s competitors’ rates have remained static or fell, partially reflecting the removal of the Willis distraction.

The company’s organic growth rate increased to 12%, up 1pt from last quarter’s 11%, and up 12pts from flat growth experienced in the third quarter of 2020. Aon’s stated goal is to deliver mid-single-digit or greater organic revenue growth, as well as margin expansion for 2021, 2022 and beyond.

Marsh McLennan remained flat from the second quarter at 13%, while Brown & Brown and Willis Towers Watson dropped 6.2pts and 1pt from their second-quarter numbers, respectively. Note, every broker covered has increased their organic growth rate substantially YoY, due to the pandemic.

Like Aon, AJ Gallagher also improved its organic growth rate quarter over quarter, improving by 1.4pts to 10%.

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Margins (excluding termination noise) remain steady.

For the quarter, Aon reported a higher adjusted operating margin than most of its peers at 28.9%, vs. Marsh McLennan at 24.3%, Willis Towers Watson at 22.7%, and AJ Gallagher at 27.3%. Only Brown & Brown, with 31.2%, reported a higher adjusted operating margin.

In the chart below, we see the industry’s rolling margins are continuing to benefit from the sustained brokerage super-cycle, even as operational expenses have largely returned post-pandemic.

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We can expect the hiring crunch to exacerbate compensation levels as brokerage firms compete for experienced talent through the fourth quarter and into the next year. Aon is well-positioned relative to its peers on the hiring front, but will its first-mover advantage be enough to keep it ahead of competitors in the long run?

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