The insurance industry is so intertwined with the economy and society. Any noticeable change in either will have impacts on the insurance industry. There is nothing like what has occurred with COVID-19, and there is no exact end in sight. It is imperative for agency owners to watch and learn about major trends when they start. The following are the eight key trends that insurance agencies should be tracking for 2021.
With the current rollout of COVID-19 vaccinations, there is some hope that the nation may reopen someday. The pace is slow, and it may be the summer of 2021 through the end of the year before a majority receives vaccines for there to be what is called herd immunity. It’s not known when things will really be “normal” again.
Our nation has never experienced anything like these shutdowns, and our insurance industry has also been greatly impacted, not just by people not being able to go into work, but from the impact on the insureds. The key insured industries most affected have been restaurants, entertainment risks, schools and non-profits. Payrolls also have been affected for several other types of agency clients.
If someone gets COVID at work, legislators have now deemed this to be a workers’ comp claim, so there is coverage for those employees. This has made employers more cautious about workplace COVID standards and limiting the number of people allowed back to work.
According to the risk management consulting firm Millman, “several states enacted measures to increase the likelihood that workers’ compensation coverage would be available as a remedy to essential workers that get COVID. This has created significant exposure for work comp insurers, and great uncertainty for estimating reserves at year-end 2020, and for pricing policies covering 2021 exposures.”
What will all other effects be on insurance clients in 2021? It is hard to say.
Natural Disasters and Insurance
Insurance companies tighten their underwriting and raise prices with disasters, whether it is the recent fires in Oregon and California or the hurricanes on the Southeast coast, or tornadoes all over the Midwest and south. There are often non-renewals as well, and legislators don’t usually allow this without an adequate amount of time for non-renewal.
Insurance agencies don’t have a lot of clout to help resolve this problem at a high level, but they can help their own clients with a few small steps. Educating the client on how they can mitigate risks to fires, floods, hurricanes and tornadoes is very helpful. We also advise agencies to review with the client the limitations of their current coverage and then offer any new options available. People will still need insurance, despite the regular threat of natural disasters. So, agents will need to work with the way the system works now.
The California Fair plan and Lloyd’s of London coverage are at times all that is available for homeowners and some property risks in the fire zones, such as wineries in the Napa Valley. Producers need to make sure the insureds know that the limits and coverages are not what they were with preferred carriers, so the agency’s E&O exposure and coverage are not at stake. Signatures should be obtained from the insureds that they understand these limitations.
Health Care Act Legislation
Now, after the end of the Trump administration, there is still no major legislative change to the Affordable Care Act (ACA), but some changes did occur. The few executive actions that President Trump did take eliminated the reimbursement to health insurance companies that President Obama allowed via executive order. Any losses the companies face are no longer subsidized. Thus, the insurance companies increased their rates to cover previous losses in anticipation of these changes. Also, the 40% tax on high-cost employer plans (Cadillac tax) has been pushed out to 2022.
With the Democrats in charge of the House and now Senate, it is hard to predict what will happen.
The bottom line is that the major changes brought in by the ACA, such as accepting pre-existing conditions will remain, and only minor changes are likely to occur.
Employers are getting squeezed on the cost of health care. According to PricewaterhouseCoopers, health insurance premiums were expected to rise by 6% in 2020. Companies are taking a hard look at affordable options, such as high deductible health plans, which can be paired with health savings accounts. Telemedicine is also on the rise. This “virtual care” allows employees/patients to consult with a medical provider via a computer, smartphone or tablet, usually at a much lower cost.
First, most agencies offer insurance to their employees. Any changes to the Affordable Care Act or the cost of health care, in general, will affect the firm’s employee benefits expenses. Changes also impact those agencies that sell health insurance. It is possible that a change to the current system could affect premiums, commission rates and even the ability to sell health insurance.
The insurance industry seemed like a ripe target for new insurtech startups to disrupt the industry by cutting costs and generating profits for their new ideas. However, it seems the takeover is not quickly happening. The general industry model is time tested, the industry is highly regulated and the key players are well entrenched.
It seems that some insurtech firms are becoming more receptive to working within the systems, including working with agents, rather than finding ways to disrupt the system or eliminate agents.
The role of sales and service staff at insurance agencies was underestimated and consumers desire to speak to a human is still an important service, so insurtech is finding that low-hanging fruit is not easily replaced with an algorithm.
