Expert Commentary

Insurance Agency/Broker Valuations Remain Uncertain

The focus of this article is to discuss the recent trends in valuation of agencies and brokers and the market's current pricing of these businesses.


Valuation of Insurance Organizations
November 2009

Several trends currently affecting the value of agencies and brokers are the current economic conditions and outlook, competition in the market, and political uncertainty. Furthermore, with regard to acquisitions, key considerations in the pricing of agencies and brokers include financing and deal structure, which have been affected by recent economic turmoil. These factors, among others, are discussed throughout this article.

Economic Outlook

The U.S. insurance market has experienced slow growth over the last several years. Public brokers have struggled to achieve organic growth since 2004, reaching just 0.4 percent in 2008. Furthermore, organic growth contracted by 0.1 percent during the first quarter of 2009.1 With revenue tied closely to the number of insurance-related transactions, the reduction in consumer transactions for new homes and new cars has negatively affected many agencies and brokers. In a difficult operating environment, public brokers look to the mergers and acquisitions (M&A) markets to achieve the growth and profitability necessary to meet Wall Street's earnings expectations.

In September 2009, Federal Reserve Chairman Ben Bernanke declared, "The recession is very likely over." Rising stock and bond markets might indicate that the economy is recovering. However, the decline in global demand for insurance and the contraction in the economy indicate that it might take several years for strong business fundamentals to return to the markets.2 U.S. personal income, a key driver of the consumer's ability to pay for insurance, fell 2.4 percent in July 2009 compared to the same month in 2009.3 As consumers have more income to spend, agencies and brokers will benefit through the sale of more policies.

Competition

Agencies and brokers are seeing more competition from new sources placing pressure on growth and profitability. Auto and term-life insurance represents the largest volume of insurance business. Insurers can sell auto and term-life insurance through the Internet, direct mail, and telemarketing. Insurance companies are also experimenting with direct mail and telemarketing. However, the majority of transactions will most likely still be processed through agencies and brokers. Nevertheless, industry experts believe that consumers will become more comfortable with these alternative marketing techniques, which could result in fewer transactions handled by brokers.4 Thus, agencies and brokers must find new ways to add value to the insurer and consumer.

Political Uncertainty

The two initiatives currently being discussed in Congress that would affect sales growth and M&A patterns are healthcare reform and capital gains taxes. The political uncertainty with regard to these issues is slowing the pace of acquisitions in the industry.

In recent months, congressional healthcare proposals have been directed at creating a public healthcare insurer. A key piece of the proposed legislation is aimed at making sure all Americans are insured. Thus, insurers would be forced to accept applicants with preexisting conditions. Consumers with limited coverage under the new proposed legislation could be in demand for supplemental health plans.5 The impact of these potential changes on growth prospects for agencies and brokers is unclear.

The other piece of proposed legislation is an increase in capital gains taxes. As the result of an acquisition, capital gains taxes are paid by the seller on the step up in the tax basis of the asset. In return for the tax liability resulting from the transaction, the seller could potentially require a greater purchase price to cover any capital gains taxes. An increase in the capital gains tax could potentially slow the pace of acquisitions.

Acquirers of Insurance Agencies and Brokers

The M&A market for agencies and brokers is characterized by three distinct buyer groups: publicly traded insurance brokers, bank-insurance companies, and private equity. Plagued by slow organic growth over the last several years, the public brokers have been active in the market to meet Wall Street earnings expectations. Among the most active buyers are Gallagher and Brown and Brown.6 Traditionally, public brokers have used debt financing as well as their own stock as large components of the consideration paid for many acquisitions. However, declining stock prices of the public brokers and the increased cost of leverage has decreased the attractiveness of these sources of capital and slowed the pace of acquisitions. While public brokers often prefer to fund acquisitions with stock, using stock as acquisition currency becomes more difficult in light of the declining stock prices. Despite these struggles, public brokers are still the most active purchasing group and should continue to be in the future.

According to Reagan Consulting, banks completed 40 percent of agency acquisitions in 2002. However, acquisitions by banks have steadily declined to just 15.5 percent of the total acquisitions in 2008.7 Increased capital restrictions on financial institutions is one of the driving forces behind the slowed M&A activity. While a majority of the buyouts were concentrated among several banks in 2007 and 2008, these banks have been shedding their insurance operations to focus on core operations.

Private equity investors were also actively involved in the acquisitions of insurance agencies during 2006 and 2007. However, activity declined during 2008 and 2009 in conjunction with the deterioration of the financial markets. Private equity funds prefer to use debt financing to fund acquisitions to generate enhanced returns to equity holders. However, given the increased cost of financing and the limited availability of debt to fund acquisitions, potential deals have become less attractive for private equity groups. Illustrating this trend, the number of acquisitions by private equity firms declined from 702 during the second quarter of 2007 to 188 during the first quarter of 2009.8

Given the difficulty in obtaining debt financing, the increased cost of leverage, and the relatively depressed stock prices of public brokers, all three buyer groups have had a difficult time financing acquisitions in the recent past.9

Structure of Purchase Consideration for Transactions

Transactions in the industry are typically structured through a combination of guaranteed prices and contingent consideration, such as earn-outs. The guaranteed component represents the amount that the seller receives at closing regardless of future performance. The contingent component represents the additional consideration that the seller will receive if certain performance targets (typically based on revenue, earnings before interest, taxes, depreciation, and amortization (EBITDA), and net income) are achieved. Generally, earn-outs range from 1 to 3 years in term.

