PERPETUATION PERPLEXITIES
by Roy Phillips
'An important element often overlooked in agency evaluation is the potential to retain existing agency business.'
As buying, selling, and merging of Property and Casualty agencies increases and insurance companies produce management studies indicating their interest in a 'vertical distribution' system of agency ownership, the emerging profile of our distribution system takes on additional chemistry for agency planning.
'Fewer agencies representing fewer companies' is a constantly repeated theme heard when agents and their company partners meet on convention panels. Perhaps the unspoken message of this dialogue is that agents must have more volume to maintain a competitive and attractive stance with their companies.
Where does this then leave the agent? The dramatic decline of gross premium levels has been further compounded by the reduction of interest yields on cash flow and questions about contingent commissions in the future. At the same time that agents have seen the decline in gross revenues, there has been a continued rise in both selling expense and general operating expense. Agents throughout the country have upgraded their sales and administrative staff significantly during the past few years in order to handle the complexities of products and increase their share of the marketplace.
Many agents have come to the realization that they are overstaffed, or overcompensated, in areas of business that produce a low revenue, but at the same time, produce a high transaction cost within the agency. This has led to a question that preys on the mind of every agency today, 'Should I sell, buy, or merge?'
As of this writing, we are seeing a closer parity between the number of buyers and the number of sellers. An example of the consternation facing agents today was indicated in one Joe Vincent Seminar. As in most seminars of its kind, the speakers addressed profitability and the general cost of doing business in a Property and Casualty agency. The interpretation of those financial statistics in the rendering of a value can be considered only the tip of the iceberg.
An important element often overlooked in the evaluation of an agency is the potential to retain existing agency business. Today's competitive environment makes that even more significant in two aspects.
First, and obvious, is the greater competition on the street which erodes the longstanding relationships that many agents have achieved over the years with middle-sized and large accounts.
Second is the slash of the gross premium rate as companies continue to offer extremely competitive prices, especially in the area of package policies. Summed up, this means that the buyer and seller must negotiate reasonably upon the retention value of accounts that comprise the assets of evaluation.
Let's identify some additional considerations which surface during the negotiations between the buyer and seller most often. The effect these considerations will have on the transition of the business directly affects the value of the agency.
The first question usually arises out of the ability of the buyer to absorb the book of business with present staff, or the necessity to create additional staff positions for servicing the purchased accounts. It obviously enhances the value of being purchased if the buyer has the in-house capability to absorb the business without the creation of additional administrative expense. Seen from the seller's view, it also increases the value of the business if he is able to match his agency with the right buyer.
Quite often, the compatibility of automation systems enters into the considerations. The availability of previous financial information and account records is to the advantage of both buyer and seller. The retention of these records is extremely important, but is frequently an overlooked area within the agency. The conversion from one batch or automation system to another can play havoc with both parties. In most transactions, both the buyer and the seller are under an agreement within the buy-sell contract to make an orderly transition of the business from one to the other. Recent industry history is full of nightmares arising from this consideration alone.
Another major consideration is the compatibility of marketplaces and how many of the same companies are carriers. In most recent instances, companies have been willing to roll over complete portfolios of business when all underwriting considerations and decisions were made in advance. This is extremely helpful when the buyer is placing business in a new company other than the one previously being used by the seller.
Some companies have offered bonus compensation plans for the transfer of this business from a previous company into their own ranks. A part of this important consideration is the possibility that some insureds and some carriers may be unwilling to continue renewing existing accounts through the new owner. Production and loss ratio statistics are valuable tools in the transition of the business to the buyer. The buyer may want to consider including negotiations of advanced underwriting and additional commission points as ways of stabilizing the new book of business.
In the final analysis, there are two major objectives in this consideration. The first is to an orderly transition of the business from seller to buyer and the second is to maintain a low attrition rate on the purchased business. It is important not to ignore the position of the marketplace, and their partnership of the agencies, during the selling phase of the negotiations. Emphasis on the importance of this consideration has been seen in the purchase payment plan that is regulated to the attention of target accounts within the same markets or other willing markets of the buyer.
The next area concerns the expansion of the current book of business being purchased by the new owner. An accurate evaluation will indicate potential areas of expansion in both Personal Lines and Commercial insurance accounts, but this is not as clear-cut as it may seem. Consideration must also be given to the marketability of other areas, as well as the possibility of actually moving that additional business from its current location. Agents who have achieved this 'account rounding' have done so on a very structured and orderly basis. It means time and dedication on the part of the agent and his staff, and, more important, it means the establishment of an accountability system within the buyer's office. The old axiom 'we are going to call on these accounts and get the rest of the business' may or may not happen. Without a system of approaching the individual accounts, it is likely to be a myth.
The last thing to consider is the contractual buy and sell agreement. While an attorney is certainly the best source of drafting such a document, the buyer and seller cannot make a general assumption that the attorney is familiar with the language and the intent of an agreement between Property and Casualty agents.
An overview of a buy-sell agreement reveals that the following areas are most likely to cause problems. The first relates to the transition of the business and the cooperation between the buyer and the seller to make such a transition orderly. The second relates to the compensation agreement between the buyer and the seller and the manner which the compensation agreed upon shall be rendered. Third, a question of the cut-off date for incurred indebtedness by the seller is extremely important. The fourth consideration revolves around an integrated piracy of expirations and covenant 'not to compete' clause. It is within these two areas that we see the most varied type of contractual language in buy-sell agreements. Consultants agree that the same language is seldom used twice by agencies in different locales.
Covenants not to compete have historically been attacked based upon their reasonableness and their duration. The same comments can generally be made about piracy of expiration clauses within a buy-sell agreement.
Agents attending seminars are constantly asking for a sample of a buy-sell agreements, just as they ask for a standard producer compensation plan. This just doesn't exist. Each agency purchase and sale is an individual issue of fact and has to be treated as such. Remember that the components of the buy-sell agreement are drafted during the 'romancing' stage. It is necessary that all of the elements of the buy-sell contracts contain the agreement between the buyer and seller, and express in contractual language the intent of the agreement.
Consultants repeat again and again a 'war story' in which there is a disagreement after the sale of an agency over what was actually intended. This always occurs after the sale has been made and one party has a different interpretation of what was really agreed upon. Remember, the first draft of the buy-sell contract is not the one that will finally be employed. Both parties need to spend considerable time reviewing the contract and assessing its ability to meet his intentions. It is not uncommon to have several stages of renegotiation prior to the final drafting of a contract. The buy-sell contract often becomes a lengthy document out of necessity, but there is no substitute for a line-by-line review.
The road to buying and selling Property and Casualty agencies is certainly not paved with gold, but is an attractive vehicle for agency growth.
Reprinted from Texas Insuror.