Minding Your Business: Trends to Exploit in 2017

It is a new era for our country, with President Donald Trump coming into power with the theme to “Make America Great Again.” Perhaps it is also the time to do the same for agency planning. Are there things in the works with our nation’s new leader that will affect the agency and the clients that we insure? One would think so, with his platforms and first 100-day agenda.

There are too many moving pieces and unknowns to predict what a Trump presidency means. Most likely, regulations will be scaled back. Carl Icahn was named as a special adviser to the president on overhauling federal regulations. The Affordable Care Act also will be overhauled. Trade deals will be revised with the intent to be more favorable to the United States. Tax laws and incentives will be re-written. It is not clear how the Trump administration will act toward federal oversight of the financial sector, but an increase in control is remote. So, this seems like it should be favorable to business. But, there will be counteracting reactions that will affect any changes made by the federal government.

Assuming the economy grows, the Federal Reserve will increase interest rates, as it already did in December 2016. Life insurance companies will directly benefit from the hike in interest. Property/casualty firms are less sensitive to interest rates and will benefit from a growing economy. However, changes in technology will have a bigger impact on the insurance industry than anything related to the government.

As the Trump administration promotes business through less regulation, revised trade deals and re-writing tax laws, “Blue” states like California, New York and Massachusetts will respond with more regulations and large-scale legal actions by Attorneys General. California just retained former Attorney General Eric Holder to fight against any moves by the Trump Administration that they disagree with.

So, what does all this mean to the typical insurance agency owner? It’s time to be proactive and think about how the industry and economic scene affects the firm. Those that don’t plan will easily be overtaken and will not attain maximum growth.

The current trend is that rates are softening in commercial and personal lines.

The last soft market has been in various lines in various regions for a number of years, from about 2007 through 2016. In commercial lines, Richard Kerr, MarketScout CEO, noted that while the composite average rate was down 2 percent last month, rate changes vary by line and industry.

“Insureds and brokers should carefully examine the rates for coverage and/or industry classifications that are germane to their placements,” he said. Commercial property and general liability have dropped 2 percent recently, with all other lines having dropped about 1 percent in commissions. The only exception is commercial auto, which had been dropping by 3 percent and now slowed to only a 2 percent decline.

Because rates are softening, in order to keep revenues up, agencies will need to sell more — 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 away for free for years. The producer needs to show that they are needed services for the client and worthwhile. If successful, the client should be willing to pay.

By industry class, rates have been flat or have decreased as follows since February: Manufacturing continues to decline 1 percent, while both Contracting and Service class rates have declined 2 percent.

In personal lines, Kerr said, “Hurricane season is over. Hurricane Matthew was a scare and the net effect to insurers was minimal. With another year of relatively benign wind events, insurers are quoting more competitive rates.”

In a soft market, owners should remember that financial measurements are worse. Agency owners should be able to increase productivity if management needs are proactive, account rounding is performed, there is better use of automation and clerical work is delegated from the account managers to the least costly, qualified employee. This is called staff stratification. Revenue per employee should be $125,000 to $150,000 or higher.

We expect the mergers and acquisitions pace to continue unchanged during 2017. Baby boomers are retiring at a rate of 10,000 per day, and they own more than 60 percent of small businesses. There are estimates that 60 percent to 75 percent of these business will be sold in the next 10 to 15 years. As long as insurance agencies remain profitable, there will be buyers. The current prices paid by publicly traded brokers and private equity firms are already extremely high and will not increase on average. Local peer buyers and internal buyers cannot compete at those rates becausee 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.

National brokers are still putting resources into the middle market arena and have specific capital to do so. There continues to be the following players in the middle market arena, including equity firms and venture capitalists, such as BroadStreet Partners (with teacher union funding), Madison Partners, Hellman & Friedman and Kohlberg & Co. and Assured Partners. These entities continue to aggressively solicit and buy independent agencies and have large amounts of capital to attract independent agencies that are dynamic and are struggling with their perpetuation plan. They are, however, being more selective as they round out their current platforms.

