by Kevin Stipe, June 2005

National Underwriter

Ten years ago, the upper end of the valuation range for top-performing agencies was 1.5 times revenue.  Today the upper end has increased to 2.0 times revenue, and even occasionally higher.  Why have agency values, expressed as a multiple of revenue, increased in many cases by 33% or more? 

There are two basic reasons agency values have increased so dramatically:

1. Demand for agency acquisitions is stronger than it has ever been, due to the all-time high number of public brokers, banks and others competing for acquisitions.

2. Driven by increases in employee productivity, many agencies are far more profitable today than they were a decade ago.

Last month, Bobby Reagan addressed the issue of "demand for acquisitions" in an article on these pages titled "Supply and Demand Trumps All Other Factors" (see June 20th issue of NU).  The bottom line on the "demand" side: In 1994, a tiny number of publicly-traded acquirers competed for agency acquisitions.  Over the past decade the number of publicly traded acquirers has exploded nearly ten-fold!  This is important because publicly traded acquirers frequently have such a competitive advantage in doing acquisitions - their capital base is often so much stronger than that of privately held acquirers.  The increase in agency values is not surprising given the record number of well-equipped acquirers competing for acquisitions.
 
Nevertheless, while acquisition demand frequently grabs the headlines, it is only part of the reason why values have escalated so dramatically.  We would argue that an equally important driver of growth in agency values over the past decade has been the stunning improvement in agency profitability.

Many have forgotten how bleak the world looked for agency owners a decade ago.  The viability of the independent agent distribution model was in doubt.  The Wall Street Journal, in a front page article in 1995, captured the concerns of the day by quoting one industry observer who argued that insurance agents were "the buggy-whip makers" of the late 20th century.

In fact, it was a crisis in agency values that led to the joint development of the Best Practices Study ("BPS") by the IIAA and Reagan Consulting in 1993.  The time-honored benchmark for agency valuation of 1.5 times annual revenue was in a state of serious decline, due to weak agency profits and slow revenue growth.  The typical agency's value had fallen closer to 1.0 times revenue, with only the highest quality agencies worth 1.5 times.  The BPS was created to be a tool to help agency owners reverse the downward trend.

We take great satisfaction in the belief that the Best Practices Study has contributed to the progress that has been made in agency performance over the past decade.  A comparison between the 1994 and 2004 Best Practices Studies provides a stunning picture of how much improvement has actually occurred.  To illustrate this progress, some key performance benchmarks for the $2.5 million - $5.0 million revenue study group are provided in the table below.
 

From a valuation stand-point, the dramatic increase in agency values makes sense when we see that pro forma EBITDA - the most important variable in determining agency value - has increased from 17.8% to 29.5% of agency revenue over the past decade.  ("EBITDA" is Earnings Before Interest, Taxes, Depreciation and Amortization.  In the Best Practices Study, Pro Forma EBITDA is calculated by taking reported EBITDA and adding to it owner bonuses and perks.) 

In trying to understand why agency values have increased, one needs to look no further than the increase in EBITDA to 29.5% of revenue.  Why?  Because agency buyers (whether they are employees or an outside 3rd party) determine an agency's value based on its expected future profits.  Generally speaking, the higher the expected future profits, the higher the value.

Why has EBITDA increased so dramatically?  It's all about employee productivity.  Top performers over the past decade have increased their revenue per employee from $73,563 in 1994 to $136,369 in 2004, an increase of over 85%.  The implications of this are staggering.  Consider this: A $3.7 million revenue agency in 1994 needed 50 employees to operate.  Today, that same agency needs only 27.  This is not your father's agency!

This increase in employee productivity has fueled expense reductions nearly across the board, since nearly all of an insurance agency's expenses are head-count related.  As just one example, occupancy expense (i.e. rent & utilities) for BPS agencies in 1994 averaged 6.3% of revenue.  Those agencies needed a lot of space for those 50 employees!  By 2004, the figure had dropped to 3.6% of revenue.  That means for our hypothetical $3.7 million revenue agency, occupancy expense has decreased by $100,000.  And it isn't just occupancy expense - telephone, postage, office supplies, equipment costs - they've all decreased.

One might be tempted to feel sorry for the 27 employees - after all they are the ones upon whom the burden of juicing up profits has fallen, right?  Well, yes and no.  Certainly their efforts have driven the increase in profitability.  But they have been compensated well for the effort.  The fact is the vast majority of the savings derived from carrying a lower number of employees has been reinvested in those who remain.  A statistic might help - average compensation per employee has risen by 72.3% since 1994.  The total compensation dollars haven't changed much - they've simply been spread over a smaller, but more productive group of employees.

What are the implications of this going forward?  Unleashing employee productivity has been a key driver of agency value growth over the past decade, and will continue to be so.  Does your agency have a strategy for increasing productivity?  In our experience, it all starts with your producers.  If you've developed a sales culture in which your producers are relentlessly building (not simply maintaining) their portfolio of customers, then employee productivity will inevitably follow.  And growth in your agency's value won't be far behind.
 

Kevin Stipe is a senior vice president and principal of Reagan Consulting, Inc., an Atlanta-based management consulting firm that developed and produces the "Independent Insurance Agents and Brokers of America Best Practices Study."  The Best Practices Study may be accessed free of charge at Reagan Consulting's website www.reaganconsulting.com.  Kevin may be reached at (404) 233-5545 or by email at Kevin@reaganconsulting.com.