Leaving a legacy: what happens to independent insurance agencies after their owners leave depends on how well the owners have planned.

Harold J. Borak Sr. had owned and run an independent insurance agency in California since 1970. It wasn't until three years ago, however, that he gave any serious thought to selling his business. Effective Jan. 1, he sold his major share of Valley Insurance Services, located in the Los Angeles suburb of Covina, but he is staying on to manage the firm at least through next year.

It is a story that has been repeated thousands of times in the past 15 years as agency owners have cashed in on their equity through either a sale or perpetuation. Other agencies, seeking economies of scale, have merged.

From 1983 to 2004, the number of independent agencies has declined by 44% to 39,000, according to the Independent Insurance Agents & Brokers of America. Consultants expect that this consolidation continues. And as agencies re-emerge in new forms, the new owners, partners, employees and customers are affected, some for the better and some for the worse.

Borak's is one of the happier stories. He signed a deal with Leavitt Group Enterprises, a privately owned organization of affiliated independent insurance agencies based in Cedar City, Utah. Leavitt purchases a 60% equity stake in an agency and leaves 40% with on-site personnel. "Leavitt met all of our needs," said Borak, age 68. "I had two junior partners who owned 36%, of the agency and who really wanted to stay on. I wanted to find someone to take over my position and secure my asset, and I wanted a partner that would keep my employees."

Consultants say not all ownership transitions go so well. Some can turn into nasty family squabbles. Others can self-destruct from poor planning, or no planning at all. Some end badly because an owner cannot let go.

Agency consultant Al Diamond remembers a case in which he was called as an expert court witness. Diamond said the owner was an autocratic leader who selected three successors. He did not allow them to assume command, however, until the moment he retired, and he dictated what they would then do. "He wrote the agreements in such a way that he would be ruling from the grave, even though what he required was against the successors' philosophies," said Diamond.

When he left, they changed things. The former owner didn't like the changes, and he sought legal recourse. "Neither the old owner nor the new owners were happy with the outcome," said Diamond. "The case was a toss-up, and they let a judge who knew nothing about insurance decide their future."

Considering Options

Borak's two junior partners joined the firm about 10 years ago when they brought a book of business from Nationwide when that company withdrew from commercial lines in California. In 1996, Borak converted their book of business to equity in Valley Insurance. But when Borak started to plan for his withdrawal from ownership, the junior partners did not have the resources to take over the entire agency, which currently generates annual premiums of $42 million and employs 30 people. Borak investigated a merger with another agency in the area, then looked into selling his agency to national firms. All of the big firms wanted 100% ownership, he said.

In addition to the 60% equity arrangement, Leavitt keeps employees in place and offers resources that help producers and foster agency growth, Borak said. These include a captive insurer of workers' compensation business, a premium finance company and new markets. Leavitt also provides in-house professionals, including certified public accountants, legal counsel and human-resource staff. "We were primarily commercial-lines property/ casualty, but we also had a personal-lines department and an employee-benefit life department," said Borak. "Since the merger, we have more support in life insurance and financial planning. We had been weak in those areas."

Eric Leavitt, president and one of three brothers actively running the Leavitt Group, said the foundation of the business model is that it has co-owners. "We keep 40% equity in the hands of those who effect the day-today management, those who really understand the market and know the clients, and who can really effect change," he said. "We don't try to impose cultural changes upon an agency that may be unnatural. We try for the most part to leave the agencies in place and bring to them resources that they didn't have access to before."

According to Diamond, president of Agency Consulting Group in Cherry Hill, N.J., about half of agency ownership change is through perpetuation and about half is through sale. Owners of smaller agencies, especially, simply work until it's time for them to retire and then think about perpetuation. "By then, obviously, it's too late, so they end up selling," said Diamond. Often they receive "a good strong price" for their agencies, he said.

Leavitt said that many times a seller has developed a younger person who wants to buy in as the successor, but the seller is reluctant because he or she would have to rely upon the younger person's ability to keep the agency successful. So instead, an owner might sell to a bank or a national broker. When that happens, an owner gets a good payday, but closes the ownership door on a person who helped build the agency.

"Our focus is to find agencies that are well run, that have a large share of good will in their communities, and whose owners are as much interested in perpetuating the heritage of the agency--and perpetuating ownership by locals--as they are in getting a big paycheck," said Leavitt. "That's not to say we don't pay a fair price, but it's really hard for us to compete with publicly traded brokers because they use their stock as currency."

