Last month, narrow-moat insurance broker AUB Group (ASX: AUB) raised $200 million via an institutional placement to fund the acquisition of a 70% interest in Pacific Indemnity Underwriting Solutions, an insurance underwriting agency. As the name suggests, Pacific specializes in professional indemnity, directors and officers liability, and general liability insurance.

While the norm is for a share purchase plan to be announced in tandem with an institutional placement, shareholders were made to wait weeks before learning if they could subscribe.

However, AUB Group has finally announced an share purchase plan (“SPP”), and we recommend participation, provided it is consistent with individual investment goals.
The $27.50 offer price equates to a 21% discount to our $35 fair value estimate and is a 9% discount to the current share price. The offer closes on June 28, 2024.

AUB Group doesn’t need the extra cash right now, but its appetite for mergers and acquisitions means that funds will likely be needed at some point in the future.

Pacific Indemnity appears a good strategic fit, expanding the breadth of AUB Group’s insurance lines covered by agency businesses. The underwriting agency carries no claims risk other than its insurance providers no longer wanting to work with Pacific Indemnity. Pacific Indemnity will sit with 27 other AUB Group agencies and, on a divisional basis, add around 19% to gross written premiums and 27% EBIT.

More on the acquisition of Pacific Indemnity

AUB Group is spending around $140 million to acquire a 70% interest in Pacific Indemnity Underwriting Solutions, an insurance underwriting agency. As the name suggests, the firm specialises in professional indemnity, directors and officers liability, and general liability insurance.

Pacific Indemnity appears a good fit for AUB Group, explanding the breadth of insurance lines covered by its agency business. We estimate the acquisition will account for less than 4% of group EBIT, which is small in group earnings.

Pacific Indemnity was established in 2015 and increased gross written premiums to $177 million and EBIT to $15 million in fiscal 20223. There is no detail on earnings trajectory other than a statement about a track record of earnings growth and attractive margins. But it is unlikely that AUB Group would be attracted to a declining business, rather one that has proven it can create policies that address its market needs.

The founder and staff will retain the remaining 30%, providing a good alignment of interests. The underwriting agency carries no claims risk other than its insurance provides no longer wanting to work with Pacific Indemnity. The newly acquired group will sit with AUB Group’s 27 other agencies and add around 19% to agencies gross written premiums and 27% to the divisions EBIT.

Business strategy and outlook

AUB Group operates the second-largest general insurance broker network in Australia and New Zealand. AUB Group brokers derive revenue from commissions paid by insurers, based on gross written premiums. AUB Group owns or has equity stakes in each broking business within the network. Around half of group profit is delivered by the Australian and New Zealand broker network, around 30% from Tysers in the United Kingdom, and the remainder from underwriting agencies.

A key value proposition over smaller brokers is AUB Group’s ability to negotiate more favorable policy wording and pricing. Scale also provides the capacity to spend more on technology, which helps facilitate greater analytical and processing capabilities, and marketing to help attract and retain customers. Other services such as claims support and premium funding support the value proposition.

AUB Group’s underwriting agencies distribute insurance products but take no underwriting risk. Underwriting agencies act on behalf of insurers to design, develop, and provide specialized insurance products and services.

The earnings outlook is positive. We expect further insurance price rises over the medium term, albeit not at double-digit levels recently experienced, as insurers seek to cover claims inflation and higher reinsurance costs.

We expect insurance brokers to take share of the intermediated market. Technology should allow a greater number of policies per client--for example, adding personal motor/home on top of a business clients insurance needs. AUB Group’s investment in BizCover, a self-service insurance platform targeting small SMEs, and partnership with accounting firm

Kelly+Partners to act as a lead generator, should see AUB Group take share of the small SME end of the market. This share will most likely come from the direct channel.

The acquisition of Tysers is material for AUB Group, we are optimistic that targeted cost and revenue synergy targets will be achieved, with insurers lifting prices an additional tailwind to the business.