Seller beware: insurance agencies that put themselves up for sale must understand the differences between being acquired by a bank, a publicly traded producer or another privately held agency.
Each of these organizations has specific characteristics and opportunities to offer an acquired agency, but agencies need to do a great deal of due diligence on a potential buyer before signing a sales contract.
Public Brokers. Of the eight largest public brokers, only Marsh & McLennan Cos. and Aon Corp., the two largest, appeared content to focus on organic growth. The others (Arthur J. Gallagher & Co., Brown & Brown Inc., USI Holdings Corp., Willis Group Holdings Ltd., Hilb Rogal & Hobbs, and Hub International Ltd.) continue to actively seek acquisition opportunities to grow their organizations with strategic purchases. Of these, Brown & Brown and Arthur J. Gallagher led the way with 15 and 12 transactions, respectively.
One of the current drivers of this phenomenon is the apparent softening of the property/casualty market after a run-up of prices following Sept. 11, 2001. If the brokers cannot achieve organic growth because of a leveling in pricing, then they will continue to look to mergers and acquisitions as a means to increase their market share. These brokers also may feel the need to continue to grow in order to compete with the two international powers of Marsh and Aon. Although a soft market may be an impetus for the public brokers to continue to do acquisitions, it may also make the smaller agencies more reluctant to sell because the acquirer will not be willing to pay as much for an entity as it would in a hard market where an immediate return on investment is more predictable.
Banks. National, regional and community banks continue to be active in the insurance agency acquisition game. Many banks are still attempting to build their insurance sales platform, while others are further down the road and are continuing a growth strategy to become national powers in the insurance brokerage arena. In the past 24 months, banks have accounted for approximately 30% of the insurance agency deal flow. BB&T Corp. leads the way in terms of the number of acquisitions, and Wells Fargo & Co., Old National Bank Corp., Bank Corp. South, Wachovia Corp. and UnionBanCal, among others, continue to be active. Banks see insurance agency acquisitions as an opportunity to increase fee income, as a strategic fit with their long-range diversification goals and as a complement to their other financial services products and/or their existing customer base. The recent trend appears to be for smaller banks and community banks to look at property and casualty agencies as they seem to be a good fit for their commercial and/or consumer lending areas. The larger banks and financial institutions are more focused on life insurance producers, whose businesses tend to fit better with a financial-planning-driven investment-products business.
For banks to compete with the public brokers, they need to continue to be acquisitive, as organic growth will not permit them to catch up to their competitors. For this reason, some banks may be willing to pay a premium over the price that public brokers will pay for an agency because they are more focused on long-run returns than the public brokers who may be more focused on an immediate bump-up in their earnings in order to satisfy shareholders.
Independent Agents. Aside from the public brokers and banks, there continues to be a rash of agency acquisitions by other privately held agencies. There are a number of reasons for this activity. With consolidation in the insurance industry, many of the smaller agencies are searching for new markets, and a combination with another agency may provide them with additional selling opportunities. Also, an acquisition or merger provides two independent agencies with an opportunity to increase their override commissions merely by combining their books of business. Lastly, many of the larger privately held insurance agencies would prefer to grow in their markets and continue to remain independent and compete with the large public brokers in their markets rather than be acquired by them.
Rules for the Seller
Traditionally in the mergers and acquisition context, one thinks of the buyer conducting due diligence on the seller. In the acquisition of insurance agencies, however, it is imperative for the selling agency to do its homework on any potential buyer and to understand the differences between being acquired by a bank or a publicly traded producer or privately held insurance agency. As previously discussed, it may well be that a bank is willing to pay more for an agency if it is attempting to develop a platform or if the agency is located in a strategic geographic region than a public broker or another agency may be willing to pay. Price is certainly not the only factor for a seller to consider, however.
If the potential acquirer is a bank, the seller needs to know what other insurance agency acquisitions the bank has completed and to attempt to find out how successful those acquisitions have been. It is important to know it the agency will be permitted to maintain its identity or if it is folded into the bank's culture or the culture of another agency previously acquired by the bank. If the bank is not going to allow the agency to continue to operate with autonomy, it may well raise concerns for the individual producers that the affiliation with the bank is hindering production rather than increasing it.
It is important for the seller to understand if the bank is truly going to open up its client base to the producers for the purposes of cross selling or if it is a one-way street where the bank is really trying to increase fee income and possibly bring in the producers' clients as bank customers. The seller should visit the bank's headquarters and meet with its staff who will be overseeing operations to fully understand the integration plans of the bank. As is the case with all acquisitions, the bank will be looking to cut costs, so the seller will want to know the bank's plans with regard to the seller's personnel after the acquisition. If the bank has already acquired other agencies, the seller should attempt to speak with the principals from those agencies to get their understanding of the transition process.
If the prospective buyer is a public broken the selling agency can be relatively confident the buyer knows its business, and the question for the seller then becomes why is the buyer interested in this agency. Is it a key geographic acquisition or is the buyer merely trying to increase revenues and planning on taking over the book of business, but not really interested in the personnel of the seller? In recent years most of the public brokers have completed a significant number of acquisitions, so it should be relatively easy for a seller to conduct due diligence on the buyer to get an understanding of how it folds a new agency into its structure.
