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Agency owners must watch and learn about major trends when they start. Following are the eight key trends that insurance agencies should be tracking for 2023.

Insurtech

Insurtech will continue to be the shiny object that gets much attention but might not live up to the hype. The common trope is that the insurance industry is facing its most profound disruptions in decades through artificial intelligence (AI), machine learning, the internet of things (IOT), blockchain, data analytics and other emerging technologies. Yes, those things are happening, but a “profound disruption” is hyperbole. So many new companies call themselves “insurtech-based,” but scratch the surface, and it’s more or less standard business operations.

There are plenty of areas for technology to improve the insurance industry. AI and blockchain technology can improve customer service and handling of claims.

The management of “Big Data” will streamline the underwriting process. New software applications will improve internal operations overall for the industry. The key is that all this technology is being incorporated across the industry, so it is difficult for any company to gain a distinct advantage over its competitors.

For 2023, the hype will continue because there is so much invested in promoting “insurtech.” Look at how many conferences are scheduled with an insurtech theme! However, actual industry adoption of technology will steadily continue with much less fanfare. Most likely there will be a culling of new insurtech companies.

This would be the result of higher interest rates impacting private equity and venture capital money, a lack of tangible results, and an overall shrinkage of the tech sector.

Market Conditions

2023 will bring a mixed bag of market conditions. Inflation could increase property/casualty premiums while lowering company profitability. There is a consensus that the P/C market will generally have hard market conditions with increases in the ballpark of about 6%. Cyber policy rates (which doubled in 2021) will most likely continue with higher rate increases compared to other lines of business.

Weird things are showing up post-COVID. Both commercial and personal lines auto claims have significantly increased since 2021. There are reports of unusual non-COVID-related death rates. The potential is high for medical malpractice claims to increase due to both COVID treatments and the postponement of testing and treatment of non-COVID diseases. Health insurance premiums are expected to increase; however, as noted below, government subsidies will offset much of the increased costs.

Florida has been dealing with a variety of issues with personal lines coverage. Next up will be California. Despite the high cost of homes and the significant losses due to wildfires, the average cost of homeowners insurance there is less than the national average. This is primarily due to the rate increase limitations from Proposition 103 (passed in 1988). Several insurers are no longer writing in the state, noting loss ratios and regulatory burdens. Most likely, more companies will leave or limit writing business in 2023, which will result in a crisis as people will be unable to get any coverage.

2023 M&A Activity & Pricing

The prices currently paid by publicly traded brokers, large regionals, and agencies funded by private equity firms are still high. They hopefully will continue to be high for the valuable, desirable firms. Since the supply is dwindling, the prices may be even higher for those that remain, if they fit the profiles of the key buyers today. As long as insurance agencies remain profitable, there will be buyers.

What might put a damper on some of the acquisition activity is the potential increase in federal taxes on the transaction that could occur as early as the second quarter of 2023, if President Biden has his way. (See the tax section of this article.)

Inflation is also increasing greatly, and interest rates are beginning to put a damper on the number and value of the transactions occurring.

M&A activity is again expected to continue during 2023 with some caveats, according to our discussions with key acquirers.

According to Clark Wormer, M&A director for HUB International, “HUB has brought on 70 excellent merger partners by the end of 2022 and hopes to continue this in 2023!” HUB has the tools, resources, expertise, and technology, which they believe merger partners are seeking. Their current acquisitions help expand their business.

IMA has been a new buyer in the space over the past three years and this past year did a great job acquiring some very astute firms in California and Oregon. They closed five transactions in 2022 and expect to do several more in 2023. They are looking for more retail, P/C, and employee benefit firms, as well as MGUs and wealth management firms for 2023.

Inszone is very aggressive and a relatively new buyer on the scene. It made 36 transactions for the 2022 year and anticipates doubling that number of acquisitions in 2023. They remain focused and vigilant about pricing and selection, especially in this interest rate environment and other deal-specific strategic aspects.

Foundation Risk Partners started in November 2017. They do not announce their transactions; however, they are now in the top 20 largest independent agency brokers. This past year they made numerous acquisitions and will continue that trend in 2023. They are very competitive and easy to work with and bring some significant synergies to acquired agencies.

FRP is looking for more add-ons and some new niches to spread across the nation. They would especially like to add firms in the Pacific Northwest, the Midwest, Texas, the Rockies, the Southwest, and of course, California, where they have many acquisitions already. They have 139 offices in 18 states.

