Interest rates likely will not increase rapidly in 2016, but may raise once or twice this year. (Photo: iStock)

1. What will happen to interest rates?

Insurance agency buyers and sellers have been operating in a low interest rate environment. The federal funds rate — a benchmark rate for economists, lenders, and investors — didn't budge from 0.25% from December 2008 until December 2015. The Federal Reserve Board at its December 2015 meeting announced it would raise its benchmark interest rate to between 0.25% and 0.5%. Further, the Fed said it expects “only gradual increases” in the federal funds rate, depending on the economic outlook and that the “rate is likely to remain, for some time, below levels that are expected to prevail in the longer run.”

That rate has important symbolic and actual financial impact on the economy. It cascades through the banking system. It affects rates paid by borrowers on everything from business loans to credit card debt. It is a factor on earnings on financial instruments ranging from savings accounts to stocks.

As the federal funds rate goes up, it likely will trickle through to the interest rates that buyers would pay to borrow capital to acquire independent agencies. And as buyers put together their plans and their pro forma financial statements, they have to consider whether the expected investment return from an acquired agency would clear the “hurdles” of paying back their loans.

These are two typical sets of agency buyers:

• A “strategic buyer” usually is already working in the agency as a producer; is a family member working in the business; or is otherwise interested in operating the agency after acquiring it.
• A “financial buyer” is primarily interested in the cash flow and investment return that an acquired agency could provide.

While buyers have had a low interest rate environment for borrowing for some time, a good portion of independent agency acquisitions have been funded by private-equity capital (which, presumably, is not borrowed funds).

At InsurBanc, we predict that rates will not increase very rapidly, perhaps once or twice more in 2016. The reason is that there is no indication of inflation and monies continue to flow into U.S. treasuries.

But it's a safe assumption that borrowers' ability to access capital in the marketplace at relatively low rates is not going to be here forever. Typically, our recommendation is that agency borrowers strongly consider refinancing variable-rate debt and fixed-rate debt, even if the rate is low, if it will be maturing or repricing in the next six to twelve months.

Related: What's YOUR succession plan?

Carriers, customer sets and niches all factor into agency valuation. (Photo: iStock)

2. What price could I get if I sell my agency?

Sometimes the discussions about valuations of independent agencies are about “multiples,” such as:

• “I sold my agency for three times revenue.”
• “I got 10 times EBITDA (earnings before interest, taxes, depreciation and amortization).”

Multiples are interesting, especially in discussions on the golf course or at agent conventions. But there can and should be context around any discussion of valuations. For example, two agencies with $3 million in revenue might have different valuations. One factor could be that agency A had $2.5 million in revenue in the prior year, while agency B had $3.5 million. The price is important, but no transaction can be boiled down to one ratio.

Independent agencies have a lot of commonalities. But it's our view at InsurBanc that each agency is a little different. Each agency's business mix is particular to it. Carrier appointments, customer sets, niches, makeup of the producer base — these and others are important qualitative aspects when evaluating and valuing an agency.

Any valuation of an independent agency can and should be done by a competent third-party appraisal firm. And in our view valuations should be done only in the context of an agency principal's strategic objective, or to understand what strategic options might be available to the agency owner.

Typically, the reasons for that strategic decision are: to perpetuate the agency to the next family generation so that the owner generation can exit over time; or to monetize the value of a lifetime business investment in order to exit the insurance business.

Absent a business objective, any talk about agency valuation multiples — however scintillating — is just talk.

Related: How to maximize the value of your agency

The decision to sell involves a range of factors other than price. (Photo: iStock)

3. Are valuations for independent agencies at their peak?

The values being paid for independent insurance agencies have been high during 2014 and 2015. In fact, Reagan Consulting notes that 2015 likely will be a record year for agent/broker mergers and acquisitions.

So does that mean the time is right for an agency principal to sell?

It's unwise to make that decision based solely on a financial perspective. The value of an agency sale is a vital consideration. But it should not be the only or deciding issue. Low interest rates typically keep multiples of price-to-revenue or price-to-earnings lofty. And the attractive, steady earnings of insurance agencies have drawn capital and liquidity from able buyers.

The decision to sell involves a range of factors other than price: the stage of life and career for the agency principal(s), the availability of an internal buyer for perpetuation, family priorities, taxes, the prospects for the agency's producers and staff under new ownership, and the role that the principal would play after an agency sale.

Each agency principal faces a unique set of circumstances when determining if and when a sale makes sense. Timing is in the eye of the beholder. A decision on a transaction really needs to be driven by personal and business circumstances and not merely financial considerations.

However, at InsurBanc, it is our opinion that while agency valuations may be frothy and it may be attractive to sell to the highest bidder, there is a compelling economic case to be made for executing a well-planned perpetuation program.

Robert J. Pettinichi is executive vice president and chief lending officer of InsurBanc, a division of Connecticut Community Bank N.A. E-mail him at [email protected].

Related: Selling your agency: Top 10 must-dos

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