M&A frenzy said to squeeze smaller agencies

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An increase in the number of insurance agency mergers and acquisitions across and beyond the employee benefits landscape illustrates the competitive pressures that smaller players face, OPTIS Partners’ new quarterly M&A report suggests. But that’s only part of the story.

There were 344 deals through the first ninth months of 2016 compared with 338 in all of 2015 – 108 of which were announced for the quarter this year compared with 104 at the same time last year. OPTIS is an investment banking and financial consulting firm specializing in the insurance industry that reps both M&A buyers and sellers and offers due-diligence reviews.

Daniel P. Menzer, a CPA and certified M&A adviser at OPTIS, notes that many smaller firms in the employee benefit arena “just don’t have the size or scale to offer the breadth of services and value-add products that the larger firms can, so they become somewhat less competitive.”

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While not limited to employee benefit agencies, he says the voracious appetite for acquisitions continues to chip away at the number of independent agents. Even younger agency owners will need to ponder aligning themselves with a larger partner. “Whether that’s good or bad will likely vary on your perspective,” he adds.

The details
However, there’s more to this trend than meets the eye. Madelyn Flannagan, VP of agent development, research and education at the Independent Insurance Agents & Brokers of America, hasn’t seen a significant decline in the numbers of IA storefront over the past few years.

“What we have learned is that while many agency owners are taking advantage of the opportunity to sell to gain the maximum valuation, they often go back into the business after their non-competes expire,” she explains.

Another phenomenon to consider is a significant number of startups, especially minority-owned enterprises. “These agencies are fast growing, primarily in the Southeast, and often are the result of a captive carrier pulling out of an area,” according to Flannagan. “So while mergers continue, startups do so as well, keeping the IA system alive and well.”

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One caveat to the OPTIS report is that includes only announced transactions. “There are many purchases or sales that we never hear about, so we just use our data as an indication of what’s going on in the marketplace,” Menzer reports.

As with other insurance agency principals, he observes that owners of employee benefit firms “aren’t getting any younger and are approaching retirement age at a rapid pace.” There are essentially two ways to realize the value they’ve built up in their agency: selling to outsiders or “internal perpetuation” candidates, Menzer explains. Since selling to insiders is a difficult process over the long haul that pays sellers 10% to 20% less than they can usually get by selling to a third party, he says “financial considerations often win out.”

Game changers
The Affordable Care Act has influenced this M&A activity and had an impact on employee benefit brokers “to a greater degree three to five years ago largely out of uncertainty and confusion,” notes Menzer, who considers the upcoming election “potentially a game changer.” Barring a Donald Trump victory, he says “there are fewer unknowns today, but changes will likely continue that just adds a degree of risk and uncertainty to what lies ahead. Selling to a third party takes most of this risk off of today’s owners and into the hands of the buyers.”

Given the level of technological advances within the medical industry, Menzer suspects “the pressure for more data and information at the broker level will only continue to grow.”

Despite a seemingly “furious pace” of M&A activity, OPTIS points out that most agency owners aren’t looking to buy or sell and believe patience is a virtue. “If you’re neither buyer nor seller, ignore all the hyperbole and focus on growing your agency and improving your metrics every day,” Menzer observed when the findings were announced. “Keep your long-term plans in sight and take the necessary steps to position yourself to achieve your goals.”

The OPTIS M&A database covers U.S. and Canadian agencies selling employee benefits, property and casualty insurance and both lines. Buyers are identified as private-equity backed brokers, privately held brokers, publicly held brokers, banks and other categories.

While P&C agencies accounted for 53% of all deals in 2016, sales of employee benefit brokers picked up at 19% of the total. Private-equity backed firms accounted for more than half of all reported transactions over the first three quarters amid a slight increase in the privately owned broker group and decrease in public broker activity in 2016.

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