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Mercer Capital's Valuing Insurance Agencies

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Like most professional services firms, much of the value of an insurance agency lies in its customer base, workforce, and the intangible factors that drive growth and margin. But not all insurance agencies are created equal. The recurring revenue streams, low fixed asset intensity, and favorable financing characteristics have drawn the interest of industry consolidators, private equity investors, financial institutions, and other participants, leading to a robust transaction environment. Join Lucas as he reviews the valuation methodologies and drivers of value for insurance agencies and brokerages.

Published in: Economy & Finance
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Mercer Capital's Valuing Insurance Agencies

  1. 1. Valuing Insurance Agencies Lucas M. Parris, CFA, ASA Vice President, Mercer Capital parrisl@mercercapital.com January 19, 2016
  2. 2. Contents Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 2 Background and Industry Landscape Key Value Drivers How are Insurance Agencies Actually Valued? Case Studies Other Valuation Considerations Q&A
  3. 3. A Little Insurance Jargon •  Agent typically represents the insurer, rather than the insured. •  Broker typically represents the interests of the insured, rather than the insurer. Agent/Broker •  Agency commission = agency share of insurance premium, typically recorded as revenue. •  Producer commission = producer’s share of the agency commission Commission •  Amount charged by an insurer to provide coverage. Typically recorded as revenue by the insurer.Premium •  Common term for an agent, broker, or other insurance representative who sells insurance.Producer Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 3
  4. 4. Where Do Agencies Fit? Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 4 Insurance Carriers •  Price and underwriting risk •  Investment management Insurance Agencies & Brokerages •  Intermediaries •  Commission/fee based income Insureds •  Pays premium •  Insures against risk
  5. 5. Types of Insurance Agencies •  Develop product, file rates with regulators •  Collect premiums, service policies, pay claims Insurance Carrier •  Contracted through a single carrier •  Example: State Farm, Allstate Captive Agency • Intermediary b/w Carrier and the Insured • Binding, underwriting, pricing authority Independent Managing General Agency (MGA) •  Intermediary b/w retail agent and carrier •  Typically no contact with insured Independent Wholesale Agency •  Intermediary b/w the insured and marketplace •  Relationships with one or more carriers Independent Retail Agency Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 5
  6. 6. Overview of the Insurance Market Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 6 Property & Casualty ≈ 50/50 PL/CL Auto Home Commercial lines Workers’ Comp. Marine Financial/Mortgage Life & Health Individual Annuities Individual Life Group Annuities Group Life Accident/Health Other Net Premiums Written, 2014, U.S. entities, in billions Source: SNL Financial and Insurance Information Institute
  7. 7. Property & Casualty Insurance Cycle Premium rates begin to fall as companies compete for market share Prices fall until profits eliminated or capital is depleted Fewer companies writing business, more stringent underwriting Supply of insurance limited, leads to rising prices Prospect of rising prices and higher profits attracts more capital Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 7
  8. 8. Insurance Cycle in Perspective Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 8 -20% -15% -10% -5% 0% 5% 10% 15% 20% 25% 30% 35% 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Quarterly Average Composite Rate Change for Commerical Insurance (Yr/Yr % Change) Source: MarketScout (Q3'01 - Q4'15), Mercer Capital analysis Rate increases begin slowing in Q2'13... Flat-negative since December 2014
  9. 9. Commercial vs. Personal Lines Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 9 -5.0% -2.5% 0.0% 2.5% 5.0% 7.5% 10.0% 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 Quarterly Average Composite Rate Changes Commercial Lines Personal LinesSource: MarketScout (Q1'12 - Q4'15), Mercer Capital analysis
  10. 10. Some Lines Are More Volatile Than Others… Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 10 -8.0% -6.0% -4.0% -2.0% 0.0% 2.0% 4.0% 6.0% 8.0% 10.0% 12.0% 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 Commercial Insurance Rate Changes by Line of Business Workers' Comp Commercial Property D&O Liab.Source: The Council of Insurance Agents & Brokers
  11. 11. And Account Size Matters, Too… Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 11 -6.0% -4.0% -2.0% 0.0% 2.0% 4.0% 6.0% 8.0% 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 Commercial Insurance Rate Changes by Account Size Small Accts. (<$25K) Med. Accts. ($25K-100K) Large Accts. (>$100k) Source: The Council of Insurance Agents & Brokers
  12. 12. Robust Transaction Environment Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 12 0 50 100 150 200 250 300 350 400 450 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Insurance Brokerage Transactions (2001 - 2015) Private Equity Deals All Deals Ex-PE Source: SNL Financial (as of 1/14/16). Includes all states, completed transactions only.
