Insurance Brokerage M&A: Key Regulatory and Deal Considerations amid Continuing Consolidation and New Entrants in Hong Kong

State of the Market in Asia

The insurance brokerage market has emerged from the challenging financial conditions and geopolitical headwinds of 2023 as a bright spot that demonstrates resilience and promises great growth potential. 

Despite the overall reduced insurance M&A deal volume in 2022 and 2023, insurance brokerage continues to top the most active segments within the insurance industry.

Insurance brokers are capital-light businesses that generally do not take balance sheet risks and have high profit margins, high client retention rates, and a track record of generating consistent returns despite market volatility.

Even in times of financial stress, clients are unlikely to reduce their insurance coverage – and in fact, often seek the opposite, working with their brokers to ensure they have adequate coverage and are not unprotected. In turn, stable cash flows give investors access to leveraged debt in order to achieve better returns, which is further boosted through consolidation.

These factors have understandably made insurance brokerages very attractive to financial investors, in particular, private equity firms.

In the insurance brokerage market, private equity firms are still involved in the majority of M&A transactions, accounting for approximately two-thirds of the deals in 2022¹; and slightly more than that in 2023.²

Notably, as challenger brokers are targeting clients and building out their capabilities in Asia Pacific, interest is also surging from non-traditional acquirers in industries such as retail, e-commerce, fintech and technology, who are similarly seeking access to stable cash flows and to leverage their existing platforms through inorganic growth.

Adding to its appeal, the Asia Pacific market is still largely fragmented, which makes it a ripe sector for continued deal-making and further consolidation in 2024. 

To execute a successful M&A strategy, both purchasers and sellers alike must not lose sight of the regulatory requirements and obligations that come with ownership of such a business. 

Whilst relevant regulations will differ depending on the acquisition structure and jurisdiction of the proposed target, this article specifically identifies regulations and on-going obligations that apply to a Hong Kong licensed broker. We also highlight customary issues that arise in the purchase and sale of insurance brokers. 

Regulatory Considerations 

• Responsible Officer (RO): At the outset it is important to consider whether there are any anticipated changes in management personnel, or a suitable individual to act as the RO. If a new RO is to be appointed, prior approval of the Insurance Authority (IA) will be required. The RO must meet fit and proper requirements including qualifications and experience. Generally, the RO should have at least five years' experience in the insurance industry, including at least two years in management. The IA will consider the role and functions undertaken by the applicant, and whether he/she has sufficient experience to carry out the responsibilities required of a RO.
• "Fit and proper" criteria: The insurance broker, its RO, controllers, partners and directors must all be "fit and proper". In assessing fit and properness, the IA will take into account the person's education, experience, financial status or solvency, reputation, and character.  The IA will also consider corporate governance, including whether there is an adequate organisational structure, feasible business strategy, internal controls, risks management, and information relating to group entities. 
• Particulars: If the transaction involves any change in the particulars of the broker company – such as name, business address, telephone number or email address – the insurance broker must notify the IA in writing within 14 days. The insurance broker may also need to update the Companies Registry.
• Partners, directors or controllers: If the transaction involves any change of directors, partners or controllers, the broker must notify the IA of such change within one month of completing the transaction. For a broker company, a "controller" means a person who owns or controls, directly or indirectly, not less than 15% of the issued share capital, or is entitled to exercise not less than 15% of voting power at the general meeting, or exercises ultimate control over the management.
  

M&A Transaction Considerations 

In addition to regulatory considerations, purchasers and sellers should be mindful of the following matters that often arise when structuring, negotiating and documenting insurance brokerage M&A transactions: 

• Deal structure: The structure of the deal is a fundamental question that will drive the timeline, process and negotiations. At the outset, parties should consider and understand the scope of the transaction: whether it is a share purchase or asset sale; if the brokerage business is a standalone business unit, or if it requires additional restructuring because it is being spun out of a broader business that may contain other operations; and also what geographies are involved. 
  
• Due diligence: As is customary in M&A transactions, purchasers should undertake due diligence to obtain an overview of the target business and identify any risks associated with the acquisition. This includes any change of control provisions, validity of title and ownership, pending or threatened litigation or claims, and real estate or employment issues which may have a material impact on valuation or compliance and risk.
  
• Payment mechanism: The two most widely accepted mechanisms for adjusting consideration is completion accounts, which allow for post-completion adjustment, and a locked box mechanism, which “locks” the purchase price based on the target’s most recent financial statements and shifts the risk onto the purchaser. 
  
• Key persons: It is commonplace for purchasers, especially non-traditional players, to retain the existing management personnel of the target who already have familiarity and experience in operating the insurance brokerage business. In such case, the transaction should ensure the key persons are properly motivated to continue to grow the business – through appropriate involvement in corporate governance, or additional payment incentives such as earnouts, but also restricted by non-compete and non-solicit provisions to protect business prospects of the newly acquired broker. 
  

On-going Obligations

After the transaction has been consummated, an insurance broker in Hong Kong will have continuing obligations, notably among them: 

• Share capital, net assets and client account: Under the Insurance (Financial and Other Requirements for Licensed Insurance Broker Companies) Rules (Broker Rules), the insurance broker must maintain a minimum share capital and minimum net assets of not less than HK$500,000 at all times. The insurance broker will also need to maintain a separate client account.
  
• Insurance: The insurance broker must maintain professional indemnity insurance not less than two times the aggregate amount of the brokerage commission in the last 12 months, or up to HK$3 million, whichever is greater. 
  
• Conduct requirements: The broker will need to comply with the Code of Conduct of Licensed Insurance Brokers (Code) issued by the IA when carrying out insurance services (regulated activities). Pursuant to the Code, a licensed insurance broker must act honestly, with integrity, and in the best interest of the client when providing insurance services. It must also exercise care, skill and diligence, ensuring that advice is suitable for the client.
  
• Controls and procedures: The broker must establish proper controls and procedures to assess the insurance products offered, resolve complaints, notify material incidents to the IA, and ensure proper record keeping. As part of the post-closing integration process, it is important to ensure there are effective controls and procedures in place and nothing vital is overlooked, as the RO and other senior management will be held responsible.
  
• Audit requirements: Within six months of the end of each financial year, the insurance broker must provide the IA with its audited financial statements, an auditor’s report on its financial statements, and an auditor’s report stating whether the auditor is of the opinion that the insurance broker has continued to comply with the Broker Rules. 

In conclusion, the trend among both strategic and non-traditional entrants to acquire existing brokerage operations and consolidate the currently fragmented market in the region bodes for continued deal activity in 2024 and beyond.