Risk Strategies is a nice, mid-size national broker based in Boston. They closed 32 transactions in 2022, which was their biggest year, and expect to do quite a few in 2023. They look to continue to buy quality firms of scale, and are very well capitalized with excellent capital structure.

Another privately held broker growing quickly through acquisitions is Heffernan Insurance Brokers. Their main offices are in California (with home office in Walnut Creek), Portland, Phoenix, St. Louis, and Philadelphia, which they would like to add to and are also interested in new regions. They made nine acquisitions in 2022 and plan on acquiring another 15 in 2023.

2022 was another record year for Acrisure and one that saw them make further investments in technology, data analytics, and AI to complement new verticals in Asset Management, Real Estate Services, Title Insurance, and Cyber Services. Acrisure completed 105 independent agency transactions in 2022 and has reached $4 billion in revenues.

Management expects to do a similar number in 2023. Acrisure is also acquiring specialty wholesaler organizations.

In 2022, Liberty Co. Insurance Brokers closed 37 transactions of retail firms. CEO Bill Johnson said, “We will continue to look for entrepreneurial partners that fit our culture and that we believe we can help them grow with our resources. We are already seeing cracks in the M&A market as a number of the highly leveraged PE-backed brokers are slowing down as they struggle to raise additional capital or deal with the high cost of their capital. As a result, we expect and are already seeing a softening in both the amount of competition and the multiples being paid.”

Alera closed 30 transactions in 2022, down from 49 in 2021. However, they expect to complete 10 to 20 deals in 2023. It all will depend on economic/market conditions in 2023. They will be highly selective going forward until they see improvements in the capital markets, particularly interest rates. Many 2022 transactions they completed have been registered investment advisors (RIA) rather than P/C or employee benefits agencies.

Arthur J. Gallagher will continue to be a good player in the acquisition field. They do not advertise the number and value of their transactions. However, they are competitive and looking for great agencies throughout the country.

BroadStreet Partners, NFP, High Street, and USI, as well as other new players called World, Relation, and Patriot, are funded by private equity and venture capitalists. They continue to solicit and buy independent agencies aggressively. They all have large amounts of capital to use for transactions.

Private equity firms have been buying up insurance agencies for their investors. This makes a lot of sense because the return on investment is typically 20% to 30%-plus, which is greater than most other available investments today. PE firms often pay typically eight to nine times EBITDA for well-run agencies!

Deal Terms

There is a broad spectrum of prices today based on the motivation of the uniqueness of the seller. Common multiples of EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) range between 6.0 to 10. Occasionally we may see an EBITDA multiple higher than 11 times, but that is rare. Common multiples of revenue range between 2.0 to 3.3 times revenue! Usually there are additional earnouts based on profitability and growth that can add a significant amount if the targets are reached.

In some cases, the fixed price has an earn-out over two years, especially since Covid. Most down payments consist of approximately 80% of the price in cash and the balance in stock. Sometimes the stock can be used for key perpetuation candidates to have equity that the seller and buyer want to ensure will remain in the agency after the sale. In this way, they feel a part of it and have some skin in the game to stay on for years after the key owners retire. We usually recommend that our sellers take the stock, as it can give them a significant additional amount of money when they sell it due to the high rate of growth these acquirers have compared to a typical independent agency.

Smaller books are purchased at around 5.0 to 8.0 times EBITDA. However, there aren’t many books or agencies today that do not command at least two times revenues as a minimum!

Peer Acquisitions

There will continue to be a price differential between those that receive offers from “well-funded” buyers and those that sell internally or to local competitors. Local peer buyers and internal buyers cannot easily compete at these high prices and multiples because they usually need to pay for the transactions out of cash flow.

Some independents prefer not to sell to a more prominent, often publicly traded firm, as there is often a sense of pressure to produce and write larger accounts. In addition, producers in acquired agencies usually have to write commercial lines and benefits accounts over $5,000 in commission, or even more, for some acquirers in order to get paid. On the other hand, other acquirers leave the agency alone except to provide markets, accounting, and HR support. Acquirers such as Acrisure, Foundation Risk, and BroadStreet don’t even change the seller’s name.

Internal Perpetuation Can Be Difficult

The internal purchasers’ terms are typically 20% to 30% down, with the buy-out over five to 10 years. The number of years over which it is paid out depends on the agency’s cash flow and whether or not the internal buyer has any money of their own. An internal buy-out rarely has an earn-out component, so the value should be conservative, to not jeopardize the internal buyer’s ability to use the agency’s cash flow to pay the loan off over time.

Buyers often want the retiring owners to retire after a few years so they can manage the firm without their influence and use their compensation and perks to pay off the note.

