The Revenge Of The Buggy-Whip Maker

For those of you fortunate enough to have owned an insurance agency through the peaks and valleys of recent years, your patience (and yes, vision) has been handsomely rewarded!

You turned the other cheek in the early 1990s when a state insurance commissioner, in a front page article in The Wall Street Journal, called insurance agents the “buggy-whip makers” of the late 20th century. And you hung on through the technology craze of the late 1990s when it got even tougher than usual to hire and keep young people who believed the sexy “new economy” was going to bury the old one.

Your reward? In a stunning reversal of fortune, private broker stocks have outpaced publicly traded stocks since 1994 (which, incidentally was around the time of the infamous buggy-whip maker comment.) The steady growth of insurance agency values through the late 1990s, followed by a hard-market surge over the past couple of years now stands in stark contrast to the sharp rise and fall of the major stock indices.

The graph accompanying this column compares the S&P 500 with the Reagan Value Index, a proprietary index of 30 firms appraised annually by Reagan Consulting since 1994.

In fact, the graph only tells part of the story, since it does not factor in dividends–which are, on average, better for private agencies than for publicly traded stocks. The S&P 500 dividend yield (annual dividend paid, divided by share price) has averaged slightly under 2 percent over the past 7.5 years.

For privately-held agencies “dividends” can come in many forms, but can generally be defined as income and/or perks distributed to owners in excess of what non-owners with the same job would receive. The range of this informal “dividend yield” among agencies is enormous–we work with several agencies with a double-digit “dividend yield.” However, on average, we estimate it runs about 4.5 percent, or two-to-three times the level of the S&P 500.

In contrast to the turmoil in the stock market today, owning an insurance agency looks more attractive than ever. Revenue and profit growth are strong, and outside investors–especially banks–continue to show strong interest in the business.

Even the bust of the “new economy” has helped in certain respects, as it has leveled the playing field in the battle for talent, providing agency owners with a once-in-a-generation opportunity to recruit new blood into the insurance industry.

If you already own, or are considering taking an ownership interest in an insurance agency, here are some factors to consider:

Over the next decade, the return potential of stock in a private business may well exceed that of the S&P 500.

Analysts are now cautioning the current generation of investors that there have historically been long periods where stocks moved sideways.

For example, in early 1966, the Dow Jones Industrial Average hit the 1000 level, then retreated. It bobbed up and down for years, and didnt cross through the 1000 level for good until 17 years later, in 1983! If history were to repeat itself, even a slow-growth agency over the next 10 years might appreciate faster than the overall stock market.

Stock in a privately-held business offers tax advantages that are actually better than a qualified retirement plan, such as a 401(k).

Does this sound too good to be true? Consider that when an individual sets money aside in a 401(k), the contribution is tax deductible, and any dividends or capital gains within the plan grow on a tax-deferred basis until they are withdrawn and taxed as ordinary income. The tax-deduction on the contribution, and the tax-deferral on money inside of the plan have made 401(k)s the investment vehicle of choice for millions of investors.

The only negatives are that there is a stiff tax penalty for withdrawal prior to early retirement, and there is currently a contribution limit of $11,000 per year.

Now compare the 401(k) to buying stock in an agency. Granted, the stock must initially be purchased with after-tax dollars. But once the stock is purchased, most future investments in agency growth are fully tax-deductible, since they typically show up as operating expenses and thus reduce what would otherwise be taxable agency profits.

Most agency-growth investments, such as producers, support staff and other sales-related expenses, are fully tax-deductible in the year they are made. Certain others, such as a new computer system or the purchase of a producers book of business, are tax-deductible over a period of years. In any case, unlike a 401(k), there is no annual contribution limit.

In addition to these annual “tax-deductible contributions,” the ultimate sale of an agencys stock triggers a capital gains tax rather than the ordinary income tax on a 401(k) distribution. Finally, there is absolutely no penalty for early withdrawal.

Given the recent bloodbath in the stock market, many investors are being forced to reset their expectations concerning how they save for retirement. They are searching for the ideal, tax-efficient, low-risk investment that has good return potential and does not have an $11,000 annual contribution limit.

Ideally, the investment would allow for huge contributions during good times, and little or no contributions during lean times. Finally, if times get really tough, it would be ideal to be able to liquidate without penalty a part of, or potentially all of, the investment.

Today, insurance agencies, after years of patiently enduring the scoffing of the “new economy” intelligentsia, might represent just such an investment.

Kevin Stipe is a senior vice president and principal of Reagan Consulting Inc., an Atlanta-based management consulting firm that developed and produces the “Best Practices Study” for the Independent Insurance Agents and Brokers of America. He may be reached at 404-233-5545, or by e-mail at Kevin@reaganconsulting.com.

Reproduced from National Underwriter Property & Casualty/Risk & Benefits Management Edition, August 5, 2002. Copyright 2002 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.

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