Last month, Bobby Reagan addressed the issue of “demand for acquisitions” in an article in this “Final Say” spot, headlined: “Supply and Demand Trumps Any Negative M&A Factors” (see NU, June 20, page 26).

The bottom line on the “demand” side is that in 1994, a tiny number of publicly traded acquirers competed for agency acquisitions. Over the past decade the number of publicly traded acquirers has exploded nearly tenfold!

This is important because publicly traded acquirers frequently have a competitive advantage in doing acquisitions–their capital base is often much stronger than that of privately held acquirers. The increase in agency values is not surprising given the record number of well-equipped acquirers competing for acquisitions.

Nevertheless, while acquisition demand frequently grabs the headlines, it is only part of the reason why values have escalated so dramatically. We would argue that an equally important driver of growth in agency values over the past decade has been the stunning improvement in agency profitability.

Many have forgotten how bleak the world looked for agency owners a decade ago. The viability of the independent agent distribution model was in doubt. The Wall Street Journal, in a front-page article in 1995, captured the concerns of the day by quoting one industry observer who argued that insurance agents were “the buggy-whip makers” of the late 20th century.

In fact, it was a crisis in agency values that led to the joint development of the Best Practices Study by the Independent Insurance Agents of America (now the Independent Insurance Agents & Brokers of America) and Reagan Consulting in 1993.

The time-honored benchmark for agency valuation of 1.5 times annual revenue was in a state of serious decline, due to weak agency profits and slow revenue growth. The typical agency's value had fallen closer to 1.0 times revenue, with only the highest quality agencies worth 1.5 times. The Best Practices Study was created to be a tool to help agency owners reverse the downward trend.

We take great satisfaction in the belief that the Best Practices Study has contributed to the progress that has been made in agency performance over the past decade.

A comparison between the 1994 and 2004 studies provides a stunning picture of how much improvement has actually occurred. To illustrate this progress, some key performance benchmarks for the $2.5-to-$5.0 million revenue study group are provided in the accompanying table.

From a valuation standpoint, the dramatic increase in agency values makes sense when we see that pro forma EBITDA–the most important variable in determining agency value–has increased from 17.8 percent to 29.5 percent of agency revenue over the past decade.

(“EBITDA” is Earnings Before Interest, Taxes, Depreciation and Amortization. In the Best Practices Study, Pro Forma EBITDA is calculated by taking reported EBITDA and adding to it owner bonuses and perks.)

In trying to understand why agency values have increased, one needs to look no further than the increase in EBITDA to 29.5 percent of revenue. Why? Because agency buyers (whether they are employees or an outside third party) determine an agency's value based on its expected future profits. Generally speaking, the higher the expected future profits, the higher the value.

Why has EBITDA increased so dramatically? It's all about employee productivity. Top performers over the past decade have increased their revenue per employee from $73,563 in 1994 to $136,369 in 2004–an increase of over 85 percent. The implications of this are staggering.

Consider that a $3.7 million revenue agency in 1994 needed 50 employees to operate. Today, that same agency needs only 27. This is not your father's agency!

This increase in employee productivity has fueled expense reductions nearly across the board, since nearly all of an insurance agency's expenses are head-count related.

As just one example, occupancy expense (that is, rent and utilities) for Best Practices agencies in 1994 averaged 6.3 percent of revenue. Those agencies needed a lot of space for those 50 employees!

By 2004, the figure had dropped to 3.6 percent of revenue. That means for our hypothetical $3.7 million revenue agency, occupancy expense has decreased by $100,000. And it isn't just occupancy expense–telephone, postage, office supplies, equipment costs–they've all decreased.

One might be tempted to feel sorry for the 27 employees–after all, they are the ones upon whom the burden of juicing up profits has fallen, right?

Well, yes and no. Certainly their efforts have driven the increase in profitability, but they have been compensated well for the effort. The fact is the vast majority of the savings derived from carrying a lower number of employees has been reinvested in those who remain.

A statistic might help–the average compensation per employee has risen by 72.3 percent since 1994. The total compensation dollars haven't changed much–they've simply been spread over a smaller, but more productive group of employees.

What are the implications of this going forward?

Unleashing employee productivity has been a key driver of agency value growth over the past decade, and will continue to be so. Does your agency have a strategy for increasing productivity?

In our experience, it all starts with your producers. If you've developed a sales culture in which your producers are relentlessly building (not simply maintaining) their portfolio of customers, then employee productivity will inevitably follow, and growth in your agency's value won't be far behind.

Kevin Stipe is a senior vice president and principal of Reagan Consulting Inc., an Atlanta-based management consulting firm that developed and produces the “IIABA Best Practices Study,” which may be accessed free of charge at www.reaganconsulting.com. Mr. Stipe may be reached at 404-233-5545, or by e-mail at [email protected].

Flag: By The Numbers

Head: Agency Values On The Rise

The number of employees a top-performing agency needs to operate efficiently has fallen nearly by half, sending the average revenue per worker–and the agency's value–soaring.

Quotebox, with mug:

“The increase in employee productivity has fueled expense reductions nearly across the board, since nearly all of an insurance agency's expenses are head-count related.”

Kevin Stipe