It is imperative for agency owners to watch and learn about major trends when they start. Following are the eight key trends that insurance agencies should be tracking for 2022.
1. Insurtech Technology
Insurance and technology are like oil and water, they don’t mix well. During the 1990s and 2000s, the industry was replete with reports that automation was going to change the business model. Things did change but the carriers were very slow to adapt and did so reluctantly.
For the last five or so years, reports indicated that the industry will be “disrupted” by insurtech. Young tech entrepreneurs were going to totally change how insurance is done and create a new business model that uses technology to cut costs, improve products, and improve the client’s experience. Well, the immovable object (the insurance industry) did meet the unstoppable force (insurtech) and the stodgy insurance industry is standing (relatively) still.
The heady days of new and disruptive insurtech startups is behind us. Many of the promising insurtech startups were based on “vaporware” meaning the main improvement offered was marketing or perception rather than a substantial business model improvement using technology.
Now that the dust has settled, the insurance industry and society, in general, are adopting technology as a part of the regular course of business. Pretty much everything is (or could be) cloud-based, and software is primarily mature and effective. The technology promises of the 1990s have arrived.
Carriers, which were very slow to adapt to automation in the past, are expected to quickly incorporate new technology to improve their business model. Machine learning and AI will sort through and analyze all the “big data,” which will improve underwriting and cut costs. Blockchain (or distributed ledger technology) will seep into how business is done and offer greater transparency and security. Integration between the insurance industry and the wider ecosystem through application programming interface (API) will improve data, cut costs and result in better results for all parties. These are all evolutionary changes.
If there is to be any “disruption” to the insurance industry from technology during 2022 and the next few years, it will be from technology changes to the world outside of insurance. For example, self-driving cars will change how auto liability insurance is handled. Technology such as sensors or artificial intelligence used in industrial equipment and consumer products will also change or shift the risk of losses. Healthcare insurance is also seeing many changes due to little things, such as fitness trackers, as well as big things, such as new surgical technology and telehealth.
2. Market Conditions
The current path shows hard market conditions to continue for early 2022 but conditions might change toward the second half of the year. The insurance market cycles between soft, or lower rates, and hard, or higher rates based on a variety of factors.
2021 saw an increase in losses for many lines, which drove rates up. In general, the frequency of losses was not up, but the severity (dollar amount) of the claims was the key driver. Natural disasters during 2021 played a role in the increases of losses. Societal factors (social inflation), such as more litigation and larger settlement values and judgment claims played another key role. The excess casualty insurers had significant losses during 2021. The market reacted to these losses by cutting capacity and raising rates.
Changes and new entrants to the market during 2021 are taking a foothold and this could mean the hard market trend will flip to a flat, or even a soft, market for many lines within one year. However, many industry experts see certain segments, such as cyber to continue seeing rate increases, driven by the increases in ransomware losses.
Carriers are being creative with underwriting and additional capacity is entering the market. Most likely the concern and impact from COVID-19 will stabilize during 2022 and the economy might chug along within an acceptable plus and minus bandwidth. Most of the trends right now appear to be favorable to bringing a higher level of certainty to the market. However, a few wildcards, such as inflation and political change, can rapidly change the situation.
The market rates seem to be splitting between the types of risk as carriers tighten up on underwriting. The better-quality risks will see low to moderate rate increases, whereas the more challenging risks will continue to see higher rate increases. This is especially true for umbrella, excess coverage, and homeowners. Basic homeowners coverage and auto liability (both personal and commercial) will most likely see modest rate increases. However, a catastrophe-exposed homes will see significant rate increases.
Workers’ compensation was the outlier with rates in many states dropping during 2021. Employees working remotely during the year seems to be a key factor with that rate trend, although the potential of COVID-19 related losses has created uncertainty in the market. It does appear rates will flatten out with some modest rate increases expected during 2022.
Trends and current conditions are indicating 2022 will bring some stability to the marketplace and lower rate increases for most insurance buyers. However, that position is very vulnerable to a significant swing if one or two variables change during the year. Less attractive risks will continue to be hit hard.