It seems like insurtech will make its way through the industry by improving current technology and developing new technology to handle old problems. For example, carriers are using AI to improving underwriting. Blockchain might be a good solution for claims and fraud detection, as well as to improve the reinsurance process.
Technology will change insurance. But right now, it seems like technology is improving the systems rather than reinventing them. Keep in mind that the use of technology outside of insurance will also impact the insurance industry. The best example would be self-driving cars, where the liability from an accident would shift from the driver to the manufacturer.
It is important to scratch the surface of the new insurtech firms to see if they are revolutionary or evolutionary. So far, it is the latter.
The current path shows a hard market for 2021. Both commercial and personal lines are seeing a hardening of the market. MarketScout reported that composite rates for commercial lines and personal lines rose 7.1% and 6.3%, respectively, in the fourth quarter of 2020.
The commercial lines coverages with the largest average rate increases were umbrella liability, professional lines, and directors and officers (D&O) liability. This might be the result of social inflation, which is increasing litigation, broader definitions of liability, and more plaintiff-friendly litigation. With the increase in ransomware, it is a good bet to expect cyber coverage to see rate increases. Deloitte is predicting that commercial auto rates will increase 8% and 15% due to social inflation and higher repair costs.
For personal lines, homes over $1 million in value had an average rate increase of 8.2%. One of the driving factors is losses due to brush fires in the West and hurricanes in the Southeast. Many of those houses were high-priced. In general, homes in those areas that experienced losses saw 20% to 30% rate increases.
COVID-19 has exacerbated and extended the hard market conditions. Interest rates near zero have drastically cut any investment return income that insurers have typically made. The industry is seeing significant COVID-related losses in D&O, employment practices liability insurance (EPLI), event cancellation, workers’ comp and other lines.
The traditional market cycle was the result of natural disasters, a lag in the correction of pricing, and reinsurance capacity. What seems to be happing now is more of an adjustment for systemic risk. Insurers are having difficulty replacing their capital because claims are getting bigger and coming in faster. At some point, if things work out as they did in the past, the new capital will flow in, and the cycle will move to a soft market. Look past 2021 for that to happen.
2020 M&A Activity, Pricing
Mergers and acquisition (M&A) activity is again expected to continue during 2021, according to discussions with key acquirers. The current prices paid by publicly traded brokers, large regionals, and agencies funded by private equity firms are already extremely high and will likely continue to be high for the valuable, desirable firms. Since the supply is dwindling, the prices may be even higher for those that remain if they fit the profiles of the key buyers today. There will be buyers as long as insurance agencies remain profitable.
In 2020, HUB acquired 65 North American firms with a combined aggregate revenue of more than $200 million. They target producer-focused organizations specializing in key industries, including real estate, construction, hospitality, and healthcare. In 2021, they are looking for organic growth with their acquisitions and are driven to deliver world-class service supported by client-focused resources and technologies.
During a global pandemic, Acrisure continued to have record-setting success. Acrisure completed 110 transactions in 2020, and management expects to do a similar number in 2021. Revenue also increased to over $2.1 billion. Acrisure also completed a transformational transaction with Tulco LLC by acquiring its insurance practice to bring data science, AI, and machine learning capabilities to the insurance brokerage industry.
Assured Partners is very competitive and closed 50 transactions this past year and expect to do the same next year. AssuredPartners is now at $1.7 billion in revenues. They have revenue earn-outs that are very attainable.
Foundation Risk Partners is a new buyer since November of 2017. This past year they made several acquisitions and will continue that trend in 2021. They are very competitive and easy to work with and bring some great synergies to acquired agencies.
Arthur J. Gallagher picked up their pace this year, especially in California. They will be aggressive nationwide and are especially looking for the right people to grow in areas they have not been in before.
Risk Strategies, based in Boston, closed 20 transactions, which was close to their biggest year, and expects to do about the same number in 2021. They are more selective in buying agencies with specific niches, like employee benefits, healthcare, real estate, and transportation agencies.
Another privately held broker we work with is Heffernan Insurance Brokers. Their main offices are in Portland, Phoenix, St. Louis, and Philadelphia now, and they are also interested in new regions. They made nine acquisitions in 2020 and plan on doing at least the same number in 2021.
