Can you remember a year that started with more uncertainty forproperty-casualty insurance agents and brokers than 2008?

Certainly 2005 qualifies, since the crusade by EliotSpitzer--then New York's attorney general, and now its governor--toexpose bid-rigging and contingency fee abuse by major brokeragesand their carriers was in full force, and the resulting fallout wasstill being assessed.

But for my money, 2008 wins the uncertainty prize.

The Council of Insurance Agents and Brokers recently reported intheir quarterly survey that the third quarter of 2007 was the worstquarter yet in our now four-year-old softening property-casualtymarket.

Even worse, the Insurance Information Institute recentlyforecast that 2008 will be the toughest pricing environment for theindustry (personal and commercial lines) in 65 years!

And if that's not enough, the presidential election this fall isthe most wide-open race in more than a generation, with neitherparty fielding a clear favorite.

Of course, such uncertainty is even more troubling for thoseagencies and brokerages considering an even bigger but morepersonal change in the year ahead--a merger or acquisition. Howmight the concerns cited here and other potential problems impactthe M&A environment?

Questions about M&As always begin with pricing. From ourvantage point, agency acquisition pricing is holding steady atrecent historically high levels.

Despite the fact that 2007 was the worst for public brokeragestocks in over 15 years, public brokers are still hungry foracquisitions and are willing to pay a premium for key targets.

Banks also remain active, despite the fact that their stockswere clobbered in 2007 by fallout from the subprime fiasco.

Multiples of EBITDA (Earnings Before Interest, Taxes,Depreciation and Amortization) being delivered by buyers stillrange from 6.5-to-9.0 for most deals, with 75-to-80 percent of thatguaranteed, and the balance deliverable in the form of an"earn-out"--typically payable after one-to-three years if theseller hits certain performance targets.

Notably, given the soft pricing of the p-c market--and theresulting growth challenges faced by agents and brokers--certainbuyers have recently been structuring their deals with slightlylower earn-out performance targets than in the past.

Perhaps it seems counterintuitive, but buyers want sellers toearn significant earn-out dollars. Why?

An attainable earn-out is a tool used by buyers to keep aseller's head in the game after the deal. If earn-out targets areset too high, they can potentially lose their motivational impacton seller behavior.

So, in today's soft market, single-digit annual growth during anearn-out will earn a seller more money than it would have in pastyears.

Here are the key issues we see driving M&A premiums in2008.

o A sales culture is the most valuable attribute an agency canpossess.

Everybody in the industry is struggling to grow organically. In2007, the public brokers' nonacquisition growth rates averaged onlyabout 2.8 percent, marking the fourth-consecutive year in whichorganic growth averaged 5 percent or less.

I suppose 2.8 percent sounds horrible--until you consider thatcommercial p-c premiums contracted industrywide by more than 10percent in 2007!

Since agencies with a true sales culture find a way to grow evenin the worst of markets, they consistently command the highestvaluation multiples in the marketplace. Investors demand growth,and will do what it takes to acquire firms that can grow regardlessof market conditions.

o Profit margins are key--the higher, the better!

Buyers are hungrier for high-margin business than at any time inhistory. Does this sound like an overstatement?

The fact is, with each passing quarter, today's brokers mustdefend their performance to an audience of Wall Street analysts--ormore recently, as in the case of USI and Hub, their private-equityinvestors.

In our information-rich society, investors are armed with morecomparative data than ever before. The result is that brokermanagement teams find themselves explaining, over and over, whythey can't produce margins anywhere near the 38.7 percent EBITDAmargin generated by industry leader Brown & Brown.

Well, adding a low-margin acquisition certainly doesn't helptheir cause!

What does this mean in practical terms?

Some buyers aren't even interested in a stand-alone acquisitionthat cannot generate a 25 percent EBITDA margin following thedeal's closing. They'd prefer 30 percent or higher if possible--andcan sometimes get significantly higher than that if they canconsolidate the seller's operations.

Moreover, in the past, buyers typically refused to pay high-endEBITDA multiples for high-margin agencies, believing that highmargins couldn't be sustained. Today, this is no longer thecase.

Buyers seem to perceive less risk in high-margin agencies thanin low-margin ones, perhaps because they believe the stepsnecessary to reform a low-margin agency will create an employeemorale crisis after an M&A closing.

o Specialty business is king.

Our industry has for many years been in the midst of a long-termtrend toward client-type specialization. Savvy agents havecapitalized on this trend by focusing on a particular industry andthen delivering customized knowledge, service and products tocustomers within that niche.

Agents have been richly rewarded for their specialization.They've achieved higher hit ratios on new business, had betteraccount retention on renewals, and often generated higher profitsin their specialty business than in their general business.

But since this has been going on for years, you might ask,what's newsworthy about it?

What is newsworthy is how much more buyers are willing to payfor specialty business than general business. By our calculations,a block of specialty business is frequently valued at 25-to-50percent more than a comparably sized block of general business,since it is more profitable and can be projected to grow morequickly.

o Location, location, location!

National insurance brokerage buyers care more about geographythan you might think. As acquisition opportunities presentthemselves, buyers must continually ask the question: In whatgeographies can we grow our business the fastest?

From an investment standpoint, aside from those places they'vestrategically targeted for expansion, brokers normally want tofocus their growth investments in places where demographics aremoving in a favorable direction.

Over the past generation, there have been two major populationshifts going on in the United States. First, there has been acontinued flow of people to the big cities from rural areas.Second, there has been a steady migration south and west.

Contrasting Electoral College maps of 1960 and 2004 shows astartling increase in the influence of California, Florida andTexas over the past 44 years. It is no secret those states (andthose around them) have been hotbeds of acquisition activity inrecent years--and this trend shows no signs of abating.

What does all of this mean? Check the infographic accompanyingthis story for our predictions. But the bottom line, as always, isthat the top-performing agencies and brokerages--those that adoptbest practices--will come out on top in any M&A deal.

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