Many agency and brokerage buyers are concerned about acquisitiontargets with significant small group health business, but thatbusiness is not anathema to all buyers.

Buyers mostly are concerned about small groups of 50 or fewerlives but also with groups of 100 or fewer lives, according toconsultants.

“The belief is that a lot of that business will go to thestate-run exchanges” if those facilities do open as currentlyplanned in 2014 under the 2010 health care reform law, said TimCunningham, a principal at OPTISPartners L.L.C. of Chicago.

Cunningham sees agencies taking discounts of 40 percent to 60percent on the value of their small group business. “If you're aseller and you have that business, expect it to be discounted,” hesaid.

Buyers, however, will not discount the value of that small groupbusiness unless it represents about one-third or more of a seller'srevenue, said John Wepler, president of consultant Marsh, Berry & Co. ofWilloughby, Ohio.

Among the small percentage of agencies that generate most oftheir revenues from benefits business and primarily work with smallgroups, valuations are being discounted 70 percent to 90percent, experts agreed.

“Some folks are giving it no value, which isn't right—it won'tgo to zero overnight,” said Lou Caltavuturo, a partner withconsultant Dowling Halesin New York. Caltavuturo suggested that agencies focus on moving tolarger groups.

Agents and brokers who place benefits business took another blowthis summer when the National Assn. of Insurance Commissionersrefused to support their effort to exclude their commissions fromthe medical loss ratio calculation that will determine healthinsurers' profits, said insurance industry consultant andinvestment banking advisor John Wicher, principal at John Wicher & Associates in SanFrancisco.

The Patient Protection and Affordable Care Actrequired the U.S. Dept. of Health and Human Services to developcalculations on the percentage of revenues that health insurersmust commit to medical expenses.

If a health insurer meets or exceeds the prescribedpercentage—or medical loss ratio calculation—it may retain theremaining percentage of revenues to cover other expenses and asprofit. If the insurer's medical expenses do not hit the prescribedMLR, the insurer must rebate the difference to itspolicyholders.

Under the regulations the HHS unveiled last November, insurerswriting groups of fewer than 100 must meet an 80 percent MLR.Insurers writing larger groups face a more restrictive 85 percentMLR.

Because producer commissions will not be treated as apass-through expense in calculating MLRs, health insurers will haveto continue paying producers' commissions out of the 15 percent to20 percent of revenues the new health reform law allows carriers toretain to cover non-medical expenses and keep as profit.

“That's a huge deal,” because it will continue to exertpressure on the commissions insurers pay producers, Wicher said.

As a result, producers will have to turn to clients to make upthat revenue loss, he said. “For agents and brokers with books ofcommission business of under 250 lives, they could be facing a realchallenge.”

Their valuations and attractiveness to buyers will depend onthem moving to a “fee-based value proposition with clients” andassuming more risk in a merger or acquisition by accepting a dealwith a heavier loading on the earn-out based on business over oneto three years rather than up-front cash, Wicher said.

Other observers agree.

“As the exchanges roll out, we see a role for brokers” inconsulting with small businesses on their plan options andproviding services, such as plan enrollment, said Ken A. Crerar,president of The Council ofInsurance Agents & Brokers.

Atlanta-based DigitalInsurance Inc., for one, is looking for health-relatedacquisitions. “Digital loves that end of the market and gives youfull value for it,” said Dowling Hales' Caltavuturo.

Digital completed 10 acquisitions over 14 months throughSeptember, five of them this year, according to Mike Sullivan,Digital's executive vice president and chief marketingofficer.

Digital will “look for small group and middle-market business,”Sullivan said. “We believe that small group business is not goingaway.” Instead, state exchanges will add complexity to the healthinsurance buying process for small groups, which will need advisoryservices that will generate fee-based income for agents, hesaid.

Sullivan said that Digital does not discount the valuation ofagencies with small group business that it finds attractive.

However, Digital typically does not pay “as much up-front money”to sellers.

“And if this is an exit strategy for owners, we have zerointerest in that acquisition,” he said. While the earn-out elementsof Digital's acquisition deals typically are based on a three-yearperiod, Digital wants former owners to stay around five to 10years

“But no one does what we do post-transaction to allow firms togrow,” Sullivan said.

Eric Haglund, the former owner of Digital's first acquisition,is thrilled after his initial year with Digital. Haglund completedthe deal for his Lawrenceville, Ga. agency in June 2010. He wouldnot say how Digital valued his small group business, but he saidthe negotiation was not “adversarial” and that the calculation “wasquite easy, frankly.”

After the deal was completed, Haglund spent the next 6 monthsintegrating as well as servicing in-force business—split aboutevenly between groups with less than 100 lives and larger groups.He did not attempt to write new business.

Aided by Digital's marketing and technology support services,Haglund, now a principal with Digital, began focusing on generatingnew business only in the second half of the year. Even so, heincreased his revenues 24 percent compared with his top line duringthe last full year he was independent, he said. The new businesswas split evenly between small and large group business, hesaid.