  13. 13. Public Broker Valuations Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 13 Average (last 10-years) = 10.8x 11.5 12.2 10.3 13.5 12.0 9.5 11.2 8.1 10.4 9.3 9.6 12.2 12.2 12.5 12.9 0.0 2.0 4.0 6.0 8.0 10.0 12.0 14.0 16.0 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 9/30/15 12/31/15 Enterprise Value / LTM EBITDA Source: SNL Financial. Includes AON, AJG, BRO, MMC, WLTW
  14. 14. Key Value Drivers Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 14
  15. 15. Caught in the Middle? Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 15 Insureds Local/Macro Economy Employment Growth/risk Industry Insurance Agencies Market/Niche Relationships People Culture Underwriting Cycle Investment Climate Capital Insurance Carriers
  16. 16. Carriers: Pressure from the Top Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 16 Market Cycle Investment Climate Capital Product/Niche Growth Strategy Regulatory Issues Impact on Agency Supply Side issues Typically Outside of Agency Control
  17. 17. Insureds: Pressure from the Bottom Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 17 Local Economy Unemployment Industry Competition Profitability Risk Aversion Impact on Agency Demand Side Issues Typically Outside of Agency Control
  18. 18. Macro Events Impact Exposure Units Employment levels Business and capital spending Population growth and density Home ownership rates Motor vehicle registrations Per capita disposable income Healthcare expenditures Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 18
  19. 19. Impact of Catastrophes and Weather Catastrophes (CATs) include Natural disasters (hurricanes, winter storms, tornados, wildfire, earthquakes) Man-made disasters (terrorism, fire, maritime, aviation, explosions) CATs and non-CAT events trigger claims, impacting insurer capital levels, pricing, and coverage availability Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 19
  20. 20. Diversification P&C Employee Benefits Wealth Management Life & Annuities Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 20 The Grass is Always Greener on the Other Side
  21. 21. Key Value Drivers of Agency Value Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 21 Industry Conditions Local/Macro Economy Cash Flow Growth Risk
  22. 22. Revenue Expenses Profitability Growth Headcount Efficiency Metrics Concentrations Management Experience & Depth Succession Planning Employee Relationships Agency Culture Brand Value History Community Involvement Key Value Drivers of Agency Value Quantitative Qualitative Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 22
  23. 23. Management and Employees How is the agency managed day-to-day? Are executives also producers? Key-man issues Succession planning Management depth Compensation policies Commission structure Producer development Training and support Non-compete agreements Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 23
  24. 24. Products and Markets All lines to a particular industry or a specialty line to all industries? Diversification vs. product focus Growth for today or tomorrow? Product innovation Complementary lines Differentiating factors? Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 24
  25. 25. Sales and Marketing How do you get new clients? Advertising Referrals Cold-calling Cross-selling Producer incentives Community involvement Sales culture Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 25
  26. 26. Acquisition History Has the agency completed prior acquisitions? Businesses or books? Pricing and terms Integration success? New client retention Employee retention Carrier retention Contribution to growth Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 26
  27. 27. Customer Relationships Who holds the relationship? Customer retention and attrition Related parties Concentrations by line, customer, industry, geography? Servicing customers Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 27
  28. 28. Competition Market share in your area? Local/regional/national? Compete on what – price, service, access to coverage, reputation? Technology Websites and portals It’s not just the agency down the street… Direct carrier sales models Competition for talent Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 28
  29. 29. Introduced in March 2015 Online price-comparison insurance broker Started with personal auto in CA, now in other states Founded in 2014 – Raised $21M+ (through Jan’16) Online price-comparison insurance broker “Insurance help without the insurance agent” Currently offers term life, renters, long-term disability, pet Threats on the Horizon? Google Compare PolicyGenius Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 29 Disruptors to the Traditional Business Model or just a Fad?