According to Reagan Consulting, guaranteed payments are down approximately 10 percent from the highs of 2007. The typical guaranteed price was approximately 6.5 times EBITDA during 2007 and has fallen to approximately 5.75 times EBITDA.10 Guaranteed transaction multiples have fallen as a result of declining growth and profitability, falling stock prices of public brokers, and the difficulty of obtaining financing. Additionally, the expected consideration from earn-outs has fallen in recent years due to economic uncertainty. Sellers have doubt with regard to their ability to meet specified performance targets.

The guaranteed and contingent portions of the purchase price have both fallen compared to levels in 2006 through 2008. However, valuations appear to have returned to levels that were exhibited prior to 2006.11

Current Valuation Trends

Below is a group of publicly traded companies (the "Industry Group") that are representative of the agency and broker segment of the insurance industry.

  • Arthur J Gallagher & Co. ("AJG")
  • Aon Corporation ("AOC")
  • Brown & Brown ("BRO")
  • Marsh & McLennan Companies, Inc. ("MMC")
  • National Financial Partners Corp. ("NFP")
  • Willis Group Holdings Ltd ("WSH")

Industry analysts typically reference enterprise value12 (EV)-to-EBITDA multiples when discussing valuation metrics for the insurance brokers and agents.13 Figure 1 presents a current snapshot of latest 12 months (LTM) EBITDA multiples based on data provided by Capital IQ. The LTM EBITDA multiples shown in Figure 1 are based on the Industry Group's EBITDA for the LTM 12 months ended September 30, 2009. The range of EBITDA multiples is wide, with AJG having the highest multiple of 10.3 times and NFP having the lowest multiple of 4.9 times. The average LTM EBITDA multiple for the Industry Group was 8.4 times.

Figure 1:

LTM EV/EBITDA Multiples Based on LTM as of Sept. 30, 2009 Graph

With the exception of NFP, the Industry Group trades in a fairly tight range of approximately 8.0 times to 10.5 times EBITDA. These differences can be attributable to a variety of factors. One factor affecting LTM EBITDA multiples is future growth prospects. AJG and BRO have strong growth prospects because these two industry players have been active in acquisitions of smaller brokers.

Another salient factor impacting valuations is leverage. Debt-to-total capital ratios (a measure of leverage) for the Industry Group companies ranged from 8.6 percent to 46.0 percent. While leverage could be an indication of strong growth through acquisitions, it could also provide a signal that too much risk has been taken and that equity holders face potential dilution. As noted previously, NFP traded at a much lower multiple than the other constituents of the Industry Group, likely because of the leverage NFP took on to fund its aggressive acquisition strategy.14 NFP has recently experienced difficulties in meeting its interest payments and operated with negative net income in the LTM. Accordingly, the company's stock price per share fell from $52.98 at the end of the third quarter of 2007 to $8.72 at the end of the third quarter of 2009.

In determining an appropriate multiple for a privately held agency or broker, an analyst might start by analyzing the firm's growth, profitability, and leverage relative to the Industry Group. Additionally, other risk factors specific to the agency or broker are typically considered, each of which must be carefully evaluated to determine its impact on value.

Figure 2 presents the trend in the LTM EBITDA multiples for the Industry Group since the first quarter of 2006. Similar to the overall stock market performance, the average multiples have been volatile over the past 14 quarters with a high of 11.9 times and a low of 7.4 times LTM EBITDA. Multiples remained above 10.0 times through the end of 2007 correlating with strong economic activity and consumer spending. After declines between late 2007 through the first quarter of 2009, the average LTM EBITDA multiple for the Industry Group expanded during the second and third quarter of 2009, consistent with the overall stock market recovery. Although current valuations have shown an upward trend recently, multiples are still lower than those realized between 2006 and 2008.

Figure 2:

LTM EV/EBITDA Multiples Graph

Conclusion

Public broker multiples have experienced an expansion over the past few quarters. Although the stock and bond markets saw a recovery during the second and third quarters of 2009, the outlook for the industry is still uncertain. Industry experts believe that it could take up to several years for business fundamentals to return to prior levels. Public brokers, the most active buyer group of agencies and brokers, will look to fuel growth through acquisitions in the future. However, downward pressure from new sources of competition and proposed legislation could potentially make acquisitions less attractive. While the outlook for valuations is uncertain, stabilization of the economy and capital markets will likely have a positive influence on M&A and trading multiples for agencies and brokers of all sizes as valuations return to historical levels.


1Reagan Consulting, "Down But Not Out: The M&A Marketplace for Insurance Agencies and Brokerages in 2009." p. 9-10.

2Robert P. Hartweig, "Information Institute, 2009: First Half Results."

3First Research, "Industry Profile: Insurance Agencies," October 5, 2009.

4Ibid.

5Ibid.

6Reagan Consulting, "Down But Not Out: The M&A Marketplace for Insurance Agencies and Brokerages in 2009." p. 9.

7Ibid. p. 10.

8Ibid. p. 13.

9Ibid. p. 6-7.

10Ibid. p. 15.

11Ibid.

12Enterprise value represents of debt, equity, and minority interest less cash and cash equivalents.

13Robert J. Lieblein, Insurance M&A Insights 2007 Industry Sourcebook. (Cincinnati: The National Underwriter, 2007).

14Reagan Consulting, "Down But Not Out: The M&A Marketplace for Insurance Agencies and Brokerages in 2009." p. 10.


Opinions expressed in Expert Commentary articles are those of the author and are not necessarily held by the author's employer or IRMI. Expert Commentary articles and other IRMI Online content do not purport to provide legal, accounting, or other professional advice or opinion. If such advice is needed, consult with your attorney, accountant, or other qualified adviser.

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