Barring an unforeseen event as disruptive as COVID-19 was this past spring, and being optimistic that a winter wave of the pandemic is contained, 2021 looks to be a hopeful year for independent insurance agencies. Agencies have weathered the pandemic storm remarkably well thus far and have demonstrated that they can adapt to grow both organically and inorganically in the coming year.
In 2020, independent agents proved once again how versatile and resilient their business model is, and the property/casualty market, with a few exceptions, held up during one of the biggest economic dislocations in modern history.
Make no mistake, the pandemic has changed the way we work and do business, and it has laid low far too many parts of our economy. But its impact has been uneven, and overall it hasn’t led to the downturn for the insurance business that many feared.
Let’s consider a few areas where the pandemic has had—or more accurately, hasn’t had—an effect on agency values and how that may shape activity in 2021.
Mergers and acquisitions are still on a tear
There simply hasn’t been the slowdown in agency acquisitions some expected earlier this year. While there was a lull in M&A activity in April and May, acquisitions quickly picked up in June, according to Reagan Consulting. Many owners are still looking to sell, and there are plenty of buyers out there. In fact, it seems buyers have only increased their appetite for agencies and books of business. Late in the year, there are also many hints of tax-motivated selling on the part of some business owners, reminiscent of 2012.
Reasonable people may differ over whether agency owners should perpetuate internally or sell to an acquirer, but ideally everyone can agree that when competition remains keen for agencies, it’s a good sign for the industry. Here are eight reasons why we’re seeing healthy M&A activity:
- Interest rates are historically low and will likely stay that way for some time. Inexpensive capital fuels borrowing and agency acquisitions. Quite simply, low rates drive transaction activity and fuel higher value multiples. It’s important to understand that this downturn is quite different from the one in 2008, when credit markets dried up. Getting capital today is not a problem.
- Agencies are performing better than expected. Most of the agency owners we talk to are optimistic about business. It’s true that some markets such as hospitality, entertainment and transportation are suffering, but agencies rarely have all of their business in one industry. Looking at the numbers compiled by Reagan for the industry as a whole, we can see that agency sales velocity, organic growth and profitability have all been stronger than expected.
- Agency values have held up extraordinarily well. Despite most other service sectors in the economy being battered by the pandemic, there hasn’t been any real deterioration in agency cash flow and related agency values. Prices haven’t dipped. Well-run, well-positioned agencies are always in demand, now more than ever.
- Markets are hardening for some lines of business. This provides a built-in cushion for agencies. While agencies may be writing fewer policies, those policies are commanding higher premiums, and that means enhanced commission income.
- The economy is holding steady. Unemployment is quite high in some sectors, but GDP appears to be rebounding. Consumer spending has picked up in the goods sector with the hope of a steady rise in the larger services sector as well. The housing market has been a bright spot, with first mortgages and refinance loans off the charts. Construction also is holding up.
- The demographics of agency ownership haven’t changed. Owners are still getting older, and that means more agencies will be changing hands. Low interest rates make these transactions even more appealing. The pandemic is also motivating sellers who’ve been sitting on the fence. With valuations and prices holding up, these owners have decided to call it quits sooner rather than later. They’ve grown weary of the current uncertainty and just want to cash out.
- Cash flow always reigns supreme. Predictable, sustainable cash flow derived from steady premiums is what powers organic growth. Smart agency principals are finding ways to more efficiently produce revenue and minimize expenses, and they’re now willingly leveraging technology to increase growth opportunities, particularly those that are arising from the pandemic.
- Tax policy may spur even more transactions. Elections often bring changes in fiscal policy, and we likely will see changes to the tax code. If there is an increase in the capital gains tax, expect a rush in sales transactions timed to beat the effective date of the tax change.
Several factors are converging to create the perfect storm for agency acquisitions in 2021: plenty of inexpensive capital, willing sellers who want to retire, aggressive buyers who want to take advantage of the market, relatively high values, and tax uncertainty that may accelerate activity if capital gains taxes go up.
Owners who are a few years away from retiring can have the best of both worlds if they sell part of their business now and the rest later. Such staged exit strategies will continue to gain traction in 2021, with owners choosing to cash in on some of the upside of their agency’s value but still retain control of their business.
A typical scenario would be for a seller to identify a next-generation owner such as the agency’s top producer. The current owner might agree to sell 30% to the producer now and the remaining 70% three to five years later. In the interim, the current owner continues to earn income, retain control and participate in the agency’s growth.
Consumer demand for digital interaction
During the height of the pandemic, McKinsey & Company observed that “we have vaulted five years forward in consumer and business digital adoption in a matter of around eight weeks.” We all learned to work remotely and access services online. From ordering restaurant meals and groceries on the internet to telemedicine and online classrooms, Americans are quickly shifting to a new way of life.
The insurance industry is no exception. Personal lines customers and small business owners are looking for easier ways to connect with their agents. These same clients can interface digitally with banks and brokerage firms; now they have the same expectation for insurance providers. Consumers seek convenience because that’s the way business will get done in the future.
Agencies are also learning that there is a difference between innovation and agility. New technology isn’t enough if you can’t adapt and respond quickly to changing events. Digital collaboration tools are becoming the new normal and will remain in place long after the pandemic is behind us.
Bricks and mortar aren’t going to be as important, either. Customers are able to use their smart phones to power their banking relationships, so why not their insurance relationships, too? Nimble agencies that invested in technology and automation, new agency management systems and remote conferencing capability will be able to ride the innovation wave to achieve greater efficiencies and capture new business.
In 2021, agency owners will need to hold onto their best people with both hands. The battle for agency talent predates the pandemic, but remote working arrangements and greater mobility will make retaining good people even more challenging. A recent study by Cisco found that companies have 4.7 times more home workers now than before the pandemic. Agents are no longer limited by geography and can sell remotely from anywhere.
Agencies must adapt to a changing workplace where remote employees are trusted to get their jobs done, empowered to work flexible schedules and encouraged to form collaborative work groups tied to specific projects. Owners, too, must find creative ways to keep their top producers, perhaps by offering them the ability to become an owner of the agency over time.
Stress test your agency for the future
Banks regularly stress test their balance sheets to see how they would perform in a financial crisis. This ensures that the financial system has enough capital to withstand an economic shock. You can use this same concept to stress test your agency.
Look back on the year and examine your business. How did you handle the stress of the pandemic? What impact will you see on your business going forward, and how will that affect your financial well-being?
It helps to identify your strengths and weaknesses. Are there areas where you can trim expenses? Are there new markets you can enter to replace income you’ve lost from accounts you no longer have? Do you need to invest in new software or upgrade your management system? Do you have the right personnel to meet your goals for 2021?
Agencies that keep up with technology, modernize their operations, retain top producers and perfect their marketing will be well positioned for the coming year. To quote William Wordsworth, “Let us learn from the past to profit by the present, and from the present to live better in the future.” In 2021, the successful agencies will be the ones that can profit from the current uncertainty and find new opportunities to grow in the future.
About the Authors
David Tralka is president and chief executive officer of InsurBanc, a division of Connecticut Community Bank, N.A.He is responsible for keeping the bank focused on being an innovative provider of financial products and services for the independent agency community. An expert on agency mergers and acquisitions, agency perpetuation and financing, he has presented at numerous venues nationwide.
Robert Pettinicchi is executive vice president and chief lending officer for InsurBanc. He developed and continually monitors InsurBanc’s loan policies and designed the bank’s lending products for independent agents. He is also an expert on agency mergers and acquisitions and agency perpetuation and financing, and has presented at numerous venues nationwide.