  30. 30. Lemonade: The Uber of Insurance? U.S. startup aims to be the first peer-to- peer insurance underwriter Raised $13 million seed round from Sequoia Capital in Dec. 2015 Awaiting state regulatory approvals Business model not yet disclosed “Mobile-first experience” Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 30
  31. 31. Key Value Drivers – Pro Forma EBITDA Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 31 Why look at Pro Forma EBITDA? Ongoing revenue Scrutinize expenses Compensation policies Non-recurring items Reinvestment
  32. 32. Examining Revenue Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 32 Core Commissions and Fees Direct revenue from insurance policies sold Excludes contingent/ bonus commissions Often normalized for multi-year policies Not all Revenue is Created Equal
  33. 33. Examining Revenue Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 33 Core Commissions and Fees Gross or net of agent commissions? Impact of one-timers? P&C vs. life commissions Not all Revenue is Created Equal
  34. 34. What about Contingent Commissions? Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 34 CCs are profit-sharing commissions from carriers Alternative arrangement is “Guaranteed Supplemental Commissions”, not tied to loss ratios May be based on Underwriting results Volume Growth Policy retention Other Examine sources and history of CC Normalize to multi- year average? Exclude? Weren’t These Things Regulated Away?
  35. 35. Sources of Revenue Growth Total Growth Organic Growth Price (Rate) Volume (Exposure Units) Acquisition- Based Growth Revenue Mix Timing Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 35
  36. 36. Projecting Revenue Growth Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 36 How did you grow? Did a rising tide lift all boats? Context of eco, rate, volume Is the past relevant? Drivers of future growth? Why pay for past growth? Historical Future My Crystal Ball Appears Cloudy…
  37. 37. Public Company Growth Rates Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 37 Not all Revenue Growth is What is Seems… 8% 3% 2% 5% 13% 8% 8% 11% 0% 1% -2% 0% 2% 4% 4% 4% -4% -2% 0% 2% 4% 6% 8% 10% 12% 14% 2007 2008 2009 2010 2011 2012 2013 2014 Average Total vs. Organic Revenue Growth Total Growth Organic GrowthSource: SNL Financial. Includes average for AON, AJG, BRO, MMC, WLTW
  38. 38. Examining Expenses Like most professional services firms, the largest line item expense is people Like some professional services firms, always issues of owner/manager compensation Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 38
  39. 39. Owner/Manager Compensation Are owners/managers the same? Agency structure might influence compensation policies (S-corp, C-corp) Are owners also producers? Pro forma expense structure should properly account for all labor in the P&L Adjust via compensation studies, agency benchmarks, other sources Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 39 Returns on Capital vs. Returns on Labor
  40. 40. Producer Compensation Compensation via commission, salary, or both? Typical structures (new/ renewal) 30/20 40/20 Different terms for different people? Does agency pay travel, meals, entertainment, etc? Non-competes? Who owns the book? Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 40 Producers are Often the Highest Paid Individuals in the Agency
  41. 41. Other Expense Items Owner-related discretionary items Non-recurring expenses Potential Synergies (depending on the context) Professional fees Rent expense Marketing/advertising Corporate functions Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 41 Similar Considerations as for Other Professional Service Firms
  42. 42. Pro Forma EBITDA For a fast-growing agency, might be based on normalized last twelve months For a slower-growing, but profitable agency, might consider multi-year perspective For cyclical, volatile, or unprofitable agency, use appraiser judgment… Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 42
  43. 43. Margins in Perspective Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 43 Is your Agency Middle of the Pack or Above Average? 0% 5% 10% 15% 20% 25% 30% 35% 40% 2010 2011 2012 2013 2014 EBITDA Margin Comparison Public High Public Avg. Public Low RMA ($1-3mil) RMA ($25+ mil) Source: SNL Financial, RMA, Mercer Capital analysis. Public group includes AON, AJG, BRO, MMC, WLTW
  44. 44. How Are Insurance Agencies Actually Valued? Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 44
  45. 45. Like Most Appraisals… Different levels of value for different purposes External sale Internal perpetuation Buy-Sell planning ESOP valuation Estate/gift tax planning Other Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 45
  46. 46. Cash Working Capital Computers and Equipment Furniture and Fixtures Building? Assembled workforce Customer Relationships Carrier Relationships Trade name Software Technology Goodwill Asset Approach Tangible Assets Intangible Assets Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 46 Rarely Used for Insurance Agencies
  47. 47. Market Approach Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 47 Active M&A market Lots of activity but little transparency Few “pure” public brokers Potential for comparability issues re: size, diversification, growth, etc… Guideline Public Companies Use with caution… Guideline Transactions
  48. 48. Guideline Transactions Method Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 48 0 50 100 150 200 250 300 350 400 450 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Insurance Brokerage Transactions (2001 - 2015) Private Equity Deals All Deals Ex-PE Source: SNL Financial (as of 1/14/16). Includes all states, completed transactions only.
