Agency Perpetuation

AGENCY PERPETUATION

Agents and brokers need a clear picture of their objectives in order to successfully attain them. The objectives of an insurance agent should be to make a profit and to build the value of agency. In addition to profit and growth, the majority of agents are also interested in prestige and personal satisfaction.

Most people must earn a living, and few can afford to engage in the insurance agency business as a hobby. Clearly, you must make a profit to stay in business. This involves performing certain functions for your clients and companies. The performance of these functions is essential to earning an income.

In addition to current profit, the agency is generating an estate income. As an agency grows and becomes profitable, its value increases. This presents both a benefit and a problem.

Given the ability to make a profit, the accepted criterion of long-run business success is growth. The growth of an agency has economic significance because it affects net worth and income. In addition, it also has psychological and social significance. Growth is considered to be a measure of progress and success. Individual business firms and the economy as a whole are viewed as either growing or declining-there is no middle ground. This attitude results in social approval for firms that are growing, as well as a feeling of satisfaction for those who own and control them. The reward for growth is psychic income as well as economic income. Growth enhances prestige and is a major objective for most insurance agents.

While many insurance agents are concerned solely about the economic benefits to be derived from their firm, some are also concerned about their public image. That is, they desire prestige. Prestige can enhance an agent's ability to make a profit, but for many, it is an end in itself. Many actions taken by agents are designed to build their prestige. The basis for these actions is separate and apart from the economic impact on the agency.

This incentive prevails in the general insurance agency business, although it is sometimes difficult to recognize as an objective separate from that of profit-making. Some cynics insist that profit is the only objective of an agency. This is an issue which cannot be resolved here. There are many cases in which prestige is an end rather than a means because it is a source of personal satisfaction for the agent.

Income, profit, growth, and prestige provide personal satisfaction for agents who achieve these objectives by running an insurance operation. While most people are hesitant about admitting it lest they sound like 'do-gooders,' there is considerable personal satisfaction derived from the operation of an insurance agency in an honorable and ethical manner while providing valuable services to clients. Some may insist that honorable and ethical service is only a means to profit, but many people derive personal satisfaction that is far greater than the level of profit which is generated by their efforts.

In the previously discussed objectives, it was mentioned that growth and profit present both a benefit and a problem. The problem lies in preserving the value that has been created by building the agency. Most would agree that without an agency principal, the value of the firm would rapidly diminish. The proper way to solve the problem of diminishing value is through planning.

Planning is actually a form of decision making, since it involves choosing among alternatives. The entrepreneurial nature of most successful agents does not lend itself to extensive planning. Many agents will say they plan, but when you examine the situation, the plan is not in writing. Solid business planning is simply not being done by the great majority of agents. They feel they do not have time to plan . . . but, in fact they don't have time not to plan.

The minimum time-frame of a plan is one year. This plan should be extended to five years, but getting it started with a one-year plan is better than having no plan.

Fortunately, insurance companies are beginning to insist that the agencies with which they do business have certain plans committed to writing. A study done by the Florida Association of Insurance Agents found that companies were interested in doing business with agencies, even small agencies, if they met certain guidelines. The types of plans that would influence a company to contract with an agency are: a business plan, an automation plan, a marketing plan, and a perpetuation plan.

The business plan formulates objectives, evaluates alternatives for reaching those objectives, and selects a strategy to be followed by the agency. It is a guide to and for the future. The principals establish an objective or target for the agency. In addition, the time-frame for achieving that objective must be established.

In choosing an agency with which to contract, the companies are looking for a firm that knows where it is going and how it's going to make the journey. The business plan should tell about the organizational structure of the agency and its management team. It should also spell out the products or lines of insurance in which the agency has expertise and is likely to concentrate.

The business plan should contain financial information such as a budget, immediate financial needs, and the source of the funds. The plan should contain some description of the operations of the agency and any efficiencies achieved through automation or marketing expertise.

In the agency system, the application of automation principles is still in its infancy. There is much progress that can be made toward the paperless agency of the future. The agency that has thought through where it is going and how it is going to get there through automation is an attractive candidate for a company.

The marketing plan should be tailored to fit the individual agency, the companies it represents, and the public it serves. To develop a large Commercial marketing plan when the agency is located in a bedroom community representing a Personal Lines carrier would be foolish. The marketing plan should state the agency's/brokerage's target and how it can profitably reach that market. Demonstrate the potential for profitable growth.