The main reason that the national brokers are in this mid-market arena is that many of the larger independent agencies have already been bought up or do not intend to sell. Some of these national brokers that are major acquirers still include Brown & Brown, Marsh, AJ Gallagher and Integro Group.

To command top values, independent agencies, have to be profitable, growing and targeting larger commercial lines accounts, high value personal lines accounts and employee benefits accounts. With today’s improved economy 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. This confuses the understanding of “value” in the marketplace, because “value” in the past was usually based primarily on revenue that was already on the books.

Sellers today get prices from other peer independents in the 1.25 to 1.50 times range as a high, 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) are in the 6 to 6.5 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 1.3 to 1.6 times revenue, projected three years out.

Some new stronger brokerages have the goal to become a local or regional force against the national brokers. The infusion of these well-capitalized buyers is affecting the ability of smaller agencies to do acquisitions. The prices being paid yesterday and today do not always cash flow, which would be hard for smaller firms to match.

National and regional brokers seem to have a huge amount of capital to acquire so prices paid are usually much higher than peer independents can match, like in the 1.5 to 2 range as commission multiples or seven to even eight times EBITDA (earnings before interest, taxes, depreciation and amortization). However, many independents prefer not to sell to a much larger, often publicly traded firm.

The existing firm is often unrecognizable a few years later if the larger entity does the acquiring, and pressure to produce and write larger and larger accounts often is not a good fit for many small to medium size service-oriented independent agencies.

In addition producers in these acquired agencies usually do not get paid for commercial lines accounts under $2,500 to even over $5,000 in commission.

Owners often sell internally for less than an external sale, especially if family members are involved. There is also additional risk as those internal family members or key employees usually don’t have monies to put down a down-payment. However, consultants recommend to owners that these candidates show dedication and have skin in the game. The perpetuation candidates often then sign an agreement to guarantee payments to the retiring majority owner using their skills at maintaining the owners’ key accounts, continuing sales growth and the same or a good level of cash flow. If the owners don’t feel comfortable enough with these candidates to retire and let these candidates take over, they likely will sell to a third party.

From the insurance agency owner perspective, there will likely be less taxes and an ability of the owners to have capital freed up for agency improvements.

It appears to be getting more difficult for smaller 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 a good additions to the team, 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.

In January 2013, Congress and President Obama raised federal capital gains rates from 15 percent to 20 percent. There are also some rate tiers in between. Personal income taxes also went up to 39.6 percent for the higher income brackets. If Trump had not won the election, it was likely that with

soaring debt, a Clinton administration likely would have raised taxes again to help pay down the national debt that has occurred over the past several years.

Under a President Trump, it is predicted that the tax rate for corporations will go back to 15 percent and be a much more simplified system so that all Americans file their taxes and there is uniformity. It is more likely that there will be more revenue because of this to help lower the national debt, based on the concept of the Laffer curve.

From the insurance agency owner perspective, there will likely be less taxes and an ability of the owners to have capital freed up for agency improvements.

Many small to medium sized 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.” The most common ones that seem to be great for some of our agency clients are Keystone, ISU, PIIB, United Valley, Iroquois Group, Insurance Office of America and SIAA.

Clusters vary in size, style, capability and appearance. Every area of the client has different clusters to choose from. 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.

A common complaint of most agency owners is that it isvery difficut to find

good, loyal, hard-working insurance producers. Producers that are available often don’t produce and can be problems. Every year, this continues to be a problem for independent agencies. Also, if certain growth percentages are not attained, some owners may consider lowering the overall commission on the existing book by a few to even 5 percent commission points. Some agencies are encouraging producers to produce more new business so higher new and lower renewal commissions are becoming more popular. To improve profit, most agencies are also limiting the size of account the producer will be paid for. There are very few agencies today paying producers for commercial accounts under $1,000 in commission per account. The bar continues to be raised.

The key trends in this article are important for owners to pay attention to for the coming year.

Having good communication within the firm and planning sessions are a good way to keep everyone on track. Also, establishing business and marketing plans, which incorporate exploiting these trends, is important. Proactive owners 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.