  49. 49. Guideline Transactions Method Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 49 ~440 reported deals in 2015 Filter by focus (P&C, L&H, etc…) Filter by size Deal value disclosed? Deal multiples disclosed? ?
  50. 50. Guideline Transactions Method Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 50 0% 10% 20% 30% 40% 50% 60% 70% 80% 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Agency Transaction Earn-Out Trends Source: SNL Financial, Mercer Capital analysis. Includes deals wth reported (and classified) deal consideration. % of Deals with an Earn-Out Earn-Out as a % of Total Deal Consideration
  51. 51. Guideline Transactions Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 51 Rules of thumb and anecdotal multiples are just that Quality of the opinion only as a good as the underlying data With the right data in the right context, this method can be very compelling But my Buddy Sold his Agency for 8x EBITDA?!?
  52. 52. Guideline Public Companies Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 52 There are Comps. But are They Comparable? 11.5 12.2 10.3 13.5 12.0 9.5 11.2 8.1 10.4 9.3 9.6 12.2 12.2 12.5 12.9 0.0 2.0 4.0 6.0 8.0 10.0 12.0 14.0 16.0 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 9/30/15 12/31/15 Enterprise Value / LTM EBITDA Source: SNL Financial. Includes AON, AJG, BRO, MMC, WLTW
  53. 53. Guideline Public Companies Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 53 Public Brokers are Large and Diversified Company Market Cap. LTM Revenue EV / LTM Rev. EV / LTM EBITDA Marsh & McLennan Cos Inc $29.0 $12.8 2.6x 12.1x Aon PLC 25.3 11.7 2.7x 13.5x Willis Group Holdings PLC 8.7 3.8 nm nm Arthur J Gallagher & Co 7.2 5.3 1.8x 13.3x Brown & Brown Inc 4.5 1.6 3.4x 11.5x Average $14.9 $7.1 2.6x 12.6x Median $8.7 $5.3 2.6x 12.7x Source: Bloomberg, as of Nov. 30, 2015. US$ in billions.
  54. 54. Guideline Public Companies Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 54 How do Growth and Margin Compare to our Subject Company? EV / EBITDA Rev. Growth EBITDA Margin Company LTM '16E '15E-'16E LTM '15E '16E Marsh & McLennan Cos Inc 12.1x 11.0x 4.5% 22% 22% 23% Aon PLC 13.5x 11.4x 3.1% 20% 22% 23% Willis Group Holdings PLC 15.6x 7.7x 64.4% 19% 22% 23% Arthur J Gallagher & Co 13.3x 9.7x 6.1% 13% 16% 17% Brown & Brown Inc 11.5x 9.9x 5.3% 30% 33% 33% Average (ex-WLTW) 12.6x 10.5x 4.8% 21% 23% 24% Median (ex-WLTW) 12.7x 10.4x 4.9% 21% 22% 23% Source: Bloomberg, as of Nov. 30, 2015. Estimates per analyst consensus at 11/30/15.
