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Valuation of Insurance Organizations

Financial Institution Acquisitions of Insurance Agency Platforms

Jeff Balcombe | May 1, 2007

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The insurance merger and acquisition (M&A) landscape has been greatly affected by the entry of financial institutions into the industry. Not only have banks provided agencies owners with higher acquisitions prices, but they have also become major players in the insurance industry.

With the passage of the Financial Services Modernization Act of 1999 (or Gramm-Leach-Bliley Act), banks and other financial institutions were given the opportunity to enter into new lines of business including insurance, securities underwriting, and merchant banking. This new-found freedom provoked an explosion of mergers and acquisitions as banks set their sights on the insurance industry.

Although banks have found earnings in the underwriting segment of the insurance industry to be highly volatile, they have acknowledged that insurance distribution could be both lucrative and more stable. Consequently, banks have executed a total of 426 acquisitions of insurance agencies and brokers since 2000. 1 Over the past several years, the insurance operations managed by banks have performed very well. According to the 2006 addition of Who's Who in Bank Insurance by the Bank Insurance Market Research Group, 25 of the top 100 brokers in the United States are owned by banks. 2 In summary, banks have had a large effect on the insurance distribution industry over the past several years.

Strategic Drivers

In analyzing trends in insurance agency and broker acquisitions, transactions are typically divided into four categories including bank acquisition of platform agency, bank acquisition of secondary agency, public broker acquisition of agency, and privately held agency acquisition of agency. Arguably, the transaction type that has had the greatest effect on the insurance industry is a bank acquiring a platform agency.

Typically, banks do not have the internal capabilities or expertise needed to build and manage an insurance agency. As such, banks that wanted to expand into the insurance industry in the wake of the Financial Services Modernization Act of 1999 had to acquire a "platform agency" as a foundation on which to build their insurance operations. A platform insurance agency typically will have "a well-established territory, brand name recognition, seasoned professionals, ample markets, and scalable infrastructure." 3 Considering that the acquired agencies typically have superior knowledge with regard to insurance, banks usually maintain the agency's operations as they were prior to the transactions and often allow the agency to remain mostly independent. However, banks utilize cross-selling with current banking customers to enhance growth. In addition to platform agency acquisitions, banks have acquired agencies to supplement their platform agencies (known as "add-on" or "revenue" acquisitions), which has also been a contributor to the volume of M&A activity between banks and insurance agencies.

M&A Trends

Although banks remain very interested in the insurance industry, bank acquisitions of agencies have slowed over the past several years. For the years 2000 to 2006, the number of bank acquisitions of agencies (not limited to platform agency acquisitions) per year was 84, 63, 71, 55, 50, 48, and 55. Additionally, financial institutions represented 21 percent of total transactions in 2006, which was the lowest since 2000. 4 An eventual decline is to be expected considering that there is a finite number of agencies that are available to be acquired.

The decrease in M&A activity exhibited in the data may not be solely attributable to a lack of supply in agencies, however. In fact, there are several additional reasons for such declines. First, there has been stabilization and softening in product rates, which would likely make fewer acquisitions appear to be good investments. Another reason is that over 50 percent of banks involved in insurance distribution have already purchased their platform agency or agencies. In addition, banks have taken a step back to focus on integrating their platform agencies. Increased competition for acquisitions resulting from a narrower purchase price differential between banks and public brokers has also led to decreased deals in recent years.

Typically, banks pay a higher price for agencies than public brokers; however, public brokers are much quicker at closing deals. Considering this, if banks offer a high enough price, agencies will be enticed to wait longer to close the deal. But, with a narrowing purchase price differential, this incentive has declined resulting in greater competition for agency acquisitions between banks and public brokers. Also, banks have needed to focus on internal controls and disclosure associated with Sarbanes-Oxley which has put a damper on banks' ability to execute transactions. Finally, privately held agencies have been adept in finding add-on agencies to expand their operations. 5

Although activity has declined, some industry analysts state that "pipelines are filled with discussions, but fewer deals are being closed." 6 The slowdown can be credited to three phenomena. First, there are fewer candidates available due to the robust consolidation in recent years and because banks have become more discriminating. Consolidation has removed most of the attractive agencies that really wanted to be bought. Remaining agencies are generally more interested in being independent. Second, because contingent income for agencies has been high in recent years, many agencies see no reason to sell considering that they are already demonstrating high performance. The final phenomenon is, as noted earlier, increased competition. In recent years, public brokers have been a source of fierce competition against banks for agencies. 7