3. 2022 M&A Activity and Pricing
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. As long as insurance agencies remain profitable, there will be buyers.
What might put a damper on some of the acquisition activity, is the potential increase in federal taxes on the transaction that could occur as early as the first quarter of 2022, if President Biden has his way. (See the tax section of this article.) Inflation is also increasing greatly, which may put a damper on transactions occurring.
M&A activity is again expected to continue during 2022, according to our discussions with key acquirers. Here are some of their responses:
• According to Clark Wormer, M&A director for HUB International, HUB has brought on more than 70 merger partners in 2021 and hopes to continue this in 2022. HUB has “best-in-class tools, resources, expertise and technology,” which they believe merger partners are seeking.
•IMA is a newer buyer to the space over the past two years and this past year did a great job with some very astute acquisitions in California and Oregon. They closed nine transactions and expect to do several more in 2022.
•Inszone is very aggressive and is also a relatively new buyer on the scene. It acquired 25 to 30 firms in 2021 and anticipates doing 50 to 60 acquisitions in 2022.
•Foundation Risk Partners is a new buyer since November of 2017. This past year the firm made over 30 acquisitions and will continue that trend in 2022. The company is very competitive and easy to work with and brings some great synergies to acquired agencies.
•A nice mid-size national broker, Risk Strategies Company, based in Boston, closed 29 transactions in 2021, which was their biggest year of M&As. Risk Strategies expects to do quite a few more in 2022, but not at this same level due to inflationary pressures and some undisciplined competitor buyers out there. 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 based in Portland, Oregon; Phoenix, Arizona; St. Louis, Missouri; and now Philadelphia, Pennsylvania, which they would like to add to. They are also interested in expanding into new regions. They made 18 acquisitions in 2021 and plan on at least 12 in 2022.
•2021 was a record year for Acrisure. They also made further investments in technology, data analytics and AI to complement new verticals in Asset Management, Real Estate Services and Cyber Services. Acrisure completed 139 transactions in 2021 and saw revenues reach $3.3 billion. Management expects to do a similar number in 2022. By year end, Acrisure will have also completed three specialty wholesaler acquisitions.
•BroadStreet Partners, NFP, High Street and Alera, as well as other newer organizations, including World Insurance Associates, Relation 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% or more, which is greater than most other available investments today. Despite the pandemic, PE firms are often still paying typically eight to nine times EBITDA as down payments for a well-run agency.
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 3.25 times revenue. Most down payments are still about 80% to 90% of the price, with an earn-out over one to two years, especially now due to COVID.
Usually, 10% to 20% of transactions also allow sellers to obtain some of the acquirer’s stock upfront or on the earn-out. Sometimes the stock can be used for those perpetuation candidates that the seller and buyer want to remain to have equity. In this way, they feel a part of it and have some skin in the game to stay on over many years after the key owners retire.
Smaller books are purchased at around five to seven times EBITDA. However, there aren’t many books or agencies today that do not command at least two times revenues.
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 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 $5,000 in commission or even more 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.
4. Internal Perpetuation Can be Difficult
The terms for internal purchases are still typically 10% to 30% down, with the buy-out over five to 10 years. The number of years the purchase is paid out 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 they can manage the firm without the previous owner’s 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, and they often don’t have any money, or have very little money, to do a buy-out.
Often the retiring principal needs to finance the deal for the internal candidate. Oak & Associates highly recommends that the internal buyers get an SBA loan for 10 years, so the retiring shareholders don’t have to worry about getting paid.
It is also recommended that all owners of internal sales should look at whether a GRAT would work if the owners are still healthy. There is a minimum payout of five years but both principal and interest can be deducted.
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. If this is the case, an external sale makes a lot more sense.
5. Tax Law Changes Likely
With the Democrats now in control of Congress, there is no guarantee that the lower tax structure of the previous administration will continue. For agency owners, this also includes whether or not the capital gains tax will remain at its current low federal rate of 15% to 20% or change to perhaps 39.6%. What is proposed is that at a sale value of over $1 million, the capital gains rate is eliminated and instead a much higher ordinary income tax rate would be put in place, perhaps 39.6% versus the current 34.6% rate.