  55. 55. Guideline Public Companies How do we compare? •  Cash flow •  Growth •  Risk Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 55 Can We Really be Compared to Those Guys? But what about? •  Scale •  Diversification •  Capital For agencies of a certain size, market multiples should be considered But even when they are not, be aware of market sentiment
  56. 56. Income Approach Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 56 Value = Earnings x Multiple Might be considered for a stable, profitable, “slow-grow” agency Allows for specific assumptions about growth, margin, and length of forecast Commonly used Discounted Cash Flow Single Period Capitalization
  57. 57. Discounted Cash Flow Method A few caveats… The output is only as good as the quality of the inputs Greater precision does not necessarily contribute to greater accuracy The conclusion must make sense in light of other methods Use of a DCF is neither appropriate nor necessary in every appraisal Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 57
  58. 58. Status quo Pro forma for acquisition Something else? Forecast as many periods as necessary until earnings are stabilized Consider insurance cycle? Specific industry cycles? Discounted Cash Flow Method Purpose Projection Term Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 58 Observations on the DCF Method for Insurance Agencies
  59. 59. Management Other “interested” parties Industry sources Bias and motivations Discounted Cash Flow Method Projection source Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 59 Observations on the DCF Method for Insurance Agencies
  60. 60. Organic vs. acquisition Rate and/or volume Contingent commissions What does rate assumption imply about volume? What does volume assumption imply about rate? Connection to product/ industry growth? What do we assume about existing book (retention)? Do we have producer/CSR capacity to sell/service this growth? Discounted Cash Flow Method Revenue Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 60 Observations on the DCF Method for Insurance Agencies
  61. 61. What in the business is truly fixed? How are producers compensated? Is there enough marketing/ sales spend to achieve projected growth? Are synergies being considered? Interest expense – how are we financing growth? Depreciation/Amortization Margin comparisons to history/publics/privates Discounted Cash Flow Method Expenses Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 61 Observations on the DCF Method for Insurance Agencies
  62. 62. Working capital – a source or use of cash? Capital expenditures – technology replacement, system upgrades Amortization policies Earn-out payments from prior deals Debt financing – is leverage part of the business? Debt payoff for past acquisitions If our revenue projection presumes acquisitions, do we forecast the purchase prices as an outflow? Discounted Cash Flow Method Other Cash Flow Items Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 62 Observations on the DCF Method for Insurance Agencies
  63. 63. Equity or WACC? Industry betas are usually less than 1.0 Mature industry High proportion of recurring revenues Size Key-man risks with owner, executives, or producers Concentrations by customer, carrier, product, or industry Other Discounted Cash Flow Method Discount Rates Common Risk Factors Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 63 Observations on the DCF Method for Insurance Agencies
  64. 64. Discounted Cash Flow Method Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 64 Relative Value Analysis Check implied multiples against industry Check pro forma leverage multiples Sensitivity Analysis How is the value impacted by key variables (rate, volume, etc…)? Comparison to Other Methods Guideline Public Company Guideline Transaction Other Income Methods Assessing the Overall Reasonableness of Your Conclusion
  65. 65. Case Studies Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 65
  66. 66. •  $10 million in revenue. 5% EBITDA margin. 3 principals. •  50% Employee benefits, 50% individual life/annuity sales •  Appears only marginally profitable •  Digging deeper – Agency A pays out virtually all earnings as owner/ manager compensation •  Normalize compensation to owners using peer benchmarks, public data, or other sources. Adj. margin of 20% •  Consider normalizing life/annuity revenue to average levels if lumpy •  Consider separating life/annuity business and valuing separately •  Risk should reflect stability of employee benefits side but also volatility of the life side Case Study #1 Agency A Potential Adjustments Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 66 Employee Benefits Agency
