Owners of high-performing agencies, while faced with crumbling P&C pricing in most areas of the country and stagnating group insurance commissions, can remain confident that the value of their agencies is rock-solid. This confidence comes from knowing that the investments they have made in their agencies are being looked upon favorably by the acquirers scouring the marketplace.

Private equity firms have brought a tidal wave of new money into the marketplace, the likes of which has not been seen since the “Flood of 1996,” when the U.S. Supreme Court's decision in Barnett Bank Inc. v. Nelson gave banks the green light to sell insurance and acquire agencies. While private equity firms have silently infused hundreds of millions of capital into insurance brokerages over the past 10 years, the combined $3.4 billion that private equity firms announced for the HUB International and USI deals alone should send a message loud and clear to the marketplace. Additionally, both deals were priced aggressively relative to private agency/broker standards. Meanwhile, banks and public brokers are paying more for acquisitions, too.
In 2006, banks paid an average of 7.9 to 8.2 times EBITDA (earnings before interest, taxes, depreciation and amortization) for the “foundation” agencies they purchased. That was up from 7.7 to 8.0 times EBITDA in 2001. Foundation agencies are the higher-performing agencies in a community, capable of meeting the insurance needs of the acquiring bank in terms of size, profitability, growth, and operational and management skill. For agencies banks subsequently acquire to add to a foundation agency, banks paid 6.75 to 7.0 times EBITDA, as opposed to 6.75 to 7.25 times EBITDA in 2001.
Public brokers paid an average of 7.5 to 7.9 times EBITDA for the agencies they bought in 2006. That was up significantly from the 6.5 to 7.0 multiples they paid in 2001.
It is important to note that these transaction prices include earn-outs that are typically paid over a three-year period after a sale. Earn-outs are based on attaining certain revenue growth or profitability targets. After they are taken into account, foundation agency sellers have been receiving an average down payment of 7.25 times EBITDA (89% of the purchase price). The multiple is 5.28 for other agencies purchased by banks (76% of the purchase price) and 6.23 for agencies bought by public brokers (81% of the purchase price). (Please see the chart on p. 64.)
The number of publicly announced agency/broker transactions increased in 2006 relative to 2005. In all, there were 215, with banks and national brokers announcing 60 and 61 of them respectively. However, given that 1,761 publicly announced transactions have taken place since 1999, the pool of quality targets is shrinking.
Private equity buyers also are paying premium prices for desirable acquisition targets. Consider, for example, that the private equity buyers of USI and HUB International paid 10 to 12 times forward-looking EBITDA. Private equity buyers see the opportunity to privatize public brokers, leverage debt to increase the return potential, invest capital to create long-term organic growth and exit the business during a hardening market, thereby potentially capturing multiple arbitrage. This strategy summarizes the goal of the private equity gorilla. Now, these buyers have in their sights every type of distributor within our industry, including employee-benefits agencies and wholesalers.
Of the $130 billion of private equity capital awaiting deployment in the financial services sector, Marsh Berry & Co. estimates that $15 billion is looking for a home in the insurance distribution system over the next 18 months. Obviously, the market cannot accommodate $15 billion, but the numbers alone serve as a stark reminder that the competitive landscape continues to change. Private equity investors view insurance agencies and brokerages as attractive targets because of their renewable earnings streams, strong cash flow, minimal capital requirements and limited risk exposures. Therefore, private equity firms will remain aggressive and close several more transactions this year.
Private equity firms are committed to their acquistions' organic growth (often augmented with additional acquisitions). They have the time, discipline and capital to invest in producer recruiting, services, differentiation strategies, technology and high-level account executives. This may surprise most agents, who may believe that the private equity firms are just attempting to buy agencies and wring out some costs, only to turn them over.
Private equity buyers saw opportunity in the lower price/earning multiples of most public brokers. The dropping P/E multiples reflect the slowing organic growth most distributors are experiencing because of the soft market. The P/E multiples of the national brokers moved up in advance of the last hard market, however. When the market next hardens, private equity firms want to take their purchased agencies or brokerages public at what could be a significant premium.
Given the P&C industry's record surplus and profitability, a hardening market is nowhere in sight.