To prepare for the future, business owners need to observe what trends are occurring and then evaluate how those trends could impact their business. It is a guessing game, but an educated guess is usually proven to be better than a random guess, or no action at all.
The insurance industry is so intertwined into the economy and society that just about any noticeable change in either will have some impact for the insurance industry. For the insurance agency, much of what affects the business has external origins. Agencies are not in charge of regulations, government policies, technology, actuarial analysis, consumer demands, etc.
That is why it is imperative for agency owners to watch and learn about major trends when they start. Those that start adapting quickly will usually be in a better position than those that do nothing.
The trends discussed in this article can impact agencies at the macro level, the micro level or both. The macro level includes changes that start outside the agency and then trickle down somehow to the agency itself. Micro level changes are seen immediately in the agency. Below are the six key trends insurance agencies should be tracking for 2018.
Policies and Legislation
The two biggest federal policies and the most discussed issues are healthcare and taxes. Surprisingly, one year into the Trump administration, there has been no definitive legislation on either of these. Even the policy approach has been modified over time, especially toward the Affordable Care Act. The “repeal and replace” movement has been muted with a plan in the house. As of the writing of this article, tax reform/legislation has been proposed but not yet voted on.
From the insurance agency perspective, tax reform will have its initial and perhaps biggest impact directly on owners’ and employees’ personal income taxes. This includes any changes to corporate taxes since most agencies are privately held. There will be a cascading effect across the economy, but this won’t happen right away; it will take time to develop and will be broad in scope.
The current approach in the proposed legislation is to reduce corporate taxes and then offset that with the elimination of some deductions. The range of personal tax rates might be the about same, however, the number of brackets would be reduced. The intent is to grow the economy by incentivizing businesses with a lower tax rate. Many agencies tend to be S-corporations and LLCs, which are often “pass through” entities, meaning the business taxes flow through the owner’s personal taxes. Therefore, a lowering of corporate taxes will not change much for many agency owners. Most likely capital gains will stay the same or be reduced, but that only affects owners if they sell their agency.
Health care has a much bigger impact on the agency business. First, most agencies offer insurance to their employees. So, obviously, any changes to the Affordable Care Act will have ramifications on the business’s financials and the policy toward employee benefits. Next, any changes will also impact the business model for 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.
Despite the lack of new legislation, there have been a few executive actions that need to be tracked. President Trump eliminated the reimbursement to health insurance companies that President Obama allowed via executive order. This will mean that any losses companies face will not be subsidized. The companies have increased their 2018 rates to cover previous losses in anticipation of these change.
The pace of technological change is breathtaking. This overall trend will influence insurance agencies on many levels. Trends in technology will reshape society, how insurance works, how insurance companies operate and its final use at the insurance agency.
The ubiquitous use of smart phones is a multi-level trend for agencies. For example, people now have the expectation that they can do just about anything instantaneously because they not only carry a telephone but also a computer with internet access.
Distracted driving due to smart phones has caused a spike in the severity of auto accidents and insurers will increase rates to account for the jump in claims. However, in the long term, technology will resolve the distracted driver problem. The proliferation of self-driving cars is perhaps less than 10 years away, which could eventually lead to the elimination of personal lines auto insurance.
Smart phones are becoming the preferred tool for consumers to handle their insurance needs. Most insurance companies have a phone application, which allows the insured to file a claim at the scene of an accident, with pictures and all the details needed. Consumers want to access and pay for their accounts on their phone. There are also lots of tools that allow for agency producers to perform sales and service on their phone.
Other long-term technology trends to watch are artificial intelligence, blockchain technology, the built-in use of technology in products and wearable technology. These trends will shape the role of insurance and how it operates within the next 10 years.
For example, artificial technology will reduce the need for jobs like underwriters, customer service staff and even sales staff. Blockchain technology of some form, which started with bitcoin will become the way data is collected, stored and distributed since it allows for total transparency, it is not corruptible, and it is widely distributed. Wearable and built-in technology will reduce risk, and cause a shift in how liability is assigned.
Market Conditions Impact
The current trend is that rates are starting to somewhat firm in commercial lines. Soft market pricing trends have shown up in various lines and in various regions around the country from about 2007 through 2016. According to sources such as the IVANS Index and Market Scout, premium rate increases are occurring across most commercial lines. Workers’ compensation and business owner packages are the most notable exceptions as they continue to show a downward trend for 2017.
Personal auto insurance will continue to see rate increases as the losses increase due to distracted drivers and more expensive cars. Homeowners most likely will be regionally impacted by the hurricanes and fire disasters that marked 2017. Health insurance premiums will continue their upward climb.
No matter what market conditions apply, most agencies continue to improve internal, organic growth by selling more. They either cross sell or sell additional coverages to new customers. Value added services should be offered and a fee charged, to increase revenue. Many agencies have been giving away these value-added services for free for years.
Business Succession and
Merger & Acquisition Activity
We expect the large amount of M&A activity to continue during 2018. If insurance agencies remain profitable, there will be buyers. The current prices paid by publicly traded brokers, large regionals and agencies funded by private equity firms are already extremely high and will likely not increase except for those very valuable, desirable firms, as the supply is dwindling.
Two of the fastest growing national brokers are Acrisure and HUB.
Acrisure completed 102 deals in 2017 and expects to do the same level of deals in 2018. They doubled their volume in 2017 from $560 million to more than $1 billion this year.