  67. 67. •  $10 million in revenue. 50% EBITDA margin. 2 principals •  100% P&C focus •  Agency B looks extremely profitable •  Digging deeper – Agency B compensates owners solely through distributions (not in operating expense) •  Normalize compensation to owners using peer benchmarks, public data, or other sources. Adj. margin of 40% •  Contingent commissions of $350k, $45k, and $110k in each of last 3 years. Consider normalizing •  Risk considerations: agency is (still) highly profitable, solid retention characteristics. Arguably lower discount rate than Agency A Case Study #2 Agency B Potential Adjustments Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 67 Property & Casualty Agency
  68. 68. •  $5 million in revenue. 30% EBITDA margin. 2 principals (one is a bank director) •  70/30 personal/commercial lines •  Flat revenue for last 5 years •  A bank is considering purchasing the agency to diversify its sources of non- interest income •  Bank does not already have an insurance operation •  Normalized compensation and entry into employment agreements with 2 principals •  Expense synergy – rent, marketing, finance/insurance, legal, benefits? •  Revenue synergy – cross-selling? •  Risk considerations: personal lines may be subject to greater competition, lack of experience, integration risk, leadership/management issues? Case Study #3 Agency C Potential Adjustments Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 68 Potential Acquisition of a P&C Agency by a Bank
  69. 69. Other Valuation Considerations Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 69
  70. 70. Challenges for the Smaller Agency Traditional small business challenges Limited resources, competition with bigger players, key-man considerations Insurance-Specific Increasing regulation, carrier-specific rules, product/industry trends, ACA compliance But the smaller agency also has flexibility… Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 70
  71. 71. How Are Insurance Brokerage Transactions Typically Structured? Most are asset purchases, with true up for working capital Buyers don’t want the risk of a stock sale with associated liabilities Most negotiated on a multiple of pro forma EBITDA Disagreements in the EBITDA figure or the multiple usually are resolved via an earn-out Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 71
  72. 72. What Is the Typical Deal Consideration in an Insurance Brokerage Transaction? Smaller deals might be seller-financed Larger deals typically consist of 70-75% cash upfront, with 25%-30% in form of a multi-year earn-out on based of future profitability or retention Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 72
  73. 73. Created advisory opportunities for some benefits brokers Companies need help navigating the rules For small employee groups (<50), going with an exchange is just an option Some reports of rate increases this year due to unfavorable losses in the pools Employers may have trouble recruiting the talent to grow if they don’t offer healthcare benefits Likely see rise of “skinny” plans to meet minimum requirements for small groups Affordable Care Act (ACA) Impact on agencies has been mixed Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 73 Has it Helped or Hurt?
  74. 74. Consolidation is Everywhere 250+ deals a year (and that’s just what get reported) If your independent agency is doing well, chances are you’ve already been approached (and probably more than once) Buyers are not just the publics anymore (PE-firms, family offices, pension funds, institutional investors) Are you a platform agency or a bolt-on? Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 74
  75. 75. Consolidation is Everywhere Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 75 Internal Growth Leadership Deep bench Youth Validated producers Sales culture Participation Combinations of these factors is what differentiates a single- digit multiple from a double-digit multiple What are Buyers Looking for?
  76. 76. Potential Headwinds Rising interest rates Banks pulling back leverage Prolonged soft market Political/regulatory changes Industry disruptors Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 76 High Public Multiples, Robust M&A Market, What Could Possibly Go Wrong?
  77. 77. Closing Considerations What aspects of the agency are transferable, not just to a third-party buyer, but to your other partners/managers/ producers? Agencies are valued on what they’ll do in the future not necessarily what they’ve done in the past Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 77
  78. 78. Lucas M. Parris, CFA, ASA Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 78 Contact Lucas Lucas M. Parris, CFA, ASA parrisl@mercercapital.com 901.685.2120 Lucas leads the Mercer Capital Insurance Industry Team and is active in the valuation of insurance agencies, brokerages, and underwriters for corporate valuation and compliance matters. Lucas Parris is also a senior member of Mercer Capital’s Financial Reporting Valuation group, providing public and private clients with fair value opinions and related assistance pertaining to goodwill and other intangible assets, stock-based compensation, and illiquid financial assets. In addition, Lucas co-authored the book, Valuation for Impairment Testing, Second Edition (Peabody Publishing, LP, 2010).
