Revenue growth and profitability are the two key drivers of value for independent agencies and brokerages–and in 2008, both were difficult to come by. But even though 2009 is not looking much better–thanks to the shrinking economy and persistently soft insurance market–there are ways for agents and brokers to hold the fort, protecting and even boosting the valuation of their firms going forward.
Looking back at why independent agencies and brokerages are struggling, an ongoing challenge hindering growth is the soft market–a major hurdle since 2004 that continues to put pressure on rates.
However, agents and brokers also had to deal with additional threats in a faltering economy. Agencies have seen some of their clients go out of business. Many others have struggled to stay afloat–as a result, reducing headcounts and exploring other ways to reduce costs. The resulting drop in insurable exposures has placed added pressure on agency revenue growth.
From a profitability perspective, the drop in revenue resulted in compressed margins. While many agents and brokers reacted by cutting personnel–their biggest expense–headcount reductions did not offset the revenue losses.
Besides, agents and brokers were forced to evaluate not only the financial implications of reducing headcounts but also the operational impacts. They did not want to cut staff to a level that undermined service to their clients–especially in the ultra-competitive environment that they found themselves in.
Additionally, many agents and brokers struggled to find the high quality personnel they currently employ and did not want to terminate those individuals, realizing such top-quality staff positioned them for future success.
As a result of these challenges, the average private firm in the "Reagan Value Index"–a large group of privately held independent agencies and brokerages for which Reagan Consulting performs an annual appraisal of fair market value–saw its stock value decrease approximately 1.0 percent versus 2007, the first drop since the inception of this index.
While on the surface this appears to be troubling, when compared to the public brokers (who saw their values decrease 10.2 percent in 2008) and the S&P 500 (which saw its value fall 38.5 percent last year), 2008 was not such a bad year for insurance agencies and brokerages. In fact, 2008 continued a long-running trend of the private brokers outperforming the public brokers and the S&P 500.
Many of the challenges that arose in 2008 have continued to evolve in 2009. In particular, the United States is still mired in a recession, and the soft market has continued, despite waning carrier profitability.
According to Reagan Consulting's "Organic Growth and Profitability Survey," the industry saw organic growth decline 0.1 percent in the first quarter of 2009, indicating that agents and brokers actually contracted in the first quarter.
To make matters more complex, there is a considerable amount of momentum in Washington for some sort of major health care reform. There are many different perspectives as to what the final reform will be, and we aren't likely to get clarity for several months.
That said, the pending legislation has the potential to cause some significant changes to the distribution of health insurance and substantially affect the revenues and profitability of agents and brokers doing substantial group benefits business.
As a result, from a valuation perspective, we expect the results in 2009 to be similar, if not worse, than the results from 2008.
While there are factors that could dramatically affect the second half of 2009 (see the financial collapse in the fall of 2008), we think the second half of 2009 looks much like the first half of the year.
In the difficult and uncertain environment that agents and brokers find themselves in, there are two primary actions they can undertake to protect their value.
1). Fanatical Attention to Performance:
Never before has fanatical attention to the financial performance of the agency been more important. This includes an intimate understanding of every facet of the agency's operations and the drivers of revenue and expenses.
Below are just a few questions for you to ponder:
o Are you making appropriate investments in young producers, the lifeblood of the agency's future growth?
o Are young producers being compensated correctly, and are they on a strict schedule to validate?
o Are you investing in areas of the business that will drive future growth, and are you evaluating the return those investments will generate?
o Do you know the true costs of your value-added services, and does your producer compensation model take into account those costs?
o Have you evaluated your fixed expenses and identified any "fat"–unnecessary expenses that do not create value?
o Do you understand how decreases in contingent income could affect your profitability?
2). Proactively Planning for Changes.
Changes to the health care system are almost certain. There is also a substantial amount of uncertainty surrounding the economy, not to mention the direction of property and casualty market pricing.
Agents and brokers must constantly keep up to date with the latest developments in the industry–as well as the implications for their business. More importantly, they should be developing a strategic plan to address the potential outcomes of the changes.
As an industry, we are fortunate that the challenges we face aren't nearly as significant as those confronting many others.
With that said, there are still serious challenges that must be managed to capitalize on the better times that will come. Note that during the last hard market, successful agents and brokers saw their value double over a four-year period.
Those that actively address the current market dynamics and the changes on the horizon are the ones that will be in the best position to capture the potential value increases when market conditions change.
Brian McNeely (Bmcneely@reaganconsulting.com) is a consultant and Angela Bemiss (Angi@reaganconsulting.com) is senior vice president at Reagan Consulting Inc., an Atlanta-based management consulting firm that developed and produces the "Independent Insurance Agents and Brokers of America Best Practices Study." More information about the firm can be found at www.reaganconsulting.com.
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