Sept. 11 Impact Affects Agency M&A Opportunities

The problems created by the marketplace for agencies are rooted in the significant work needed to find replacement coverages with adequate limits and appropriate coverages while trying to control consumer costs. The re-marketing activities, coverage analysis and comparisons, and the search for alternative risk financing solutions has resulted in a significant increase in the workload at the typical agency.

The opportunities are created by the enhancement of income from selling commissionable products at higher prices. The enhanced commission income may provide the cash flow needed to fix problems that have gone un-addressed by many agencies, including hiring new producers, buying new technology or upgrading office space. These changes could also positively impact the profitability of an agency, which increases the attractiveness of the agency to a third-party buyer.

Will these problems and opportunities result in an increase in the level of M&A activity, or serve as red flags to buyers to delay or abandon an acquisition strategy? Lets first look at the historical motivation of buyers and sellers and draw some conclusions about the future.

The buyers of agencies have generally fallen into three broad categories:

Banks, which are attempting to diversify their sources of income and product offerings.

National brokers, which are using acquisitions as a way to enter new geographic areas, achieve economic efficiency by combining offices or gain expertise that can be franchised throughout the brokers organization.

Regional agencies and brokerages, which are using acquisitions to enter new areas or as a basis to grow to a sufficient size to ensure long-term viability with clients and carriers.

Considering potential bank M&A opportunities first, the stock price and market capitalization of many banks have suffered significantly over the last 12 months with the softening economy and the reduction in interest rates. The soft economy has reinforced the need for banks to diversify revenue sources.

But the economy has also depressed the primary currency banks have used to buy agencies–their stock. Banks that were trading at about 18 times their earnings a year ago are now trading at 13-14 times earnings. The consequence of this is that to achieve the same valuation, significantly more shares of bank stock must be offered for the agency shares to achieve the same valuation.

Bank CFOs are reluctant to offer deflated currency when they believe the price will recover in a short period. Bank senior management is also being pulled away from ancillary business activities–such as insurance–to refocus on the core business, which is banking.

The net impact of these changes for bank buyers will vary from bank to bank. Most will continue as active acquirers of independent agencies, even if there is a short lull in the pace of activity. If there is a lull, it will be because banks elect to focus on their core business while letting the rapid changes taking place in the insurance business to settle down.

During the time that the stock price of banks has generally gone down, the stock price and market capitalization of the public insurance brokerages–especially those that are active acquirers of agencies–have gone up significantly. Brown & Brown, HRH and Gallagher have all enjoyed huge increases in their market capitalizations since Jan. 1. During the same period, the S&P 500 has decreased almost 20 percent.

While some of these increases in the public brokerage valuations are attributable to the management skills of the officers of these companies, it is clear that investors believe that the insurance price increases and the revenue increases to the brokers will more than offset the reduction in payroll, receipts and values that are a reflection of a soft economy.

Many of the publicly-held brokers have used their enhanced currency (their stock), as well as the reaction of investors to acquire quality agencies. But with the positive motivation to pursue acquisitions, public brokers appear to be more selective in the firms they are acquiring, recognizing that a failed acquisition of any size will impact their share price.

Many of the same factors affecting the public brokers are also having an impact on regional brokers. There will be a clear revenue lift due to insurance pricing increases. But the regional brokers (which do not have a stock currency for acquisitions that can be valued daily in a public market) will not enjoy the immediate enhancement of their stock as these firms are generally valued on an annual basis and their stock is not as "liquid" as the stock of banks or public brokers.

However, regional brokers remain a good alternative for many sellers. Some selling agencies do not have the type of operations that will result in a successful bank-owned agency. Some are not willing to give up the autonomy that the public brokers often require. Others may believe that while they need to join a larger firm to gain access to carriers, they are not ready to "sell out."

The regional broker can be a good way for the seller to ensure access to insurance carriers while maintaining their private ownership.

So if these are the changes that are taking place with the buyers, what is going on with the sellers?

All businesses go through a predictable life cycle that include addressing the succession of ownership. In 2000 and 2001, many agency principals accelerated their plans for the sale of the business because the valuation of the agencies, expressed as a multiple of revenues and earnings, reached 15-year highs.

A recent study by the Washington-based American Bankers Insurance Association in conjunction with Reagan Consulting reported that of the acquisitions by banks in the prior 12 months, 63 percent were completed at revenue multiples of 1.50 times revenue or more, and 27 percent were completed at multiples of twice revenues or higher. Pricing at these levels have compelled agency owners to sell their business.

At the same time as valuations reached record levels, the formation of new independent agencies has reached record highs as well. A recent study by the Alexandria, Va.-based Independent Insurance Agents of America suggests that as many as 15 percent of the agencies that exist today have been formed since 1995. These statistics indicate a reversal of a trend that had showed a decrease in the number of independent agencies nationwide.

The recently completed "Best Practices" results (available online at www.reaganconsulting.com) completed annually by the Independent Insurance Agents of America, shows that Best Practices agencies enjoyed significant increases in revenues, profits and productivity in 2000. In addition, interim numbers compiled by Reagan Consulting indicate that this trend will continue through 2001.

The summary results are simple: good agencies are working harder, are more productive, have better growth and better profitability than any time in recent history. These factors will result in one quantifiable outcome–greater value.

So what does the future hold for the buyers and sellers of independent agencies? All buyers of agencies–whether publicly traded banks, public brokers or privately owned regional brokers–are earnings-sensitive buyers. This means that selling agencies have to deliver to the buyer predictable revenues and earnings that will grow over time. Those organizations capable of achieving growth in revenues and earnings will achieve the greatest valuation.

Finally, whether a particular agency is considering selling in the next 12 months or never, this market creates great opportunities to reinvest in your business. Agency principals should take great confidence in the value of growth oriented, profitable agencies.

Now is the time to be adding new producers to the sales force, to make significant upgrades to your automation, to increase the quality of your staff, and to consolidate premium volume with companies critical to your long-term success.

If independent agents take advantage of this unique opportunity, they can ensure their viability for years to come.

Robert C. Smith is senior vice president at Reagan Consulting, Inc., an Atlanta-based management consulting firm working with insurance agents, brokers and companies. Reagan developed and produces the Independent Insurance Agents of America "Best Practices" study.

Reproduced from National Underwriter Property & Casualty/Risk & Benefits Management Edition, November 19, 2001. Copyright 2001 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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