  79. 79. Mercer Capital’s Insurance Resources Quarterly Newsletter – Value Focus: Insurance Industry The Financial Institutions Group of Mercer Capital publishes Value Focus: Insurance Industry, a quarterly e-mail newsletter illustrating trends affecting firms in the insurance industry. Subscribe at http://mer.cr/vf-insnc Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 79 Whitepaper – How to Value Your Insurance Brokerage Soft market or hard market, it is important for insurance brokerage owners to have an idea of what their business is worth. A lack of knowledge regarding the value of your business could be costly. Opportunities for successful liquidity events may be missed or estate planning could be incorrectly implemented based on misunderstandings about value. In addition, understanding how insurance agencies and brokerages are actually valued may help you understand how to grow the value of your business and maximize your return when it comes time to sell. The purpose of this whitepaper is to provide an informative overview regarding the valuation of insurance brokerages and agencies. Download at http://mer.cr/wp-insnc
  80. 80. Mercer Capital’s Insurance Services Mercer Capital provides the insurance industry with corporate valuation, financial reporting, transaction advisory, and related services. Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 80 Industry Segments Mercer Capital actively serves the following industry segments: •  Agencies •  Independent agencies and brokerages •  Bank-owned agencies •  Retail, wholesale, and MGAs •  Underwriters •  P&C, life & health, and managed care •  Reinsurance •  Captives and risk retention groups •  Services •  Third-party administrators •  Claims adjusters and other service providers •  Financial sponsors and industry lending platforms Mercer Capital Experience •  Nationwide client base •  Agency clients include single office agencies, public brokers, and private equity backed firms •  Underwriter clients range from monoline privates to publicly traded multi-line carriers Insurance Team Lucas M. Parris, CFA, ASA parrisl@mercercapital.com 901.685.2120 Travis W. Harms, CFA, CPA/ABV harmst@mercercapital.com 901.685.2120
  81. 81. About Mercer Capital Mercer Capital is a national business valuation and financial advisory firm. We offer a broad range of services, including corporate valuation, financial institution valuation, financial reporting valuation, gift and estate tax valuation, M&A advisory, fairness opinions, ESOP and ERISA valuation services, and litigation and expert testimony consulting. We have provided thousands of valuation opinions for corporations of all sizes in a wide variety of industries. Our valuation opinions are well-reasoned and thoroughly documented, providing critical support for any potential engagement. Our work has been reviewed and accepted by the major agencies of the federal government charged with regulating business transactions, as well as the largest accounting and law firms in the nation in connection with engagements involving their clients. For over thirty years, Mercer Capital has been bringing uncommon professionalism, intellectual rigor, technical expertise, and superior client service to a broad range of public and private companies and financial institutions located throughout the world. Feel confident in our experience and expertise. Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 81 Mercer Capital | www.mercercapital.com
  82. 82. Mercer Capital’s Core Services Valuation & Financial Opinions •  Litigation Related Expert Witness Opinions •  Succession & Shareholder Planning •  Valuations for Corporate Tax Planning •  Valuations for Gift & Estate Tax Planning •  Fairness Opinions •  ESOP & ERISA Advisory Services •  Bankruptcy Related Valuation Services •  Valuations for Buy-Sell Agreements Transaction Advisory Services •  M&A and investment banking services •  Fairness Opinions •  Buy-sell Agreements & Private Company Transactions •  Strategic Assessments Valuing Insurance Agencies | Lucas M. Parris, CFA, ASA | © 2016 Mercer Capital 82 Mercer Capital | www.mercercapital.com Litigation Support Services •  Statutory Fair Value •  Business Damages & Lost Profits •  Valuation, Labor & Contract Disputes •  Family Law & Divorce •  Tax Related Controversies •  Corporate Restructuring & Dissolution •  Initial Consultation & Analysis •  Testimony & Trial Support Financial Reporting Valuation Services •  Purchase Price Allocation Services •  Impairment Testing Services •  Portfolio Valuation Services •  Equity-Based Compensation Valuation Services

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