8 Industry Trends to Exploit for 2016
It is time to put on the thinking cap and roll up the sleeves to determine what needs to be done to put the firm in a great position for growth and profit in 2016.
Those that like to be proactive by being strategic and aware of the industry trends will be well ahead of the competition by thinking of ways to be better and more astute. This is what we see:
1. The Market is Softening
The current trend is that rates are softening. On average in commercial lines the rates have decreased 3 percent recently, especially in the manufacturing, contracting and servicing industries, according to MarketScout. This includes workers’ compensation and even personal lines has gone down 1 percent recently. The hard market that is just ending began sometime during the second half of 2013 and lasted barely two years. The hard market before this one was firmly in place from about 2000 through 2003. Prior to this nearly a whole generation had lived under soft market conditions. The last soft market has been in various lines in various regions from about 2007 until second half of 2013.
In a hard market, there was a lot of time spent quoting for little reward in increased premiums and thus, commissions. Since the 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 for free for years. Show that they are needed and worthwhile, and the client should be willing to pay.
2. Profit Margins Will Shrink
In a soft market, owners should remember that financial measurements are worse. Management needs to be proactive, do account rounding, make better use of automation and delegate clerical work from the account managers to the least costly, yet 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.
3. National and Regional Brokers Aggressively 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 BroadStreet Partners (recently acquired InterWest and Bearence Group), Madison Partners (owns National Financial Partners), Hellman & Friedman (owns HUB International) and Kohlberg & Co. (with majority interest in Risk Strategies) 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.
The pace of national brokers acquiring for growth has continued through 2015. 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 include Brown & Brown, Marsh, A.J. Gallagher and Integro Group.
4. Agency Value for Good to Great Firms Still High
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 a 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 1.25 to 1.65 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) prices 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 in the off chance that an agency gets 1.75 to 2.25 times revenue, this is actually a price closer to 1.3 to 1.6 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 reflect 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. 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 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, even over $5,000 in commission.
5. Internal Perpetuation is Difficult & Expensive
Owners usually have to sell internally for less than an external sale. There is also additional risk as those internal family members or key employees usually don’t have monies for a down payment. However, as consultants we recommend to owners that these candidates need to 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 some growth and the same level of cash flow, if not more so the owners feel comfortable to retire and let these candidates take over.
For many reasons, it is getting 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 great addition to the team, merge with a peer agency or sell to a larger firm that has capital to acquire. Also, when an owner reaches retirement age, many competitors solicit them to take an easier route and just sell to them, so they are guaranteed their money versus the chance that internal candidates may not be able to pull it off and also transfer the relationship with the owners’ key customers.
6. Capital Gains and Ordinary Income Taxes May Go Higher
In January of 2013, Congress and President Obama enacted new federal capital gains rates that went from 15 percent to 20 percent with some tiers in between. It is predicted these taxes could go even higher, maybe 25 percent to 35 percent. Personal income taxes also rose to 39.6 percent for the higher income brackets. With a 2016 election on the horizon and a new regime in power and a soaring debt, the feds may 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 they can 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 to remain an owner for now and sell after attaining more growth. Because of the likely higher tax rates, anyone wanting to sell their business since 2013 needs 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 the commercial market is already softening.
7. 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. 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.
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.
8. Producer Dilemma Continues
A common complaint of most agency owners is that it is hard to find good, loyal, hard-working insurance producers. Producers that are available often don’t produce and can be problems. They often are shopping from one agency to the next to just get more commission or benefits. The ones that do produce are often unaffordable or they want ownership in the agency. For those we suggest a vesting contract if they meet certain size books and time with the agency. Vesting can be exchanged for stock in the agency.
Another option is stock options and when they join the firm. These options can freeze the value to give a producer a chance to buy-in at a fair price.
The lack of good producers is an ongoing problem. It is hard for owners to perpetuate internally without great producers who often also have good management skills.
The account executive role is an option that can be used, which can ease the burden of the workloads of the owners and non-owner producers with large books. True AEs usually still have service persons to delegate the day-to-day service work on an account. The AE is usually compensated on a percentage of the commissions handled. For those account managers that are afraid to move to commission, moving to an AE role on a salary could work.
Summary
Having good communication within the firm and establishing business and marketing plans that incorporate exploiting these trends is important. Proactive owners know how current trends will affect the firm. Managing the agency in a way that exploits these trends will then allow the firm to succeed.
Oak & Associates has both a Sales and Marketing Planning tool, as well as a Business Planning tool available for sale, for those who want to be prepared for 2016 and do this work in-house with a template. The cost is $299 each or $450 for both. Schedule a personal planning session for the agency at a discounted rate, if you mention having read this article.