by Tom Doran, October 2006

National Underwriter

Having now completed the bulk of our client appraisal work for our clients this year, we can confirm what you probably already know - organic growth (i.e., growth excluding acquired revenue) is difficult to come by these days.  Single digit revenue growth is the norm.  This is borne out in our new 2006 Best Practices Study, which shows organic revenue growth of only 6.8% for the average Best Practices agency.  Current property and casualty market pricing, which shows no signs of improvement in the near future, combined with the ongoing questions regarding the long-term potential for contingent income, gives little hope that the prospects for organic revenue growth will improve in the short-term.    And yet, growth is essential to remain viable as a business.  What to do?

Given the need for growth and the challenges associated with organic growth in today's marketplace, many independent agents are venturing out into the M&A marketplace to acquire growth - most frequently with frustrating and unsuccessful results.  The reality is that the vast majority of independent agency buyers are effectively priced out of the M&A marketplace at this time.  The competitive pricing seen in the marketplace today is simply too high for most independent agency buyers.  How has this happened?

The first factor affecting agency values in the marketplace is basic supply and demand.  Supply is down, demand is up - all things being equal, this raises the cost of agencies being marketed.  The supply of high-quality insurance agencies available for sale is greatly diminished after an extended buying frenzy on the part of banks, national brokers, private-equity groups and large regional independents.  Many of those who remain independent have made a conscious decision to do so (with an eye for internal perpetuation) and are simply not for sale.  Demand, on the other hand, remains very, very strong.  In 1994, there were only three national agency buyers with significant acquisition activity.  Last year, we were able to identify over thirty buyers (including regional banks) competing for deals!  That's great news if you're a seller, not so great if you're competing for a limited supply of agencies available for purchase.

Another issue materially affecting agency purchase values involves recent valuations for the national brokers.  At the end of 2005, a sample of publicly-traded insurance brokers (Hub, Brown and Brown, HRH, Gallagher and Willis) had market values that averaged almost twelve times pre-tax cash-flow (or EBITDA, Earnings Before, Interest, Taxes, Depreciation and Amortization).  This means, on average, every dollar of EBITDA for this group of brokers translated into twelve dollars of value in their own stock values. 

Now, compare this to the average independent insurance agency whose value (assuming it's perpetuating internally) typically ranges from 5.5 - 6.5 times EBITDA.  If the investment community rewards the public brokers with double-digit valuations for each dollar of acquired EBITDA, why wouldn't they stretch and pay a premium to get the right deal done?   If I pay a 7 to 8 multiple for a dollar of EBITDA and my own valuation goes up by a multiple of eleven or twelve times for that same acquired dollar of EBITDA, I'll take that deal all day long. 

Unfortunately, this acquisition arbitrage opportunity does not exist for a privately-held buyer.  If you buy an agency whose actual economic value is simply the same 5.5 to 6.5 times EBITDA that your agency is probably worth and you pay 7 to 8 times EBITDA to get the deal done, guess what?  Your own agency value was just diluted.  You were better off before you did the deal.  If you have to pay 7 to 8 times EBITDA to get an asset worth 5.5 to 6.5 times EBITDA, is that typically going to be a smart decision?  Unfortunately, seller expectations, which reflect the higher multiples, make it very tough for independent agents to get deals done at reasonable prices.

For most independent agents and brokers, now is not the time to try to compete for agency purchases.     

If organic growth is anemic and acquired growth is too pricy, where does this leave the average independent agency?  Back to the basics - build on your ability to sell more insurance - focus on the development a significant sales culture.  If you're wondering whether your agency has a sales culture or even what a sales culture looks like, the 2006 Best Practices Study (available at www.reaganconsulting.com) provides some interesting benchmarks for you to consider.  The table below is a summary of new business results, by line of insurance, for validated (mature) producers for each of the Best Practices revenue categories.

These are results that are reflective of what a sales culture is able to produce.  How does your agency compare?  If your numbers exceed these (remembering the goal is to accelerate your own growth rates), then consider comparing yourself to the results achieved by the top 25% of agencies in the Best Practices Study (the best of the best).

To improve your existing sales culture, invest in the tools and resources that will enable your own producers to generate Best Practices-like (or better) new business results.  In addition, continue to invest heavily in the hiring and development of new, young producers. 

On that point, another interesting trend involves producer recruitment.  In the 2003 Best Practices Study, roughly 10.0% of new producer hires identified were from outside the insurance industry.  In 2006, this percentage jumped to over one-third.  Increasingly, agencies are seeking out sales talent from other industries.  The old adage "it's easier to teach a good salesperson insurance than it is to teach a good insurance person to sell" is beginning to have a real impact on our industry's recruiting practices. 

An increasing number of agencies, recognizing their limited ability to develop production talent, are targeting their recruiting efforts on companies with reputations for developing high-quality technical sales people (Xerox, P&G, Coke, Northwest Mutual, etc.).  Given the annuity-nature of producer compensation and the quality of life upgrade our industry generally provides, many salespeople with ever-increasing sales quotas and ever-shrinking territories are finding good homes in the independent insurance agency world.

Growth is essential to agency health, but for the average independent agency today, acquired growth is probably neither wise nor viable.  Although not nearly as sexy or exciting as "doing deals," the basic blocking and tackling activities associated with developing and enhancing a successful sales organization remain the best means to success as an independent agent.
 
Tom Doran (tom@reaganconsulting.com) is a Principal with Reagan Consulting, an Atlanta-based management consulting firm that serves the insurance distribution system.  Visit Reagan Consulting at www.reaganconsulting.com.