According to MarshBerry, the number of deals where an agency sold to a third-party buyer, excluding small transactions that were not publicly reported, increased to 190 during 2002 from 178 during 2001. There is no slowdown in sight. MarshBerry predicts that the number of deals will increase to at least 210 during 2003.

The public and large independent insurance agency competition with dramatic revenue growth, stellar core profitability and strong employee productivity are taking their future seriously and are gaining momentum.

A choice to stand on the sidelines frozen with inaction will become a sword in the heart of the average independent agency as larger firms continue to acquire, gain market share, build accountability-based sales management systems, develop proprietary program specialties and increase their focus on middle market business.

Buyers continue to pay premium value, but the big numbers are only being received by those insurance agencies that are of better than average quality and are willing to accept a partial earn-out structure. (An earn-out involves a supplemental payment that is not part of the original acquisition cost based on future earnings.)

Agency value, as measured by pro forma EBITDA (pro forma earnings before interest, taxes, depreciation and amortization) increased 5.8 percent during 2002 to a weighted average of 6.97 times EBITDA. Agency value as a multiple of revenue increased at an even greater pace of 15.2 percent, or to a weighted average of almost two times revenue, including the value of the acquired balance sheet.

For some peak performers in the right market, with ample buyers, with the right metrics and an institutionalized production staff, value has exceeded eight times EBITDA and 2.5 times revenue.

Would your future be threatened if your most competent privately held competitor was lured to sell to a well-capitalized partner that is focused on the middle market? Are you prepared for such a fight?

Many agency principals have their head in the sand and dispel the concept that market consolidation will come home to roost. We often hear from agency principals that “banks in insurance” is a fad. Eventually, they feel, the wind will blow in a different direction and the banks will exit the business.

If agents asked their insurance companies, they would hear that banks have a desirable middle market focus and are community committed. Banks are well capitalized and have gone from zero to, in some cases, 25 percent of insurance company premium volume, in five short years. Banks are here to stay.

Public brokers are also in an enviable competitive position relative to independent agents.

Agency principals often site the fact that public brokers lose as much out the back door as they acquire and cannot provide continuity in the service area. Whether that is true or not, brokers have superior market access and therefore a vast array of products to sell.

Insurance companies burdened with capacity issues and damaged combined ratios are looking for the largest amount of premium volume per relationship. They are openly taking on a greater volume of business from public brokers and running off independent insurance agencies that are not committed to perpetuation, have high loss ratios, slow premium growth and sublevel volume commitments.

Opinions vary, but the numbers do not. The average independent insurance agency posted revenue growth of 9.5 percent during 2002, which is paltry compared to the rates achieved by public brokers, large bank-owned agencies and large independent insurance agencies.

Brokers have access to public capital and their stock for currency in acquisitions. As a result, they did not feel the need to maintain tangible net worth greater than a 6.2 percent deficit at the end of 2002.

Bank-owned agencies focus on building accountability and cross-selling sales management tracking systems to support a one-stop-shop sales pitch and tend to take a balanced approach to growth. As a result, larger bank-owned agencies achieved revenue growth of 14.2 percent during 2002, which is slightly less than their peers, but did so for the sake of driving short-term EBITDA of 28 percent and tangible net worth of over 40 percent of revenue.

Large independent insurance agencies, not burdened by public scrutiny of profit, are reinvesting their profit and tangible net worth for growth. As a result, they achieved revenue growth approaching 19 percent during 2002.

The large independents are reinvesting for long-term survival in areas such as sales management training, mentoring and accountability, new producers, internal ownership perpetuation, and staff incentive compensation. They are also investing in value-added services such as human resource consulting, claims administration, risk management and loss control.

The average independent agency is struggling with reinvestment in value-added services. As a group, they are achieving inadequate productivity, slower growth, and therefore lower profitability and balance sheet strength. Perpetuation in the average agency is stuck in a perpetual filibuster mode where promises by agency principals are made and not kept due to a general unwillingness to broaden employee ownership. This results in an inability to attract and retain new blood in the production area.

Independent agencies can win the war to remain independent if their focus is shifted to driving long-term performance. The silver bullet to performance is attracting, hiring and retaining talent.

We believe the solution to developing talent is to implement a roadmap for perpetuation. Agents need a plan to attract entrepreneurial self-starters and to ensure their success in production and participation in agency ownership. The best plan should teach perpetuation candidates how to manage debt to facilitate perpetuation and how to attain long-term personal net worth.

Many large independent agencies have pursued such a plan and have become the employer of choice compared to public brokers and banks that often provide no comparable ownership incentive.

What is your battle plan to become an employer of choice to drive agency performance?

Too many independent insurance agencies perceive perpetuation as a transaction. It is not a transaction. It is a long-term process. It is a process to attract, retain and shape perpetuation candidates that drive agency value. These candidates must be willing to amass personal debt to facilitate perpetuation as planned buyouts occur. This could be accomplished through a Perpetuation Stock Incentive Plan. (See related article, next page.)

The time is now for those committed to independence to develop a battle plan for survival. Growth and profitability sufficient for survival will only accompany a plan to build the right team, a process to help producers become acclimated to perpetuation debt service, and a mechanism to put talent to the test.

Independent insurance agencies will thrive and continue to be an employer of career choice for the nations leading producers only if independent agencies embrace the concept of helping the best producers participate in the risks and returns of private ownership and to build personal wealth.

John Wepler is Executive Vice President of Marsh, Berry & Company Inc., headquartered in Concord, Ohio, an insurance management consulting firm. He can be reached at [email protected].

Reproduced from National Underwriter Edition, June 9, 2003. Copyright 2003 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.