Perpetuation Planning: No Time Like The Present

Perpetuation Planning: No Time Like The Present

All signs indicate that commercial property-casualty insurance is moving away from the hard market of recent years and toward moderation. Experienced agents might be asking, “Is now a good time to begin my perpetuation plan?”

The answer hinges on what the agent wants their perpetuation plan to look like and how quickly they want it to happen, consultants say.

The moderating market could impact revenues and thereby decrease the value of the agency, affecting a decision to sell outright. But for the owner looking to continue the agency and ease out of the picture with a stock retirement portfolio, market conditions are less of a concern than making sure that good planning is set in motion years ahead of retirement.

“Changes in the market cycle do affect an agency in terms of pricing,” said Shirley Lukens, senior vice president and partner of Reagan Consulting, based in Atlanta. “In a hard market cash flow increases and that does make it difficult to put a price on” an agency for someone who is looking to sell the agency.

However, a well-run agency puts itself in a league of its own, unaffected by market conditions.

“The opportunity never passes for a good agency,” noted Ms. Lukens. “If an agency is well run, and continuously enhanced through good management that returns profits to the agency, then there is never a bad time.”

She added that “someone always wants to get their hands on a good agency. Banks and regional brokers always want to buy such agencies.”

The primary reason that a bank or broker makes an acquisition is because the agency fits into its expansion plans. A top-flight agency can get a premium price because “there is a real shortage of really good, well run agencies,” Ms. Lukens said.

However, for the average agency, she continued, the market cycle can have a negative impact because its value has declined. It is a missed selling opportunity, she admitted.

During the hard market, “an average producer may feel it is a great time to hold onto the agency,” she noted. “During the soft market, the producer might begin to think about selling,” she said, adding that the agency lost value because it failed to make the necessary reinvestments while it was flush with cash during the hard market.

The good agency, and the good agency owner, is someone who, during the better market cycle, has returned the extra profits into the agency, investing to improve the agency with an eye toward internal perpetuation. The best perpetuation plans, the consultants note, involve years of planning and working toward perpetuation, no matter what the market is doing.

“You should never wait to plan,” said Al Diamond, president of Agency Consulting Group Inc., based in Cherry Hill, N.J. “Unfortunately, some owners feel that formal planning is not worthwhile. They don't want to survey the forest; they just want to cut down the trees.”

A perpetuation plan should be started three-to-five years before the agent is looking to retire, he said. Agents who look to retire in less than a year usually end up selling their agency or merging with another agency, which normally entails the seller staying on for an extra year to supervise the transition.

“Whenever there is a transition in the marketplace from one cycle to another,a certain number of agents throw up their hands and say, 'I'm getting out,'” Mr. Diamond said. “When agents are in the throes of the hard or soft market, there is less [merger and acquisition] activity than at changeover of either” cycle.

However, if an agent does have internal perpetuation plans, a softening cycle, bringing less profit to the agency, could have an effect on the planning, noted Albert Lloyd, senior vice president at Marsh, Berry & Company Inc., the management consulting firm based in Concord, Ohio.

“In the context of market softening, you have the same amount of expenses, but profits are down,” he observed. “This profit squeeze makes a lesser balance sheet, and this does not allow an agency to go out and get better producers, which is a prime ingredient to any perpetuation plan.”

But it does not mean the plan won't work, so long as the principal remains committed to it, he continued.

“It's a process, not a transaction,” he advised, adding that in bringing in new people, the principal must teach them how to run the agency, which takes time.

Bringing new blood into the agency also gives the principal more options, he continued. The principal can look to sell the agency to the new producer, at some point, or sell it outright.

New talent can help to increase the agency's value “because to an outside buyer, they can see more worth in an organization because it has the people there,” he said. “Either way, it helps enhance the value of the owner's stock.”

One problem with internal perpetuation planning, he admitted, is that principals are having trouble finding new talent.

“That is why a lot of acquisitions are taking place?because they can't find people to buy them out,” Mr. Lloyd said.

David Bauer, principal of Capital Bauer Insurance in Albany, N.Y., merged his agency in 2003 with the focus on the future. In his case, his partners are older and were looking for younger blood to come into the agency.

Today, the firm has commission revenue of $5.2 million and employs 33 people. The agency deals in personal and commercial lines insurance, employee benefits and a small amount of financial services.

“We are looking for organic growth and to make acquisitions regionally,” he said. “And we are looking for talent,” he added, noting that talented individuals can be 20, 30, 40 or 50 years old. “We are looking to build a sales organization and to build with more sales individuals. We are also looking to diversify our lines.”

As for the market cycle, he noted, it is not significant other than to ask oneself, “Do we have enough market to satisfy our clientele, and will we be a viable organization 10-to-20 years from now? You have to get rid of your shortsightedness and ask yourself those questions.”

Mr. Bauer said he remains concerned about finding the people to keep the agency going in the future. Companies are not bringing new people into the insurance industry as they merge and trim their ranks, and that is causing problems for independent agents and brokers to recruit a new sales force, he said.

“The magic bullet is to find individuals in their early 30s who are committed to this business and are looking for equity ownership,” he noted.

“There is no recruitment from the carriers. That stopped about 12 years ago. There's a vacuum right now that needs to be filled.”

“All agencies, regardless of size, are looking for perpetuation answers,” he observed. In “the next five-to-ten years, it will be interesting to see where we will pull these individuals from. It is going to be a challenge,” he said.

Reproduced from National Underwriter Edition, May 28, 2004. Copyright 2004 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.