In summary, bank acquisitions of platform agencies have slowed and are likely to continue to be slow as many banks have already acquired their platform agency or agencies. In addition, banks are taking time to integrate their acquisitions from the past several years. While 2006 displayed some platform agency acquisitions, most acquisitions of agencies were to fill existing geographic markets or expand existing operations. Add-on or revenue agency acquisitions should persist considering the banking industry's interest in building its insurance capabilities.

In general, bank acquisitions of agencies are driven by a need to offset declining product rates, acquire new talent, and expand into new market of product lines. In addition, banks seek involvement in the insurance industry as a means to diversify into less volatile sources of noninterest income. Also, banks are able to utilize cross-selling to their existing customer base, and insurance allows banks to offer a broader array of products and services. As such, banks are likely to remain as a player in M&A activity in the insurance industry.

Valuation Drivers

Valuations are driven both by the motivations of the particular buyer and seller involved as well as by industry and macroeconomic trends. Platform acquisitions occur because banks do not have the capability or expertise to build or manage an insurance agency. As such, banks are often willing to pay a premium for "expertise, management, sales force, and infrastructure of a well-managed, high-performance agency." 8 Typically, platform agencies are high performers relative to their peers, and, as such, they are not in great supply. As a result, banks often pay higher multiples in platform acquisitions than in add-on acquisitions. Additionally, banks tend to have a lower cost of capital which enables them to pay higher prices while still earning their required return. A multiple is a representation of the amount paid for the agency divided by some earnings figure such as earnings before interest, dividends, depreciation, and amortization (EBITDA). The following chart illustrates the higher EBITDA multiples paid by banks for platform agencies than add-on agencies.

EBITDA Multiples Chart

Although banks pay higher multiples for their platform acquisitions, subsequent acquisitions usually have multiples that are similar to what a public broker would pay. Typically, acquisitions at EBITDA multiples of 8 or above involve larger entities such as agencies with $5 million or greater in revenue and/or an acquiring bank with $10 billion or greater in assets, and are structured as asset purchases. In addition, platform acquisitions are only valued at less than 7 times EBITDA in smaller deals such as a community bank buying a local agency. 9 While these are the typical multiples paid in their respective situations, multiples are determined based on several key valuation drivers.

Over the past several years, the levels of supply and demand and platform acquisitions have greatly affected the overall multiples of insurance agencies. As organic growth rates have declined, both banks and public brokers have turned to acquisitions to fuel their growth, thus creating high demand for insurance agencies. In addition, due to the volume in M&A activity in the past, the supply of high performance agencies has decreased. These two effects can lead to higher multiples.

In contrast, fewer platform acquisitions have pushed overall multiples down. In all, the downward effect of fewer platform acquisitions has been stronger than the upward effect of supply and demand resulting in lower overall multiples. With regard to individual agency valuation, there are several key drivers that influence multiples, including number of policies, number of customers, pricing, relationships with customers, relationships with brokers and wholesalers, size of available markets, and commission rates. In addition, an agency that exhibits success on variable commissions typically demands a higher multiple.

In summary, integration strategies are being created and implemented, and beginning to prove successful. As such, banks will likely continue to be active acquirers in the insurance industry, although much of this will be for the purpose of expanding already developed insurance platforms. With the slowdown in platform agency acquisitions, agencies will likely see multiples that are similar to offers from public brokers; thus a gradual decline in valuation multiples may be expected.

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1 Lieblin, Robert J., Insurance M&A Insights: 2007 Industry Sourcebook (Cincinnati, Ohio: The National Underwriting Co., 2007), 50.
2 Ibid., 5-6.
3 Ibid., 39.
4 Ibid., 55.
5 Ibid., 55.
6 Campbell, Jim, "Are Banks Losing Interest in Agency Deals?" National Underwriter: Property and Casualty 28 (Aug. 2006): 34.
7 Ibid., 34.
8 Lieblin, 39.
9 Ibid., 61.