Industry Trends to Exploit for 2015

It’s time to get out the crystal ball to think about what trends might help or hurt the agency in the coming year. By being proactive and strategic, agencies could stay ahead of the competition. And if today’s trends can be exploited and taken into account in the firm’s business plan, then owners can more likely be a step ahead of the competition in 2015.

Here are a few trends we see that agency owners should pay attention to.

The Market Isn’t Getting Harder

The current trend is the market has leveled off and is most likely going to start to soften. The hard market that is just ending began sometime in the second half of 2013. The hard market before this one was firmly in place from about 2000 through 2003. Prior to this almost a whole generation had lived under soft market conditions. The last soft market has been in various lines and regions for a number of years, from about 2007 until the second half of 2013.

Most of our clients and industry experts have felt that the rates are no longer hardening.

With the past hard market, there was a lot of time spent quoting for little reward. Increased premiums and thus commissions were maybe only about 5 percent higher. If this hardening ends, 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 for free for years.

Profit Margins Will Shrink

Agencies’ financial measurements will become worse as the market begins to soften, unless management is proactive, does a good deal of account rounding, maximizes use of automation and delegates clerical work from account managers to the least costly, qualified employee. This is called staff stratification.

Agencies should be able to increase productivity doing these things. Revenue per employee should be $125,000 to $150,000 or higher.

National Brokers Buying Independents

National brokers are still putting resources into the middle market arena and have specific capital to do so. There are some new players in the middle market, including equity firms and venture capitalists, such as Madison Partners (owns National Financial Partners), Hellman & Friedman (owns a majority interest in HUB International) and Kohlberg & Co. (with majority interest in Risk Strategies) and AssuredPartners. These entities are aggressively soliciting and buying independent agencies and have large amounts of capital to purchase independent agencies that are dynamic and have not yet figured out their perpetuation plan.

Also, national brokers continue to be competitive in acquiring to keep growing and adding volume. The pace is eventually unsustainable, but has continued through 2014. In fact, the reason they 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, Arthur J. Gallagher and now Integro Group.

Agency Value Still High

Agency valuation today remains good because of the improved economy, willingness of banks to provide credit lines, and the number of acquirers willing to buy. However, to command top values independent agencies have to be profitable, growing and targeting larger commercial lines accounts, high value personal lines accounts and benefits accounts.

There is still some 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, since “value” in the past was usually based primarily on revenue that was already on the books.

Sellers today get prices from other independents in the 1.2 to 1.6 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 and depreciation) prices are in the 5.5 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 in the off chance that an agency “gets” 1.75 to 2.0 times revenue this is actually a “price” closer to 1.25 to 1.4 times revenue, projected three years out.

The goal of some of these new stronger brokerages is to become a local or regional force against the national brokers. There could also be attempts to bring enough brokerages together to go public or sell out to an interested deep pocket. The infusion of these well-capitalized buyers is impacting 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 independents can match, like in the 1.50 to 2.0 range as commission multiples are 7 times EBITA. However, an independent has to want 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. Pressure to produce and write larger and larger accounts often is not a good fit for many small- to medium-sized service-oriented independent agencies. In addition producers in these acquired agencies usually do not get paid for commercial lines accounts under $2,500 in commission.

Internal Perpetuation Planning

Owners need to plan ahead and structure their business to sell internally or externally for their perpetuation plan. Baby boomers have now reached around 68 years old. This is a new tier of owners that need to retire, which will peak in the next one to two years. Because of the competitiveness in the marketplace it is getting difficult for smaller agencies to perpetuate internally. Often, it seems that the next generation does not have both the management and financial skills to pull it off. These are the firms that will have to either merge with a peer agency or sell to a larger firm with deep pockets and a well-structured management team.

Taxes May Go Higher

Congress and President Obama enacted new federal capital gains rates effective January 2013 from 15 percent to usually 20 percent; however there are some tiers in-between. It is still predicted that these taxes could go even higher, maybe 25 percent to 35 percent. Personal income taxes also went up to 39.6 percent for the higher income brackets. With an election on the horizon a new regime in power will most likely have to raise taxes again to help pay down our national debt that has occurred over the past several years.

Owners that are contemplating selling the business have two choices. First, sell before the tax rates go up again for as much down payment as possible to lock-in lower tax rates. For those that are not quite ready to sell, this will require the acceleration of preparing the agency to sell and realigning one’s financial goals and expectations.

The second option is remain an owner for now and sell after attaining more growth. Since 2013, agency owners wishing to sell their business need to grow the business by more than the tax increase in order to net the same amount of after tax proceeds they would have received before the tax increase. This is difficult because it is predicted that the commercial market will start to soften soon.

Cluster Option for Smaller Agencies

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.”

Clusters vary in size, style, capability and appearance. Generally speaking, the individual agency can maintain some, if not all their autonomy. These entities can also be a way for new people to open their own independent agency. Some cluster organizations even provide perpetuation for their members within the group or umbrella entity. This option is becoming much more popular for agency owners than selling out. Then the cluster members can become the perpetuation plan for retiring principals of agency owners in the cluster.

Producer Dilemma Continues

Most agency owners agree that it is very hard to find good, loyal, hard-working insurance producers. Producers that are available don’t produce and can be problems. The ones that do produce are often unaffordable or they want ownership in the agency.

The lack of good producers is an ongoing problem. It is hard for owners to perpetuate internally without great producers, who often also do not have good management skills.

An option is the account executive (AE) role. This AE role can ease the burden of the workloads of the owners and non-owner producers with large books. AEs usually still have service staff to delegate day-to-day service work. The AE is typically compensated on a percentage of the commissions handled, such as 15 percent to 25 percent, so it is more cost-effective for the agency.

Summary

These key trends are important for owners to pay attention to for the coming year. Having good communication within the firm and establishing business and marketing plans that incorporate these trends is imperative. Understanding how current trends will affect the firm is the first step. Managing the agency in a way that exploits these trends will lead to success.

Oak & Associates has a sales and marketing planning tool, as well as a business planning tool available for sale, for those who want to be prepared for 2015 and do this work in-house with a template. For more information, or to schedule a personal planning session for the agency at a discounted rate, mention this article.