If an owner sells internally, it is usually for less than the value of an external sale. There is a risk that the internal candidates might not work out, and they often don’t have any or very little money to do a buy-out.

Often the retiring principal needs to finance the deal for the internal candidate. Oak & Associates recommends that the internal buyers get an SBA loan for 10 years, so the retiring shareholders don’t have to worry about getting paid. O&A also recommends that all owners of internal sales should consider whether a GRAT (which stands for Grantor Retained Annuity Trust) would be the internal perpetuation tool to use if the owners are still healthy. There is typically a minimum payout of five years, and both principal and interest can be deductible.

It is often problematic for small and medium-sized independent agencies to perpetuate internally. The next generation often lacks the management and sales skills set to be able to replace the majority owner. In some cases, there are no perpetuation candidates at all. If this is the case, an external sale makes a lot more sense, as an internal sale may not work out, and retired principals don’t want to have to come back to work.

Tax Law Changes Likely

With the Democrats continuing to get bills passed with a large amount of spending, it is very doubtful that the lower tax structure of the previous administration will continue. For agency owners, this also includes whether or not capital gains will be at their current low federal rate of 15% to 20% or be changed to perhaps 39.6%.

What is proposed is that for over $1 million in the sale value of any assets, the capital gains rate be eliminated. Instead, a much higher ordinary income tax rate could be put in place, perhaps 39.6% versus the current 34.6% rate.

Many agencies concerned about higher taxes insisted on selling in 2021 and 2022 to avoid this concern. There is also a strong possibility that the state income tax rates will increase, such as in California. Personal income taxes, especially in the higher brackets, are predicted to rise substantially because of the stimulus money and the infrastructure and federal budget packages that were passed.

Natural Disasters’ Effect on Insurance

Natural disasters and severe weather are on the rise. Insurance companies tighten their underwriting and raise prices with disasters such as fires in the Pacific Northwest and California, hurricanes on the Southeast coast, and tornadoes all over the Midwest and South. There are often non-renewals, as well, and legislators don’t usually allow this without an adequate amount of time for non-renewal. But often this has no longer been the case, and many agencies get non-renewals monthly from several of their carriers.

Insurance agencies can help educate their clients on how they can mitigate the risks of fires, floods, hurricanes and tornadoes. We also advise agencies to review with the client the limitations of their current coverage and then offer any new options available. People still need insurance, despite the common threat of natural disasters.

Agents’ E&O exposure and coverage are at stake. Hence, producers need to ensure the insureds know that the limits and coverages in their new policies are not what they were with their preferred carriers and policies written previously. A signed agreement that the insured understands that the coverage is more limited is an astute way for the agency to protect itself.

Group Benefits and Health Insurance

2023 will see another year of fine-tuning the Affordable Care Act (ACA) with adjustments to several rules and limits.

Premium rates are expected to increase on average by about 4% nationwide. However, many will see no changes due to expanded and enhanced marketplace premium subsidies. This includes the American Rescue Plan Act (ARPA), which took effect in 2021, and the recently passed Inflation Reduction Act (IRA), which ensures that the ARPA’s subsidies continue without interruption for an additional three years through 2025. Affordability due to expanded subsidies and an extended enrollment period likely contributed to marketplace enrollment in 2022, reaching a record high of 13.8 million, with 12.5 million people receiving a subsidy.

New rules will take effect in the 2023 coverage year regarding measuring the affordability of family coverage based on the worker’s premium contribution for family coverage. If the amount is more than 9.12% of household income, family members will have the option of buying health coverage through the Marketplace and will be eligible for premium tax credits based on their income. This fixes the “Family Glitch” issue.

There is a trend for medium-sized businesses (for this discussion, assume a mid-sized company is around 100-500 employees) to develop customized healthcare plans. These plans include basic medical coverage augmented with specialized coverages and services. For example, there are services that search for the best price for medical procedures, lower-cost pharmaceutical services, mental health services, and medical management services for the chronically ill. Very often, these companies opt to have self-funded plans. However, a high-deductible, fully insured plan can also be used. In addition, some employers add benefits like pet insurance, group personal lines, and travel insurance as additional perks.

Summary

The first step is being proactive and knowing how current trends will affect the firm. Managing the agency in a way that exploits these trends will then allow the firm to succeed. Agency owners must also establish business and marketing plans to stay ahead of the competition.

Please look at Oak & Associates’ website www.oakandassociates.com to download our Sales and Marketing or Business Planning templates for free.

Topics Trends