But often a seller wants to keep working four or five more years and has not identified a successor. In those cases, the Leavitt Group might identify one or more successors, even from another member agency, facilitate purchase of the existing owner's stock, and guarantee that payment. At the same time, the successor has a transition time and resources to ensure success, including markets, automation, management and capital, said Leavitt.

Shaping Successors

As an alternative, the Leavitt organization has created an intern program at Southern Utah University in Cedar City and in other accredited universities in areas in which it has offices. The organization recruits people in their senior year of college. These recruits concentrate their courses in insurance, and they serve an internship at one of Leavitt's retail agencies, underwriting divisions or operating divisions. Levitt said they generally emerge from college licensed and sometimes with a CIC (certified insurance counselor) designation. "Then we place them into agencies with the understanding and the hope that in seven to 10 years down the road, these young men and women will turn into our co-owners of the future," said Leavitt.

"One of the problems with our industry right now is that there's a dearth of young people getting into the business," he said. "That is accentuating that lack-of-succession problem that agency owners have because they don't know who is going to perpetuate their agency. Our goal is every year to find 10 or 15 young people to put into our system. If hall" of them succeed in becoming producers and potential agency co-owners, we're happy."

Diamond, too, has embarked on a goal of helping small agencies survive and retain their independence. About 10 years ago, he created the concept of what he calls the virtual insurance agency. "It's going strong because it allows smaller agencies to consolidate, gain the economies of a larger agency, but not lose their presence, their authority levels and management of their own locations," he said.

Under the VIA, agency owners pool resources by forming a board of directors, and no single entity or agency controls it. Each agency remains its own profit center. Some VIAs, however, are effectively operating under the control of one agency, said Diamond.

Diamond said he and other consultants also recruit in high schools and colleges and place recruits in agencies. Contractual relationships define "strike points" the recruits strive to achieve, he said. If they do, they qualify for equity positions in the agencies that can lead them to becoming agency perpetuators.

"Many agents are starved for young talent, so they love to get these guys," said Diamond. "If they don't work out, there's no obligation, and if they work out as strongly as the owners and the young men and I hope they will, then they have raised their own successors."

Levitt said that the demographic challenge to independent insurance agencies today is "staggering." The average agency owner's age continues to rise almost a year for each year that passes, he said. Meanwhile, there is great pressure on agencies, especially smaller ones, to consolidate due not only to a lack of qualified successors but to achieve the volume of business that insurers require of them. But Leavitt said his organization "bristles at the notion we're a consolidator;" it rather views itself as trying to be a perpetuator of the independent agency system.

NEW AGENCY PARTNERS: Harold J. Borak Sr., seated at right, opted for an uncommon solution to cashing in on the equity of his independent agency by selling a 60% share to Leavitt Group Enterprises, an organization of independent insurance agencies. Consultants say retiring agency owners have a wide variety of options, but that most owners haven't prepared their agencies for selling or perpetuation. From left are Dixie Leavitt, founder of Leavitt Group; Dane Leavitt, chief executive officer; Mark Leavitt, director of affiliation marketing; Eric Leavitt, president; and Kelly Russell, chief affiliation officer.

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Key Points

* Independent insurance agencies are undergoing consolidation as their aging owners retire or phase out of the business.

* If owners do not plan for their departures, their agencies may suffer.

* While large purchasers may change the culture of an operation, other forces are at work to help agencies remain independent.

Quick Stats, Independent Insurance Agencies

1 in 7

Number of independent agencies involved in an ownership change in 2003 and 2004, most through acquisition.

15%

Percentage of agencies in 2004 with annual insurance revenue of $2.5 million or more, up from 11% in 2002.

7%

Percentage of revenue in independent agencies generated by life/health or employee-benefits products. Only half of agencies sell those lines.

1,256

Average number of personal lines accounts per independent agency.

326

Average number of commercial accounts per independent agency.

Source: Independent Insurance Agents & Brokers of America, 2004 Agency Universe Study

Agency Ownership

Non-employee owners include
banks, credit unions, outside
individuals, other insurance
agencies, other producers and
Other entities.

Partially or
wholly owned by
non-employees    16%

Wholly owned
by principals    84%

Note: Table made from pie chart.

