Since 1998, the banking industry has been the most active acquirer of Property/Casualty insurance agencies. So relevant are these transactions to the development of bank-insurance that, today, most banks selling Commercial insurance do so through an acquired agency. James Campbell examines the issue of whether banks overpay for agencies.
Indeed, for banks with $1 billion in assets, more than 70% that sell Commercial insurance use an acquired agency to do so.
Along the way, however, banks have developed a dubious reputation as acquirers. Conventional wisdom suggests that banks, inexperienced in the ways of agency acquisitions, have overpaid for agencies, often paying wildly aggressive multiples of revenues and earnings. Enticed by these rumors, many agency principals have pursued a deal of their own with a bank. After all, if banks are giving money away, why not get in line?
But are these rumors accurate? Do banks really overpay for agencies or have they been portrayed unfairly? Are the price multiples attributed to bank buyers based more in fact or fiction? For answers to these questions, let's consider a few facts.
In October of 2003, the American Bankers Insurance Association released its sixth annual “Study of Leading Banks in Insurance.” Of the 407 participating banks from throughout the U.S., 52 reported on their most recent agency acquisition. Most of these transactions are current, including 58% that closed in either 2002 or 2003. Findings from the analysis of these transactions included:
Price multiples paid by banks are in line with the current market. In today's market, agencies typically sell within a range of 5.5-to-8-times pro forma EBITDA (earnings before interest, taxes, depreciation and amortization). A majority (53%) of the transactions reported by banks were priced below 7-times EBITDA ? well within the current market range — and 45% were priced below 6-times. Only 12.5% of theses deals exceeded 8-times EBITDA.
Translated into a multiple of revenues, 47.9% were priced below 1.5-times agency revenues and 65.3% were priced below 1.75-times revenues. Only one in 10 (10.9%) of the selling agencies was paid more than 2-times revenues.
Banks often require sellers to share the future performance risk. Not only are price multiples paid by banks more conservative than speculated, but nearly half (45%) of these deals include an earnout — that is, a component of a deal which makes a portion of the proceeds contingent on the future performance of the agency. For most of the reported deals, the earnout held between 15% and 25% of the total proceeds, with a payout schedule of three to five years.
Earnouts are used so extensively because value is largely a function of future earnings. Lacking a crystal ball, buyers value acquisition targets based on reasonable projections of future earnings . An earnout allows the buyer to adjust the ultimate price closer to true value if actual earnings fall short of projections.
What if earnings exceed projections? Many of these transactions allow for upward price adjustments as well.
Tax-deferred transactions are the exception, not the rule. Okay, maybe banks aren't paying wildly aggressive multiples for agencies, and maybe they're requiring the sellers to assume some of the future performance risk through an earnout provision. But at least they're structuring the deals as an exchange of stock so the sellers can defer their tax liability, right?
Wrong. Cash was the predominant currency in 79.1% of the reported transactions, and the exclusive currency in 72.9%.
Why are banks reluctant to part with their stock? Some banks simply view their cost of capital as too high. Others are compelled to buy the agencies' assets (rather than stock) to get some tax relief on the amortization expense; otherwise their return-on-capital requirements would be out of reach.
Bank buyers will continue to acquire agencies. How successful are banks as acquirers of insurance agencies? Are they so discouraged by the results of their acquisitions that they plan to stop acquiring, perhaps even divest?
Not exactly. In fact, of the 52 reporting banks, 46 (88%) have plans to acquire additional agencies. These plans are supported by the finding that 45.6% of these banks have experienced actual results that exceed their pre-acquisition expectations, and another 32.6% have met expectations.
So, if banks are structuring sound deals and achieving solid results, why have they developed a reputation as naive acquirers of agencies? The answer probably lies in a combination of factors. First, some banks have overpaid. In particular, some of the earlier transactions were overpriced due to inflated cross-sell projections and general inexperience in the industry.
But second, and perhaps more significant, banks have demonstrated a willingness to occasionally stretch to do the right deal. In other words, banks are often looking for high-performing agencies that provide a platform on which to build or that add significant depth to an existing operation.
These agencies are usually larger, have relatively young leadership, a true sales culture, and a history of consistently strong growth and profitability. And these agencies are more valuable than most.
An indication of this trend is evident among our 52 banks. Specifically, only 40.7% of the reported acquisitions of agencies below $5 million in revenues were priced above 7-times revenues. But for larger agencies, 75% were priced above 7-times revenues. Simply put, premium pricing is reserved for exceptional agencies.
So, perhaps it's time to reconsider the story of bank-agency acquisitions. Despite their relatively short history in the insurance distribution business, banks are financially sophisticated organizations and experienced acquirers. Most are conservative, disciplined capital investors that are accountable to boards of directors and to shareholders.
As a growing component of the insurance distribution system, banks will continue to rely on agency acquisitions to drive their commercial lines strategies. And most will continue to acquire agencies in a thoughtful, strategic and disciplined manner. The expression “win-win transaction” is overused and often misapplied. But successful acquisitions enable both buyer and seller to realize their objectives.