Many agencies that were concerned about higher taxes, insisted on selling in 2021 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 more than 16%.
In addition, personal income taxes, especially in the higher brackets, are predicted to rise substantially because of stimulus funding and now infrastructure packages that were approved.
6. COVID 19
The COVID-19 pandemic was the defining factor in 2020, and it continues to play a major role in 2021, largely due to the spread of the Delta variant. Now, with a new strain called the “Omicron” variant, it is likely that this will cause more fear among people to return to work, travel, socialize and remove their masks in 2022.
Many state orders that prohibited gatherings and forced nonessential businesses to close or switch to remote work, have eased. Companies had to comply with these orders while also trying to stay in business, keep their customers and workers safe, and avoid lawsuits. Not all of them succeeded.
Our nation has never experienced anything like the 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 it’s had on insureds. The key industries most affected have been restaurants, entertainment risks, schools and non-profits. Payrolls have been affected for several other types of clients.
If someone gets COVID at work, the legislators have now deemed this to be a workers’ compensation 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.
Those who refuse to get vaccinated continue to lose their jobs in many industries, such as in healthcare and education, as well as in large corporations. This may change on a state-by-state basis, which often is dictated by politics.
7. Natural Disasters’ Impact on Insurance
Natural disasters and severe weather are on the rise. Insurance companies tighten their underwriting and raise prices with disasters, whether it is fires in the Pacific Northwest and California, hurricanes in the Southeast, 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. But this has no longer been the case, many agencies get non-renewals on a monthly basis from some carriers.
Insurance agencies can help educate their clients on how they can mitigate risks to fires, floods, hurricanes and tornadoes. We advise agencies to review with the client the limitations of their current coverage and offer any new options available. People will still need insurance, despite the regular threat of natural disasters
Agents’ E&O exposure and coverage are at stake, so producers need to make sure the insureds know that the limits and coverages are not what they were with preferred carriers before.
8. Health Care Act Legislation
From a big picture perspective, not much changed during 2021 to the Affordable Care Act (ACA), although rules and limits were revised. Further tweaks to the rules will kick in during 2022, including a reversal of a few changes made during the Trump administration.
Changes include the cap to out-of-pocket expenses slightly increasing to $8,700 for a single person and $17,400 for a family. Open enrollment is extended to January 15 and special enrollment period eligibility terms will expand for people with life-changing events. For 2022, applicable large employer’s health coverage is considered affordable if the employee’s required contribution to the plan does not exceed 9.61% of the employee’s household income for the taxable year, which decreased from 9.83% for 2021.
Rules and regulations covering the ACA and the overall health insurance marketplaces/exchanges are updated. Some experts say that the update process for 2022 resulted in several favorable changes for consumers or rolled back proposed changes that would have negatively impacted consumers.
The impact of COVID-19 on health care will cascade into 2022 and beyond. Not only the direct impact due to the disease, but the postponement of treatment for other diseases will have an effect going forward. On the other hand, COVID-19 does significantly result in death of the elderly and those with significant co-morbidities, which will lessen the burden on the healthcare system in the short term.
The cost for health care in the United States crept up to about 18% of the economy in 2020, which has been a steady but small increase since 2005 when it was 16% of the economy. In 1960, healthcare costs accounted for approximately 5% of the U.S. economy. Healthcare costs going forward in 2022 will have several offsetting factors, such as lower costs due to the increase of telemedicine and higher costs for drug coverage. 2022 will be a year of re-alignment in the healthcare industry as the world moves past COVID-19.
Being proactive and knowing how current trends will affect the firm is the first step. Managing the agency in a way that exploits these trends will allow the firm to succeed. Agency owners also need to establish business and marketing plans to stay ahead of the competition. Oak & Associates’ website (www.oakandassociates.com) offers free downloadable Sales and Marketing or Business Planning templates for your use.
Was this article valuable?
Here are more articles you may enjoy.