Privately Held Agencies
Oftentimes the insurance agency transactions are private entities buying or merging with each other, and this may be for strategic reasons to compete against the large brokers and banks or just to increase market share for increased revenues from the insurance companies. In any case, many of the same questions arise in terms of due diligence that the seller must do on the buyer. The questions for agencies that are combining in the same geographic region will be ones of integration and how integration will affect personnel at the two agencies. They will also need to understand each other's insurer markets to understand the synergies and possibilities for growth going forward.
Negotiating Contract Terms
In negotiating the sale of its business, the seller must consider many factors other than price in the acquisition agreement. With respect to price, the seller will want to negotiate for as few contingencies as possible and to be able to exercise some control over the factors that will influence the calculation of any earn-out formula in the acquisition agreement. An earn-out is a payment to the seller of a portion of the purchase price over a period of time based on some benchmark to be achieved by the business. The last thing the seller wants is for the buyer to be able to diminish the earn-out calculation by employing some clever accounting practices. This means the seller will want to remain active in the operation of the business. This may or may not be a reasonable expectation depending upon how the particular buyer interprets its acquisitions. Additionally, the seller will want to do all it can to limit the amount and duration of any indemnification that it is providing to the buyer and also to limit the amount, if any, of the purchase price that is held in escrow for contingent liabilities.
Other key contract terms for the seller will be employment contracts and noncompete requirements. The seller does not want its producers to be in a position in which their books of business are controlled by the buyer and they are out of work and subject to a noncompete agreement with the buyer. The seller's staff may not be comfortable, however, with long-term employment commitments with new management in control. The seller will be best advised to engage counsel early to negotiate a letter of intent that will set out many of these terms and to negotiate the purchase agreement to ensure it has maximum protections for the seller after the closing.
Setting a Value
There are many methods that a purchaser may use to value an insurance agency. Industry analysts frequently refer to multiples of earnings or revenues as a benchmark for the potential value of an agency. Such concepts are useful for a snapshot reference point of the market value of an acquisition after it has taken place, but they are not indicative of how a seasoned acquirer formulates its purchase price. In fact, even the going-concern value of an agency (tangible assets plus intangible assets, such as goodwill) may have little bearing on the actual purchase price of an agency. The two most widely used methodologies for determining price are accretive analysis and return on equity.
Public companies often focus on an accretive analysis because they do not want to dilute shareholder value. Therefore, an acquirer looks at its own earning projections and then factors in its assumption about the target. If the merger results are neutral or there is an increase in earnings per share, then the proposed purchase price is within an acceptable range for the buyer. Many banks tend to focus on return on equity and operate their acquisition strategies based on expected rates of return on capital. Most banks look for between 10% and 15% return on their capital. For example, if an agency generates $1 million of free cash flow, then a $10 million purchase price would generate a 10% return for the buyer.
In making purchase price determinations, there are many factors that affect the purchaser beyond the revenues of the seller. There may be many friction costs associated with buying a particular seller that decrease the value for the purchaser, such as a seller with higher than average expenses or one that will have to be re-tooled to fold into the operations of a bank or broker purchaser. On the other hand, it may well be that a purchaser is willing to pay a premium for the agency if it fits into a particular niche that the purchaser wants to acquire or is of particular geographic importance. Other intangibles include the personnel associated with the agency, the agency's competitive position in its market and its growth potential. All of these involve very subjective analysis. Generally, strategic acquisitions will generate a higher purchase price than earnings driven acquisitions. There are many additional factors to consider when valuing an insurance agency, and a professional adviser with industry-specific expertise is recommended. This is true for both buyers and sellers.
M&A Outlook for 2004
All indications are that 2004 will continue to be extremely active in the mergers and acquisitions of insurance producers. With a leveling of, or possible decrease in, pricing, public brokers will face more pressure to find ways to grow their businesses to increase earnings, and national, regional and community banks are still actively pursuing fee-based business provided by insurance agencies. Some banks are just getting started, and others are in the midst of growing their agencies to compete with the largest public brokers. With approximately 30,000 independent agencies in the United States, there are plenty, of opportunities for savvy purchasers in terms of meeting geographic goals, increasing agency size and acquiring a niche player in a specific segment of the insurance industry. From the seller side, there will always be producers looking for an exit strategy ready to sell. There may also be an inclination to merge or sell now, even if it is not for the perceived top dollar, rather than miss the wave altogether.
Who's Buying Agencies?
* Arthur J. Gallagher & Co.
* Brown & Brown Inc.
* USI Holdings Corp.
* Willis Group Holdings Ltd.
* Hilb Rogal & Hobbs
* Hub International Ltd.
In the past two years banks account for 30% of agency acquisitions.
* BB&T Corp.
* Old National Bank Corp.
* Bank Corp. South
* Wachovia Corp.
Oftentimes the insurance agency transactions are private entities buying or merging with each other.
Source: Charles R. Welsh
Charles R. Welsh is a partner in the Insurance and Reinsurance Department at national law firm Edwards & Angell LLP.
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|Title Annotation:||Agent Issues|
|Author:||Welsh, Charles R.|
|Date:||Apr 1, 2004|
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