In the early 1990s a state insurance commissioner, in a Wall Street Journal front-page article, called insurance agents the 'buggy-whip makers' of the late 20th century. Several years later, you seem to be doing just fine, and in many cases, even better than investors in other areas. Kevin Stipe offers an overview of the insurance agency as an investment vehicle in this document.
For those of you fortunate enough to have owned an insurance agency through the peaks and valleys of recent years, your patience (and yes, vision) has been handsomely rewarded! And you hung on through the technology craze of the late 1990s when it became even tougher than usual to hire and keep young people who believed the sexy 'new economy' was going to bury the old one.
Your reward? In a stunning reversal of fortune, private broker stocks have outpaced publicly traded stocks since 1994 (which, incidentally was about the time of the infamous buggy-whip maker comment). The steady growth of insurance agency values through the late 1990s, followed by a hard-market surge over the past couple of years, now stands in stark contrast to the sharp rise and fall of the major stock indexes.
The S&P 500 dividend yield (annual dividend paid divided by share price) has averaged slightly under 2% during the past 7.5 years. For privately held agencies 'dividends' can come in many forms, but can generally be defined as income and/or perks distributed to owners in excess of what non-owners with the same job would receive. The range of this informal 'dividend yield' among agencies is enormous (we work with several agencies with a double-digit 'dividend yield'). However, we estimate that the yield averages about 4.5%, or two-to-three times the level of the S&P 500.
In contrast to the turmoil in the stock market today, owning an insurance agency looks more attractive than ever. Revenue and profit growth are strong and outside investors — especially banks — continue to show strong interest in the business. Even the bust of the 'new economy' has helped by leveling the playing field in the battle for talent, providing agency owners with a once-in-a-generation opportunity to recruit new blood into the insurance industry.
If you already own, or are considering owning, an interest in an insurance agency, here are two points to consider:
- During the next decade, the return potential of stock in a private business might well exceed that of the S&P 500.
Analysts are cautioning the current generation of investors that historically there have been long periods in which stocks moved sideways. For example, in early 1966 the Dow Jones Industrial Average hit the 1,000 level, then retreated. It bobbed up and down for years, and didn’t cross the 1,000 level for good until 17 years later, in 1983! If history were to repeat itself, even a slow growth agency during the next 10 years might appreciate faster than the overall stock market.
- Stock in a privately held business offers tax advantages that are better than those of a qualified retirement plan, such as a 401(k).
Does this sound too good to be true? Consider that when an individual sets money aside in a 401(k), the contribution is tax deductible and any dividends or capital gains within the plan grow on a tax-deferred basis until they’re withdrawn and taxed as ordinary income. The tax-deduction on contributions, combined with the tax-deferral on money in the plan, have made 401(k)s the investment vehicle of choice for millions of investors. The only negatives are the stiff tax penalty for withdrawal prior to early retirement and the current contribution limit.
Now compare the 401(k) to buying stock in an agency. Granted, the stock must be purchased with after-tax dollars initially. But you’ve bought the stock, most future investments in agency growth are fully tax-deductible, since they usually show up as operating expenses and thus reduce what would otherwise be taxable agency profits. Most agency growth investments, such as producers, support staff, and other sales-related expenses, are fully tax deductible in the year they’re made. Certain others, such as a new computer system or the purchase of a producer’s book of business, are tax deductible over a period of years. In any case, unlike a 401(k), there’s no annual contribution limit.
In addition to these annual 'tax-deductible contributions,' the ultimate sale of an agency’s stock triggers a capital gains tax rather than the ordinary income tax on a 401(k) distribution. Finally, there’s absolutely no penalty for early withdrawal.
CONCLUSION
Given the recent bloodbath in the stock market, many investors are being forced to reset their expectations about retirement savings. They’re searching for the ideal tax-efficient, low-risk investment that offers good return potential and doesn’t have a contribution limit. Ideally, this investment would permit hefty contributions during good times, and little or no contributions during lean times. Finally, if times get really tough, it would be ideal to be able to liquidate a part of, or potentially all of, the investment without penalty.
Today, insurance agencies, after years of patiently enduring the scoffing of the 'new economy' intelligentsia, might represent just such an investment.