With a declining economy, agency owners thinking about getting out of the insurance industry or taking a smaller role in operations should consider streamlining their businesses to get the most out of their investment.

Wayne A. Walkotten

In these changing times, insurance industry experts say agency owners can maintain an agency’s value so it appears more attractive to potential buyers, whether ready to sell now or preparing for the future.

Well-run agencies, characterized by sound long-term business plans, strong growth cultures, differentiation platforms, and strong operating profitability, will be able to withstand the current economic climate, but those agencies void of the above and unwilling to make the necessary changes will not be as well-received in the market, according to a MarshBerry report published last year.

“In agencies where performance is dictated primarily by external market conditions such as rate, buy-side demand and the overall economy, value will decline,” John M. Wepler, president of the firm, and Patrick T. Linnert, executive vice president, wrote in the report.

Wayne A. Walkotten, a senior vice president for Marsh, Berry & Co. Inc., told IFAwebnews.com that agencies with more than $3 million in revenue are better positioned because they generally have enough volume to keep the insurance companies reasonably satisfied, “as long as they grow some depth of products and services to offer consumers and the financial wherewithal to weather tough economic times.” In the current economic climate, he said, growth will depend completely on new relationships, as most business risks are shrinking.

He noted that agencies of all sizes are dealing with several obstacles, including the recession and soft market, which are eroding their value, revenue stream and contingent income.

“Agencies that are not well-run are already seeing their values fall, as top-line revenue declines, combined with increasing expenses, pressure bottom line margins,” Walkotten said. “Last year saw the worst organic growth rates and profitability percentages in a decade.”

Health agencies sell for more than property-casualty agencies, he said, in large part because buyers can bank on consistent rate increases. The recession is leading to higher unemployment, which is deteriorating the number of lives enrolled in many groups.

When to sell

The issue of when to sell an agency is not set in stone and relies on multiple factors, according to experts.

Walkotten said ideally, agency owners “who are not committed to an organic growth strategy” should think about putting their businesses on the market sooner, rather than later, because there could be several more years of erosion before the market conditions get better.

The economic obstacles might be too difficult to overcome for the average agent and some are asking how long to ride it out, Walkotten said.

“At the same time, those agencies both willing and able to make institutional changes are well positioned to control their own future and maximize returns by remaining independent,” he added.

Val Teagarden, president and CEO for Oakland, Md.-based First United Insurance Group, said she thinks “we’ll see a flat-line economically.”

“I’d say we’ll be back to a hard market soon, so unless a seller needs to get out because of health reasons, for example, they will hold off on selling until the hard market,” she said. “Each situation is different depending on the owner.”

First United acquired two Cumberland, Md. agencies in 2007, and bought three more West Virginia agencies at the end of 2008 with hopes for more acquisitions this year.

Brown & Brown, which has bought agencies across the U.S., bought 11 agencies in the third quarter of 2008, part of 44 acquisitions last year, for $99.6 million in forward revenues. The average size of the transaction in 2008 was about $3.2 million versus $4 million in 2007, with the firm noting it purchased more “fold-in” opportunities, consolidating offices in the same community, last year, according to the company.

Jim Henderson, Brown & Brown’s vice chairman and chief operating officer, said in an earnings conference call last fall that “this is the best of times” for the merger and acquisition environment for two reasons.

“Number one, we have an ample supply of motivated sellers,” he said. “And number two, we are purchasing revenues at a lower point in insurance market cycle compared to higher rates. We will continue to exercise our disciplined approach.”

Key characteristics

Among a key characteristic in weighing a merger partner, Teagarden said, is succession planning.

“If someone selling is not staying on board, is there someone to grow the agency or do we need to go out and find someone? Keeping talent and experience is a key,” she said.
Technology is also key, she said, as “it is much better to have an agency system.”
“If there is not a management system, you need to get on one, because that’s time and money to set-up [for a buyer],” she advised.

When weighing a potential acquisition, Teagarden added that the potential buyer looks at its return on investment and return on revenue as well as a percentage the bank wants them to hold to along with income as a percentage of gross revenue.

“We see what we feel the ability to grow the agency is and what that capability of growth is,” she said.

As for setting a price, Teagarden said First United does three different analyses and sits with the owner for discussions on a fair value.

“I’ve heard some say ‘two times the book value’ is the price, but we figure earnings before interest, taxes, depreciation and amortization,” she said.  “It’s really tough.”

David King, president of Horst Insurance of Lancaster, Pa., bought 11 agencies in the last 10 years, after talking to about 30 possible acquisition targets. Key reasons for the termination of discussions are a lack of “a cultural fit” and a “bidding war possibility,” he said.

King said he favors “one-on-one discussion situations,” where the agency principals and he meet to determine how it will benefit consumers, staff and principals.

King said banks are taking a wait-and-see approach toward how insurance premiums will go, affecting their revenues from the non-interest income provided by banks’ insurance operations. “The day of the banks paying big money for an agency are gone,” King said.

This story originally appeared in the April 2009 print edition of Insurance & Financial Advisor.