Hub International also completed more than 50 transactions in 2017. The firm expects to focus now on adding to its existing offices in 2018, while being more selective on new offices.
Other national brokers are also putting resources into the middle market arena and have specific capital to do so. The main reason is that many of the larger independent agencies have already been bought up or do not intend to sell.
Local peer buyers and internal buyers cannot compete at those rates since they need to pay out of cash flow. So, 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.
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 percent, plus or minus, which is greater than most other available investments today.
Private equity firms and venture capitalists that fund BroadStreet Partners, Assured Partners and NFP continue to aggressively solicit and buy independent agencies. They have large amounts of capital to attract independent agencies that are dynamic but struggling with their perpetuation plan. Some firms, like Risk Strategies Co. that completed 10 deals in 2017, are being more selective and buying agencies with specific niches such as employee benefits, healthcare, real estate and transportation agencies.
Private equity firms are paying typically eight to 10 times EBITA (earnings before interest, taxes, depreciation and amortization) and sometimes even more. When the value is translated to a multiple of revenue this means two to three times revenue.
However, many independents prefer not to sell to a much larger, or publicly traded firm. The existing firm often is completely transformed a few years later, and not always for the better. There is often a sense of pressure to produce and write larger accounts. These criteria are not a good fit for even medium-sized, service-oriented independent agencies. In addition, producers in these acquired agencies usually do not get paid for commercial lines accounts below $5,000 in commission.
It is getting more difficult for small- and medium-sized agencies to perpetuate internally. Often, it seems that the next generation does not have both the management and financials skills to pull it off. These are the firms that will have to bring in good hires, merge with a peer agency or sell to a larger firm that has capital to acquire. Also, as owners reach retirement age, many competitors approach them with great offers, so the retiring principals are guaranteed their money versus the chance that internal candidates may not be able to perpetuate the firm and the customers and pay the retiring owners.
If an owner sells internally, it is usually for less than the value of an external sale. There is 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. Most owners, however, don’t want to do this, and would rather the internal buyer get their own loan outside of the agency, for at least the down payment. Then they can use the agency’s profits to finance the retiring principal, if those internal buyers can continue to manage and grow the firm, once the key owner retires. If not, the internal buy-out will not likely work out.
Usually the terms are 25 to 30 percent down, with the buy-out over five to 10 years, depending on the agency’s cash flow and whether 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 and not jeopardize the internal buyer’s ability to use the agency’s cash flow to pay off the loan over time. Buyers often want the retiring owners to move on after a few years, so they can manage the firm without their influence.
Agency Profitability and Equity
Agency owners should be able to increase productivity and profitability if management is proactive, performs account rounding, and conducts work in a paperless environment. It’s also important that account managers do a better job for the customer and should have great assistants and clerical support.
There are outside support organizations for commercial lines service through organizations such as Resource Pro with U.S.-based staff to support independent agencies, as well as Patra with resources available on an hourly basis utilizing staff in China and India. Having outside help assists account managers so they can perform more client service and less clerical work. These services are becoming very cost effective. One bonus is that the staff is trained off-site and the work is managed elsewhere.
From the insurance agency perspective, tax reform will have its initial and perhaps biggest impact directly on owners’ and employees’
personal income taxes.
Independent agencies must remain profitable, consistently grow and target larger commercial lines accounts, high value personal lines accounts and employee benefits accounts to receive the highest prices. With the economy continuing to improve and the ability to get credit lines from banks, the value of agencies is still good, especially because there are so many acquirers. There is often a misunderstanding about the “real price” being offered. Many of the deals have a sizable portion of the “price” based on earn-outs for future performance.
The number of well-capitalized buyers (both national and larger independents) is impacting the ability of agencies to do acquisitions. The prices being paid today do not always cash flow, which makes it harder for both small and medium sized firms to match.
National and regional brokers seem to still have a large amount of capital to acquire so prices paid are usually much higher than peer independents can match, like in the 1.75 to 2.50 range, as commission multiples are seven to even eight times EBITDA.
Sellers today still get prices from other peer independents in the 1.25 to 1.75 times range, if there is at least close to a 25 to 30 percent profit margin. As a multiple of EBITDA these values are in the six to seven 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.
Therefore, if an agency gets 1.75 to 2.25 times revenue today, this is actually a “price” closer to 1.3 to 1.6 times revenue, projected three years out.
Entry into Insurance is Easier
Perhaps partially because of the current M&A frenzy there is spike in the number of new agencies and producers creating their own business. The use of aggregators and franchise type agencies has made starting a new agency much easier than in the past. Historically, small- to medium-sized firms could individually maintain the number of quality markets they need to compete today with larger firms. Through an aggregator or as a member of a cluster, an agent can access great standard markets with the concern of volume commitments. For agencies above the “mom and pop” level, the use of clusters or networks are becoming more common. Generally, the individual agency in a cluster can maintain some, if not all their autonomy, while getting higher commission and contingents than from an aggregator.
Oak & Associates feels the key trends in this article are important for owners to pay attention to for the coming year.
Agency owners need to establish business and marketing plans. 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 then allow the firm to succeed. Having good communication within the firm and meetings and planning sessions is a good way to get everyone involved and headed in the right direction.
Contact Oak & Associates if templates for sales and marketing or business planning are desired.
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