In a poem written 2,000 years ago by Horace, he used the phrase “carpe diem,” which is commonly translated as “seize the day.” Although interpretations of this phrase vary, one interpretation can mean to take action and not let time run out. Another way of saying this is to be proactive not reactive.
In order to be proactive, one needs to understand and exploit current and future trends. Most trends can be predicated by understanding recurring cycles and applying that knowledge to current situations.
So what will 2008 be like for insurance agents and brokers? The following is a list of major industry trends that need to be factored into the business plans of agents and brokers.
1. Soft Market Here for a While
The hard market was firmly in place from about 2000 through 2003. Prior to this, almost an entire generation had lived under soft market conditions! The current soft market has been in various lines in various regions for a number of years. It has finally hit most lines across the country in 2007 and it seems to have no real end in sight.
The market cycle (hard or soft) is primarily a function of insurance company profitability and investment risk willingness of the reinsurance market (capacity). When profits are low and perceived risk high (low capacity), insurance rates increase. This is a hard market. When profits are high and risk is low, premiums drop, which is a soft market.
The signals right now are somewhat mixed. Property/casualty insurance companies are doing well financially. The reinsurance market, however, is not clear in its direction. Capacity is there; it might just be a question of price for certain risks. So, it seems that the soft market will be around for another year, or more.
Agencies need to know that a soft market means a lot more work quoting, usually for less commission dollars due to lower premiums. In order to keep revenues up, agencies will need to sell more — either cross sell or to new customers. Value added services should be offered and a fee charged in order to increase revenue.
2. A Financial Squeeze
With the continuation of the current soft market in which the industry is deeply entrenched, profit margins will continue to drop for most agency owners. Other revenue sources are also threatened.
There has been a realignment of compensation to national brokers, which eventually will trickle down to the smaller independent agencies. Spitzer’s criticisms and actions resulted in many national brokers no longer receiving contingents. The impact was not too significant, since due to their size they were able to negotiate higher commission rates or some other sort of compensation.
The national brokers also charge fees for client services, such as for loss control, claims management, HR consulting or risk management. This is to add to the top line revenue beyond just sales commissions.
Independent agencies still have contingency agreements in most cases. Because the issue is not headlines in the news, it is not expected that this will change for a while. However, due to the push for national regulation, consumer disclosure, interest groups and the profit motivation of insurance companies, there is a strong potential that the contingency structure will change at some point. If it does, it is a good assumption that most carriers will make up the difference for the majority of the firms that represent them. This will be done through higher commission rates or other bonus plans arrangements.
In addition to adding new revenue streams, agencies will need to become more productive. This will be done through either automation or streamlining the work that is currently being done — or both. Paperless systems will be necessary. Insurance companies will be pressured to follow the lead from agencies and become more automated, as well.
3. Agency Ownership and M&As
A new twist in the M&A marketplace is that the national brokers are now focusing on the middle market arena and have specific capital to do so. Aside from Brown & Brown, which has been there already, the new players are Marsh, Gallagher and USI. These national brokers are acquiring merely to keep growing and adding volume. The pace is eventually unsustainable, but will continue through 2008. In fact, the reason they are in this arena is that the larger firms have already been bought up or do not intend to sell.
Today there is also a lot of capital still coming into the marketplace, via new brokerages starting up from players that have left agencies, especially those having sold to banks. These new buyers have the cash to pay sellers a large down payment and offer an earn-out based on performance or growth. Credit unions are another source of aggressive buyers active in the market.
Because of today’s well-capitalized buyers, the value of agencies has been climbing up. They are paying big bucks, so it is a good time to sell. However, there is also a big misunderstanding about what are the real prices being offered. Many of the deals have a sizable portion of the price based on earn-outs for future performance. This confuses the understanding of value on the marketplace, since value is usually based primarily on revenue that is already on the books.
Rumors of sellers getting prices from two to three times revenue are now common. First, these sellers are often well-run firms that are platform agencies for the buyer. Second, the earn-out portion of the price requires the seller to grow the business, not just maintain it. Terms based on future growth should be discounted when determined value based on cash today. So, an agency that gets two times revenue might end up with a price of 1.4 times revenue projected three years out.
The infusion of well-capitalized buyers is impacting the ability of smaller agencies to do acquisitions. Today, the short earn-out period and high prices being paid for agencies cannot be totally paid out of the net agency profits, or cash-flow. This is especially true since revenues have dropped due to the soft market conditions. Unless the smaller independent agency owner is wealthy or can get a loan, it will be difficult to match the price and terms of the aggressive, larger buyers. Therefore, smaller firms will be doing fewer acquisitions.
However, there will still be activity within the smaller agency community in the form of mergers. Small independent agencies merge today for the purpose of being a better firm, not just to be a bigger firm.
The goal of some of these new stronger brokerages is to become a local or regional force against the national brokers. There will be some attempts to bring enough brokerages together to go public or sell out to an interested deep pocket during the next year.
Baby boomers have now entered their sixties. This is a new tier of owners that need to retire, which will peak in the next five to 10 years. Because of the competitiveness in the marketplace it is getting difficult for smaller agencies to perpetuate internally. Often, it seems that the next generation does not have both the management and financial skills to pull it off. These are the firms that will either merge with a peer agency or sell to a large firm with deep pockets and a well-structured management team.
4. Support for the Small Agency
The network organizations, consolidators and clusters are becoming more and more popular, although this trend is a bit contradictory with the current soft market conditions.
Small firms cannot individually maintain the number of quality markets they need to compete today with larger firms. Consolidators, networks and clusters provide that service, so the agency can compete on equal footing with the big boys.
Clusters vary in size, style, capability and appearance. Generally speaking, the individual agency can maintain some, if not all their autonomy. These entities can also be a way for new people opening their own agencies to own their own firms. Some cluster organizations even provide perpetuation for their members within the group or umbrella entity.
However, the soft market will have a big impact on consolidators. With carriers dropping premiums, the agency itself might have a competitive market already and have no need for a consolidator with preferred markets.
5. The Producer Vacuum
Most agency owners will agree that it is very hard to find good, loyal, hard-working insurance producers. Producers who are available don’t produce. The ones who do produce are unaffordable or they want ownership in the agency.
Perpetuation plans are held in abeyance when it is hard to find these good producer players, especially with any management talent. The lack of good producers is a perennial problem and will remain so from now on. There needs to be a shift in perception for the traditional producer role to be split into a pure sales role and an account technical service role.
Many firms today are adopting the account manager (or account executive) role to ease the burden of the workloads of the owners and non-owner producers with large books. The account manager approach costs the agency less money and provides the service staff more room for advancement in the organization.
A Final Thought
These are some of the key trends that Oak & Associates predicts as being important for brokerage owners to pay attention to in the coming year. There may not be much an owner can do about the external threats to their agency. It is far easier to be proactive in the areas that are within one’s control. Understanding how current trends will affect the firm is the first step. Managing the agency in a way that exploits these trends will then allow the firm to succeed. So, go out and seize the day!