These plans have been desired by companies for some time, but the request for a perpetuation plan for both management and ownership is relatively new. The perpetuation plan should be in writing and in place at least five years ahead of any change in management or ownership.

A plan-whether a perpetuation plan, a marketing plan, or any other plan- should contain four major divisions. These divisions are true, whether the plan is short-term or long-term. These divisions are: mission statement, strategies, goals and objectives, and the budgeting of resources.

The mission statement refers to the long-term vision of what an agency seeks to do and the markets and customers it seeks to serve. The statement asserts the purpose of the agency. When expressed in managerially meaningful terms, the statement provides a view of what activities the firm intends to pursue, now and in the future.

The following example shows how a mission statement might be composed. The statement is meant to be an example or guideline to follow in individualizing a statement. The name of the hypothetical agency is Total Insurance Planning (TIP).

TIP is organized to write Personal and Commercial lines of insurance in the five-county area of Northeast Georgia.

TIP will underwrite these risks to a high standard, to provide the most competitive premiums to those select insureds.

TIP's sales will be conducted using insurance companies with no less than a B rating by A.M. Best.

TIP's goal is to provide the highest quality of service to its customers, at a competitive rate, and to experience premium growth while maintaining financial stability.

TIP is committed to an action plan that will maintain a profitable operation while acquiring agencies.

TIP will have a written and updated perpetuation plan that will guarantee continuity of service to our customers and preserve the principal's value.

TIP will be operated with the highest level of integrity and ethical behavior.

The mission statement is established; the strategy to be used in accomplishing that mission is the second division. Most agency strategies will fall within these categories:

• Growth
• Financial
• Perpetuation
• Marketing
• Internal procedures

If, for example, the agency desired to concentrate on growth as a strategy, it would consider increasing commission income, increasing premium writings in specific lines of insurance, and acquiring agencies.

If the agency desired to add the strategy of ownership perpetuation, it would need to deal with the person of the perpetuation. After identification of the person or persons, more detailed planning is necessary in the areas of buy-sell agreements, legal and tax considerations, timing, mergers or sales, and financial arrangements. The same type of procedure could be done for each of the other categories.

The mission statement and strategies are given in broad, general terms. Goals and objectives, on the other hand, are meaningful and challenge the agency to accomplish its mission. Goals and objectives will have the following characteristics:

• Specific
• Measurable
• Time-framed
• Results-oriented
• Controllable

Assume that you want to develop a perpetuation plan as one of your agency's goals. You must answer some questions:

• Is the perpetuator identified?
• Will this be a case of internal perpetuation?
• Are these people on board, or do we develop them?
• Should this be an external merger or sale?
• What time-frame?
• Is the cash flow of the agency able to meet the financial objectives of the seller?
• Are other sources of perpetuation capital available?
• Can we have a written plan in effect by December 31, 19XX?

One of the major problems in the perpetuation process is financial resources. An internal perpetuation can seldom be accomplished without the agency principals' salaries going back into the firm. Will the new management be able to reduce expenses to a level to finance the buyout of a major principal?

Working with an insurance company to obtain financing is an excellent source of resources. Unfortunately, as you well know, insurance companies want a return on their invested capital (as they should) and the capital must be repaid. Can the agency budget its resources to the extent that the cash flow is sufficient to buy out the existing principal(s)?

One of the mission statements is to preserve the value of the agency through a perpetuation plan that is committed to writing. The problem confronting the principal is not necessarily the physical continuance of the firm, but preserving the value of the agency for owners.

There are a limited number of alternatives available to agency owners (with regard to the firm) at death, retirement, or termination. The choices are as follows:

• Abandonment
• Will
• Gift
• Internal sale
• External sale

It is hard to imagine an agent investing time in building a customer base, and then abandoning the agency. Unfortunately, abandonment does happen. When a company takes over an agency for whatever reason, the action is tantamount to abandonment. When no plan has been made for the preservation of agency value, then abandonment occurs.

It is highly unlikely that an agent would abandon an agency at retirement. Unfortunately, many principals have effectively abandoned the firm when they died, due to lack of legal instructions as to what happens to the agency.

One of the legal devices that can be used to continue an agency is to pass the ownership to someone through a will. Many agents have died without a will, which would have indicated what they wished done with the operation. For all practical purposes, they have abandoned the agency, and its value will diminish rapidly.