Source: Independent Insurance Agents & Brokers of
America, 2004 Agency Universe Study

Consultants: Owners Give Little Thought to Agency Perpetuation

The graying of independent insurance agency owners is reducing the number of agencies in the United States. As these owners retire, most would rather execute an internal succession plan than sell their agencies to outsiders. But the fact is that most don't take the steps necessary for an internal plan, and their only alternative is to sell, said Tim Cunningham, founder of Optis Partners LLC, a Chicago-based consulting farm to the insurance distribution system.

"The biggest mistake principals make is that they view perpetuation or succession planning as an event, not a process; said Cunningham, himself a former insurance broker. The key components are having the right people in place, a strong financial discipline and a realistic sense of value, he said.

People are the most important. "You can't hire someone, and six months later, they're going to take over the firm," he said. "It doesn't happen overnight. Part is qualitative, some is quantitative, and part of it is maturity, fit and culture" Cunningham recommended that an owner groom four or five candidates over several years in order to decide on one or two successors.

Cunningham said owners today typically value their agencies as a multiple of revenues, a practice he describes as "the myth of the multiples." The real value is a measure of earnings before interest, taxes, depreciation and amortization. Buyers are front-ending the payment to the owner, and earnings determine how long it will take to get their cash back, he said. Two-thirds of firms are valued at five to six times these earnings, while only the superior firms are valued at more than six times. That simply means that buyers will wait five to more than six years to get back the price they paid.

Of course, those calculations assume the owner will stay on to manage the agency for a certain time. If principals were producers, it's critical that they stay because the revenue might otherwise go away, said Cunningham. Often, principals want to stay and sign employment agreements that typically last two to five years.

Al Diamond, president of Agency Consulting Group in Cherry Hill, N.J., said ongoing surveys of 3,000 to 4,000 agencies by his firm showed that the average age of agency owners in the early 1990s was 53. Last year, the average age was close to 59. "That's a serious problem," he said. "If we are going to continue the agency system, we have to get young blood into the mix."

All in the Family

Perpetuation plans still involve family members at least 70% of the time, Diamond said. "The corporate-owned agencies are the prevalent ones, the large and active ones, but you just don't realize how many small agencies there are out there." One agency owner recently told him that one of his daughters had asked about coming into the agency. Like of her generation, she saw her father working 50 to 70 hours a week and did not want to follow in his tracks." Now that they're in the business world for five or 10 years. they're looking at the kind of money he is making and kind of lifestyle he leads, and they're beginning to realize this is not a bad thing compared to the rat race they run working for Mobil Oil or for a law firm or an accounting firm," Diamond said.

Unfortunately, most agency owners are not well prepared to cash in on the equity of their businesses. Diamond said they run their businesses like a piggybank, taking money from it I and borrowing money against it, and when it's time to retire, "they're shocked when they see a tangible net worth that runs into some serious negative numbers."

What Diamond says he tries to do with them is catch them four or five years ahead of their retirement and get them to clean up their balance sheets. He also advises that they prepare their children to take over the agency. "Those children are selling insurance, serving customers or administering policies, but they never have the opportunity that daddy, has of dealing with the insurance companies and vendors and customers at a higher level until right before daddy is ready to leave," he said. "When the owner is three months from retiring, it's a little late to be starting the management-training program."

When passing the business to sons and daughters, an annuitization plan is often better than the business, paying the owner a lump sum. Instead of paying a lump sum, the children agree to pay their parents a certain amount of money each year for life. "And then the Children work around that." said Diamond. "If the parents die within a short time, then not much is paid. If the parents live for 25 years or more, the kids are paying a terrific premium, but it's for their parents, and it makes sense."

Aside from the economics, there is a whole due-diligence process to an agency sale, and it's not all on the back of the buyer. The seller rarely performs due diligence, Diamond said.

"The seller, for some reason, thinks that because someone wants to buy their agency, they are straight and honest and will treat their employees and customers with the same care that they would," he said. "They are sometimes in for a rude awakening when customers, normally their friends after 30 or 40 years, start calling and telling them how shoddily they're being treated by this new owner. And there's nothing you can do about it except escape to Florida."

Diamond said both sides of a sale should look at business practices, collection practices, at the way the other party treats employees, their company loss ratios and many other items. He uses a 20-page questionnaire to help buyers become beware and sellers to qualify the buyers on financial soundness and moral character.