Direct writer deals generally are characterized by a guaranteed purchase price. Typically, few of the agencys employees will transfer to the buyers operation after the acquisition.

These transactions have historically been a win-win for both parties, with “S” corporations receiving the highest selling prices and the most favorable after-tax proceeds.

Post-acquisition, the direct writer will allocate business to an exclusive agent(s), warehouse the business for future placement, or place the book in a service center. There have also been some cases where the direct writer kept a stand-alone operation intact.

Many direct writers have paid prices well into the two-times-revenues range, with some transactions achieving over three-times-revenues. (Revenue multiples indicated are used to express prices, not calculate prices. Prices are calculated based upon earnings multiples. Revenue multiples referenced throughout this article include the value of the balance sheet.)

Banks have learned that they must pay for quality. As a result, a bank will target the highest quality agency within their respective footprint when making their platform acquisition, which is often labeled a “foundation acquisition”–the first insurance agency acquired in a particular market area. These agencies have the means and wherewithal to remain independent and typically have no compelling reason to sell. Foundation agencies are typically acquired only if the combination yields a unique business opportunity.

Agencies selling to banks often realize an entirely new set of opportunities, including access to the banks customers and relationships. Reciprocal cross-selling of accounts and capitalizing on each entity's strongest relationships typically yields additional revenue production, but results generally take longer than expected.

A key lure to such a deal is that banks offer something most agencies do not have–liquidity. After the dust settles, most banks use the acquired foundation to scout for further acquisitions. This has the potential to offer a new and very exciting career path for sellers.

If an agency is the foundation acquisition for a bank, it will typically realize a higher transaction price relative to non-foundation acquisitions. Multiples during 2001 averaged 2.49-times-revenues for foundation acquisitions.

Once a bank has made its foundation acquisition, it will typically reduce the pricing on subsequent acquisitions in the same market area. The pricing decrease for subsequent acquisitions occurs because the bank has paid for the infrastructure with the foundation acquisition.

In subsequent acquisitions, banks seek additional volume, market penetration and production talent. Subsequent acquisition pricing is more in line with industry norms, unless a compelling reason dictates a different pricing structure. Multiples for subsequent acquisitions during 2001 averaged 1.63-times-revenues.

Insurance companies are following a path similar to banks. They will make a foundation acquisition and use it as the platform for future growth. Likewise, the talent in the foundation acquisition has budgetary authority and is charged with the responsibility to go out and find new acquisition opportunities.

Many carriers acquire insurance agencies, but do not change the agencys name. One reason for retaining the name is to reduce the market awareness that the company is competing with independent agencies. Besides competing for the same customers with the same products, companies and independent agencies are competing in the merger and acquisition arena–in some cases for the same agencies.

Companies and direct writers are always looking to increase market share and decrease loss ratios. Logically, after the acquisition, companies and direct writers are highly motivated to move business fitting their underwriting criteria away from existing companies to themselves, a fairly common practice.

Becoming a foundation acquisition for an insurance company can offer many opportunities, including market access, a premium transaction price, and capital to expand through production or acquisition. Incentives to write and roll business to the buying company can also add up to lucrative increases in compensation and the purchase price. Similar to direct writer acquirers, insurance companies typically base some portion of the purchase price on premium volume, post-closing retention and loss ratios.

For the seller, the key to selecting the best partner is having faith in the companys management, competitiveness and staying power, which will control the ability to leverage the relationship.

Publicly traded insurance brokers making successful acquisitions are the darlings of the public equity market. The price/earnings (“P/E”) ratio of these brokers represents, among other things, the amount a buyer is willing to pay for each dollar of earnings. The closest equivalent to a P/E ratio for a privately held insurance agency is the after-tax earnings multiple.

Privately held agencies typically trade between nine- and 15-times after-tax earnings. Publicly held brokers are trading above their historical highs, and are experiencing P/E ratios in the range of 23 to 34.

For example, assume a publicly held broker buys an agency at 12 times after-tax earnings and has a P/E ratio of 25. Upon the consummation of the transaction, the value of the agency to the broker has effectively doubled on a cash flow earnings per share basis because the purchased agencys after-tax earnings multiple (P/E ratio) jumped from 12 to 25. This “private to public multiple arbitrage” is at a high point, driving the interest of public brokers to quickly consummate acquisitions.

Public brokers have a pipeline of agencies they visit on an intermittent basis. An enormous amount of time, energy and money has been invested wooing, qualifying, indoctrinating and developing these relationships. For many reasons, public brokers have not historically paid the kinds of prices banks are now paying for foundation acquisitions. Despite the relationship, the price difference has caused many brokers to miss opportunities with high quality sellers.

Dashed hopes and inflated public broker P/E multiples have forced and allowed public brokers to be much more competitive in pricing. Brokers have quickly learned that they must be willing to “pay to play” to avoid losing a quality agency deal to another buying segment. They are now paying higher multiples for acquisitions relative to banks making subsequent acquisitions. The average price paid by brokers in 2001 was 1.71 times revenues.

Because of the aggressive consolidation in the insurance arena, the number of available agencies will continue to dwindle. Understanding each buying segment and knowing how each views your agency will help in understanding the advantages and disadvantages regarding divestiture opportunities.

Albert Lloyd is a senior vice president with Marsh, Berry & Company Inc., a national agency, company, bank management consulting firm headquartered in Concord, Ohio. He can be reached at [email protected].

Reproduced from National Underwriter Property & Casualty/Risk & Benefits Management Edition, July 15, 2002. Copyright 2002 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.