InterWest, based in Sacramento, has averaged two transactions a year over the past four years. Their acquisition strategy seeks programs, talent, new or enhancing a territory, and a good cultural fit. They then look to invest, grow, and offer equity. Two transactions are expected for 2021 unless there are additional good opportunities, mainly in California and Nevada.
BroadStreet Partners, NFP, and new ones called World Insurance Associates, Relation Insurance Services, and Patriot Growth Insurance Services are funded by private equity and venture capitalists. They continue to aggressively solicit and buy independent agencies and have large amounts of capital to pay well.
Private equity firms have been buying up insurance agencies for their investors. This makes a lot of sense because the return on investment is typically 20% to 30% plus, which is greater than most other available investments today.
Despite the pandemic, private equity firms are often still paying typically eight to nine times EBITDA as down payments for a well-run agency. Smaller books are purchased at around five to seven times EBITDA.
In addition, there are usually earn-out bonuses that can also be significant as a multiple of EBITDA or topline. When the value is translated to a multiple of revenue, this means 2.5 to 3.0 times revenue. Sometimes the down payments require at least 10% to 25% of the acquirer’s stock. Most down payments are about 80% of the price, with an earn-out over one to two years, especially now due to COVID.
There will continue to be a price differential between those that receive offers from the well-funded buyers and those that sell internally or to local competitors. Local peer buyers and internal buyers cannot easily compete at these high prices and multiples since they usually need to pay out of cash flow.
However, some independents prefer not to
sell to a much larger, often publicly traded firm. There is often a sense of pressure to produce and write larger accounts.
In addition, producers in these acquired agencies usually have to write commercial lines and benefits accounts that are over $2,500 for some and $5,000 in commission for other acquirers in order to get paid.
On the other hand, there are other acquirers that leave the agency alone, except for providing markets, accounting, and HR support.
They don’t even change the seller’s name, such as Acrisure, Foundation Risk, and Broadstreet.
Sellers today still get prices from other peerindependents in the 1.5 to 2.25 times range, if there is at least close to a 25% to 30% profit margin. As a multiple of EBITDA (earnings before interest and depreciation), these values are in the six to seven times revenue range. In the earn-out portion of the price, the seller is expected to grow the business, not just maintain it. Terms based on future growth should be discounted when determining value based on cash today. So, if an agency receives 1.75 to 2.25 times revenue over time, like three to four years, this is actually a price closer to 1.3 to 1.6 times revenue today.
Internal Perpetuation Can be Difficult
It is often hard for small and medium sized independent agencies to perpetuate internally. The next generation often does not have the management and sales skills set to be able to retire the majority owner. In some cases, there are not perpetuation candidates at all.
The terms for internal purchases are still typically 10% to 25% down, with the buy-out over five to 10 years. The years it is paid out over depends on the agency’s cash flow and whether or not the internal buyer has any money of their own. An internal buy-out rarely has an earn-out component, so the value should be conservative, to not jeopardize the internal buyer being able to use the agency’s cash flow to pay the loan off over time. Buyers often want the retiring owners to move on after a few years, so then they can manage the firm without their influence and use their compensation and perks.
If an owner sells internally, it is usually for less than the value of an external sale. There is a risk that the internal candidates might not work out, nor do they often have the money to do a buy-out. Often the retiring principal needs to finance the deal for the internal candidate.
Tax Law Changes Likely
With the Democrats now in, there is no guarantee that the lower tax structure that President Trump put in place will continue. For agency owners, this also includes whether or not capital gains will be at their current low federal rate of 15% or is changed to perhaps 40%. Many agencies that were concerned about higher taxes with a new regime, sold in 2020 to avoid this concern. There is also a strong possibility that the state income tax rates are going up, such as in California with the move to over 16%. Personal income taxes, especially in the higher brackets, are predicted to rise substantially because of the stimulus packages that were approved.
Managing the agency in a way that exploits these trends will then allow the firm to succeed. Being proactive and knowing how current trends will affect the firm is the first step. Agency owners also need to establish business and marketing plans to stay ahead of the competition.
Visit Oak & Associates’ new website www.oakandassociates.com for a free download for a Sales and Marketing or Business Planning template, or to listen to two seminars titled “Perpetuation Planning” and “Pay for Performance.”
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