When planning ahead, 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 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 better position than those that do nothing until it is too late.
The trends discussed in this article can impact agencies at the macro level, the micro level or both. The macro level are changes that start outside the agency and then trickle down somehow to the agency itself. Micro level changes are seen are immediately seen at the agency. So, what are the six key trends that insurance agencies should be tracking for 2018?
- Federal Government Policies and Legislation
The two biggest federal policies are the two of the most discussed ones – health care 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 the owners and employees for their personal income taxes. This includes any changes to corporate taxes, since the majority of agencies are privately held. There will be a cascading affect across the economy, but this won’t be 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 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 get the economy growing by incentivizing business with a lower tax rate. Many agencies tend to be S corporations and LLC, which are often “pass through” entities, 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 only affects the owners if they sell their agency.
Health care has a much bigger impact on the business itself. First, most agencies offer insurance to their employees. So, obviously, any changes to the Affordable Care Act will have ramifications on the business 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 re-imbursement to health insurance companies that President Obama allowed via Executive Order. This will mean that any losses the companies face will not be subsidized. The companies have increased their 2018 rates to cover previous losses in anticipation of these change.
It is clear that the pace of technological change is breathtaking. This overall trend will influence insurance agencies at 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 communication devise, but a computer with internet access, plus all the toys that go along with it.
Distracted driving due to smart phones seems to be causing a spike in the severity of auto accidents, since some drivers are looking down and not hitting the brakes at all before a collision. 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 will eventually neuter personal lines auto insurance.
Smart phones are becoming the preferred tool for consumers to handle their insurance needs. Most 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.
Four long-term technology trends to pay attention to 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 ten 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 incorruptible and it is widely distributed. Wearable and built-in technology will reduce risk and also 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. The last soft market has been in various lines in various regions for a number of years, from about 2007 through 2016! According to sources such as IVANS Index and Market Scout, premium rate increases are occurring across most commercial lines. Workers’ compensation and Business Owner Packages are the most notable exception as they continue to show a downward trend for 2017.
Personal lines auto will continue to see rate increases as the losses increase due to distracted drivers and more expensive cars. Home owners most likely will be regionally impacted by the hurricane 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 M&A Activity
We expect the large amount of M&A activity to continue during 2018. 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 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 did 102 deals in 2017 and expects to do the same level in 2018. They doubled their volume in 2017 from $560 million to over $1 billion this year. HUB also had done 50 transactions and expects to mainly add to its existing offices, 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% 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 and are struggling with their perpetuation plan. Some like Risk-Strategies that did 10 deals in 2017 are being more selective and in buying agencies with specific niches they have like employee benefits, healthcare, real estate and transportation agencies.
Private equity firms are paying typically 8 to 10 times EBITA and sometimes even more! When the value is translated to a multiple of revenue this means 2 to 3 times revenue!
However, many independents prefer not to sell to a much larger, often 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 is expected. These criteria are not a good fit for many even medium size service oriented independent agencies. In addition, producers in these acquired agencies usually do not get paid for commercial lines accounts often under even $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 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 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 his or her own loan outside of the agency, for at least the down-payment. Then they can then use the agency’s profits to finance the retiring principal, as long as 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% down, with the buy-out over 5-10 years, depending on the agency’s cash flow and whether or not 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, to not jeopardize the internal buyer being able to use the agency’s cash flow to pay the loan off over time. Buyers often want the retiring owners to move on after a few years, so then they can manage the firm differently, without their influence.
- Agency Profitability and Equity
Agency owners should be able to increase productivity and profitability, if management is proactive, account rounding is performed, there are paperless environments and carriers download their information to the agencies. Also, Account Managers need to 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 staff in the US 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 AMs so they can perform more client service and less clerical work. These services are becoming very cost effective. Also, a bonus is that the staff is trained off-site and the work is managed elsewhere.
Independent agencies have to be profitable, growing and targeting 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 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.
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 or 7 to even 8 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% profit margin. As a multiple of EBIDA (earnings before interest and depreciation) these values are in the 6 to 7 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.
- Entry Into Insurance is Easier
Perhaps partially as a result of the 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 the use of 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 speaking, 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.
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Oak & Associates is an international consulting firm for independent insurance agents