When an agent dies without leaving a will (called 'intestate'), the estate is distributed in accordance with state laws of descent after debts are paid. The likely result is, the agency will end up with a widow or widower with little or no experience in the business. The agency will probably be sold in a distress situation, which hardly ever meets the objective of preserving value.

Planning for agency perpetuation means choosing a technique both feasible and desirable from the standpoint of preserving its value. It is essential to establish the legal mechanics for carrying out a perpetuation plan while the principal is alive.

It is possible to continue the agency and preserve its value by giving it to an appropriate party. This assumes that the proper person is within the agency and can continue the operation. Generally, this is a member of the family. It must be remembered that the donee must be willing and capable of running the business, or the value will not be preserved.

These gifts can be through the will ('testamentary') or during the lifetime of the owner ('intervivos'). The latter method has the advantages of the counsel of the principal, and the fact that it can be done over time.

Assuming the family member is active in the firm prior to becoming the donee, it might be well to enhance the gift by permitting the family member to contractually own the agency's book of business. This reduces the amount of value that might be subject to estate taxes or the value of things that might have to be purchased.

The most likely method of agency perpetuation that fully preserves the value of the firm is a sale. This transaction can be an internal sale or an external sale.

If the agency principal has properly planned, there will be an internal buyer in place. This means that for a considerable time prior to the sale, a person has been hired, trained, and put into a financial position to perpetuate the agency. There are considerable pitfalls at each one of those steps.

• Buyer's resources
• Owner financing
• Accumulated earnings
• Current or future profits
• Banks
• Insurance companies
• Combination of above

If all of the ingredients are in place, a legally binding buy-sell agreement should be drawn. The seller is guaranteed a buyer, and the buyer is guaranteed the agency will not be sold to someone else. The buyer will have the first right of refusal to purchase the firm. The potential widow(er) should also be part of the agreement to overcome an unwillingness to part with the agency when the agreement is triggered.

There are four critical issues concerning a buy-sell agreement of any kind. The agreement must be kept up-to-date, because no agreement is good indefinitely. Second, the agreement should contain a dynamic valuation provision. Obviously, value changes over time. Third, the source of funds must be dependable. A Life insurance policy in the proper amount is appropriate for the death of the seller, but disability, retirement, or termination must also be considered. Fourth, the agreement (as well as the seller's will) should be drawn up by a competent attorney. This is not a do-it-yourself project.

An internal perpetuation plan could also include the sale of the agency using an Employee Stock Ownership Plan (ESOP). This technique has many advantages if properly executed. (The treatment of an ESOP is beyond the scope of this article. Some suggested reading is listed in Additional Sources of Information included with your 'SUPPLEMENTARY MATERIAL' accompanying this issue.)

Most agency principals indicate they prefer an internal perpetuation plan over an external sale. Nonetheless, many such plans fail because the principal lacks the commitment and the necessary planning to make internal perpetuation work.

Further, the psychological make-up necessary to be an entrepreneur is not possessed by everyone. Good salespeople will say they want to be owners, but when it comes down to bearing the risk and tolerating the headaches, they tend to back away. Consequently, even those agencies that think internal perpetuation is for them should be prepared to seek an external sale.

The prospects that are available to the agency principal for an external sale are not endless. Such a sale basically centers around someone attempting to enter the agency business: a major broker or a local competitor.

If, in fact, that new person is your buyer, then one giant caution: GET YOUR MONEY UP FRONT. The agency is likely to suffer hard times before it stabilizes, if it does so at all.

All agencies face a similar perpetuation problem; therefore, a solution that would solve both sets of problems would be highly desirable. Such a win-win vehicle exists: a reciprocal buy-sell agreement. This concept has also been called a stand-by agreement.

The reciprocal buy-sell agreement involves two or more agencies whose principals face the same perpetuation problem. The agreement is triggered when a principal dies, becomes disabled, or retires. Otherwise, the reciprocal agreement is, like a will, a dormant document until it is triggered.

Two or more agencies get together and work out the details to buy all or a share of the business belonging to the first agent to die, be disabled, or retire. The reciprocal buy-sell agreement binds the surviving participant to buy, and binds the sale and purchase of the estate of the deceased. Each agency that is a party to the reciprocal agreement is assured of a purchaser at the death or disability of the owner. Obviously, the parties to the agreement do not know at the time it is made whether they will be buyers or sellers. Consequently, the terms and conditions negotiated are generally mutually acceptable.

Generally, the reciprocal agreement will spell out how the value of the triggered agency is determined, where the agency will be located, how accounts receivable and payable will be handled, and other