The typical insurance agency generates a majority of its revenue from commercial P&C activity, so this rising commercial P&C tide has significant implications for agency valuations. Since growth plays such a big part in an insurance agency's valuation, when growth in commercial P&C is stunted, so too is an agency's valuation. On the flip side, when commercial P&C growth is robust, the impact on agency valuations is highly positive.

From 2008-2010, agency-value revenue multiples, as captured in the Reagan Value Index (a composite of 30 agencies nationally that we appraise annually) fell dramatically—and in lockstep with commercial P&C growth rates. The average independent insurance agency was valued at 1.27 times revenue at the end of 2008. Commercial P&C growth remained negative or anemic for two more years, and agency valuations bottomed out in 2010. By year-end 2011, as rates began to improve, so too did agency valuations, increasing to 1.21 times revenue.

Barring a significant reversal of fortunes in the second half of this year, we believe that agency valuations, expressed as a multiple of revenues, will again approach 1.27 times revenue in 2012, replacing most, if not all, of the erosion that has taken place in agency-valuation multiples since 2008.

So, how long will the good times roll for commercial P&C growth? It's a safe bet that the near term will likely continue to show improvement. If history is any guide, however, the party may be shorter than we would like.

The “new normal” appears to be longer soft-market cycles, punctuated by infrequent and much shorter hard-market cycles. Since the late 1980s, the duration of the two soft P&C market cycles exceeded the only hard-market cycle by better than a 2:1 ratio. Going back even farther, to the early 1970s, the typical hard market lasted only three to four years. As the current commercial P&C market turned positive in 2011, we are now roughly 1.5 years into a modestly hard market.

What are the implications of these P&C pricing cycles for agency owners? 

• Accept the “new normal” regarding long-term pricing in the commercial P&C marketplace. Don't bank on commercial P&C pricing to be a significant help in fueling long-term organic growth. Invest heavily in building a sales culture capable of generating positive growth in commercial P&C even when the inevitable P&C pricing headwinds return.
• Consider converting to a fee approach when appropriate to ensure that your agency is compensated for the value it delivers, even in a down pricing cycle.
• Diversify your agency's income base to make it less vulnerable to swings in commercial P&C pricing. Consider using a portion of the improved earnings that current P&C pricing will likely deliver to your agency to invest in other sources of revenue and growth, including personal P&C and life & health. Although small employee-benefits business remains at significant risk as a result of the Patient Protection and Affordable Care Act, the prospects for large employee-benefits and ancillary L&H products remain excellent.
• Finally, plan for the dry commercial P&C seasons financially. Without question, this is a cyclical business. Build a strong balance sheet when times are good so that you can continue to make the necessary growth and people investments, even when times are tough.