It is time to take out our crystal ball and plan for 2019 and how our insurance industry will be impacted by the trends around us. Those that consider these changes, and plan ahead, will usually be in a better position than those that do nothing until it is too late.
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. That is why it is imperative for agency owners to watch and learn about major trends when they start. What are the six key trends that insurance agencies should be tracking for 2019?
1. California and Northwest Wildfires, Hurricanes on the East Coast
The impact of the California wildfires in October of 2017 and the fires that plagued the Santa Barbara area a few months later, is now even worse, with the recent Camp fire in Paradise and the Malibu fires. The future of both affordability and availability of homeowners insurance in all of these areas remains to be seen. Not only were lives and thousands of homes and businesses lost but, many still don’t have their homes and businesses rebuilt from the 2017 fires. Many of the areas where the fire occurred, especially in Sonoma County, may not be able to rebuild due to lack of contractors, a question of insurability, and even contamination of the water table.
Natural disasters will always occur. 2018 was a safe year from tornados and an average year for hurricanes. Growing populations and expansion into previous wilderness exacerbates the dollar amount of damage that occurs. It is most likely that the wildfires will likely cause significant earnings volatility and could stress some balance sheets.
Farmers is estimating $2.1 billion in claims out of an estimated $9 billion total from the November 2018 fires. So far, one carrier (Merced Mutual) has been declared insolvent because of the fires.
People will still need insurance, despite the regular threat of natural disasters. Agents and brokers are going to have to explore new options. Homeowners in threatened areas will be forced to leave the standard markets and move to non-admitted carriers and government sponsored programs, like the California FAIR plan.
2. The Affordable Health Care Act
Two years into the Trump administration, there is still no major legislative change to the Affordable Care Act. However, with the removal of the tax penalty, a judge declared the ACA unconstitutional. But with appeals likely to occur, the Trump White House said the law will remain in place for now. With the Democrats now in charge of the House, it is hard to predict what will happen. New Speaker of the House Nancy Pelosi says she will make ACA revisions a priority, but it remains to be seen if this will happen and that both sides can come to agreement.
Despite the lack of new legislation, the few executive actions that President Trump did eliminated the re-imbursement to health insurance companies that President Obama allowed. Any losses the companies face are no longer subsidized. Thus, insurers increased their 2018 rates to cover previous losses in anticipation of these changes. This will likely continue in 2019. 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.
Changes in technology trends have reshaped society, how insurance works, how insurance companies operate and how technology is ultimately used at the insurance agency.
People know they can do just about anything instantaneously because they not only carry a phone, but also a computer and all the toys that go along with it. Smart phones are becoming the preferred tool for consumers to handle their insurance needs. Most companies have a phone application that allows the insured to file a claim at the scene of an accident, with pictures and all the details needed.
Technology is having a big impact on how the industry is looking at risk. The insurance approach toward the large pooling of risk is being replaced with a much more granular approach. Many life insurance companies have policies based on the insured’s exercise routine. John Hancock Financial sells so-called interactive policies that provide premium discounts to policyholders that share fitness data.
Technology is allowing insurance rates to be based on the insured’s personal risk profile. The use of telematic devices (the automotive equivalent of an airplane’s black box) is becoming more frequent as insurers invite customers to install the devices with the promise of premium discounts of up to 50 percent. The most common programs are Snapshot from Progressive, Travelers Insurance’s IntelliDrive and State Farm’s Drive Safe and Save.
Risk is also being transferred from the consumer to the manufacturer as devices become smarter. The user of self-driving cars will no longer have the liability, but the manufacturer will be responsible instead. This trend is occurring across the board, not just with cars.
Agents and brokers need to track these trends and adjust what products and services are being sold, because in a few years some won’t exist and new ones will be created.
4. Market Conditions Impact
Rates are starting to firm in commercial auto and to increase dramatically in certain states for personal lines, due to wildfires, hurricanes and the like.
Soft market pricing conditions have been present in various lines and regions from about 2007 through 2016.
Personal lines auto will continue to see rate increases of 3 percent (+/-) as losses increase due to distracted drivers and more expensive cars. Homeowners most likely will be regionally impacted by the hurricane and fire disasters that marked 2017.
Commercial auto is facing a capacity problem, so expect sizable rate increases or companies tightening up on underwriting.
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.
5. 2018 M&A Activity and Pricing
The large amount of merger and acquisicion (M&A) activity is expected to continue during 2019. As long as 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 stay high for the valuable, desirable firms. Since the supply is dwindling, the prices may be even higher for agencies that remain, if they fit the profiles of key buyers.
There is a new acquisition player for retail agencies. According to President Mike Marcon, “Altamont Capital has committed significant capital behind an experienced brokerage executive to build a new retail brokerage called Symphony Risk Solutions. Symphony Risk is currently in the market for a foundational platform agency with $5.0 million – $15.0 million in revenue and located ‘east of the Rockies and west of the Poconos.'”
Private equity firms are paying typically eight to 10 times EBITA (earnings before interest, taxes and amortization) and sometimes even more. When the value is translated to a multiple of revenue this means two to three times revenue!
Local peer buyers and internal buyers cannot compete at the high prices and multiples since they need to pay out of cash flow. So, there will continue to be a price differential between those that receive offers from well-funded buyers and those that sell internally or to local competitors.
6. Agency Pricing
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 misunderstanding about what the “real prices” being offered are. Many of the deals have a sizable portion of the “price” based on earn-outs for future performance.
Sellers today still get prices from other peer independents in the 1.5 to 2.0 times range, if there is at least close to a 25 percent to 30 percent profit margin. As a multiple of EBIDA (earnings before interest, depreciation and amortization) 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. So, if an agency “gets” 1.75 to 2.25 times revenue today, this is actually a “price” closer to 1.4 to 1.6 times revenue, projected three years out.
7. Internal Perpetuation Can be Difficult
It is often hard for small and medium sized independent agencies to internally perpetuate. The next generation often does not have the management and sales skills set to be able to retire the majority owner. If they are unable to bring in additional producers and/or an agency manager, then it may be possible to accomplish the perpetuation of the agency and pay off the owner in a reasonable timeframe.
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 his or her own loan outside of the agency, for at least the down-payment. Oak & Associates has options for these internal buyers, for needed capital.
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.
Being proactive and knowing how the key trends discussed in this article will affect the firm is the first step. Managing the agency in a way that exploits these trends will allow the firm to succeed. Good communication within the firm is imperative! Meetings and planning sessions are a great way to get everyone involved and headed in the right direction.
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