Today’s independent insurance agency faces increasing capital intensity, technological needs, human resource complexities, and intensified competition from national and super regional aggregators.  As insurance carriers have scaled back their training programs, there is a shrinking pool of technically qualified people who migrate into the agency ranks.  As a matter of survival, scale becomes critical in enabling an agency to build the appropriate levels of infrastructure and profitability to avoid being devoured by entities larger than themselves before they are ready to sell.

The agency landscape continues to undergo a series of fundamental changes based upon the impact of scale, private equity and insurance carrier capital flowing into the sector, increasing demands of insurance carriers for volume and the ongoing capital needs and complexity of the business. As agencies grow in size, it becomes exponentially more difficult to perpetuate internally.  Given the limited flow of entrepreneurial and driven talent, even a reasonably successful insurance sales professional with a book of business typically doesn’t have the capital and willingness to provide the requisite cash, individual personal guarantees and debt financing required to engage in a transaction in excess of $1 million.  Today, the industry has become dominated by size.  20 years ago, an agency would have needed $5 million of annual revenue to appear on Business Insurance’s top 100 broker list.  Today, that number exceeds $25 million!

To achieve scale, profitably as you increase in size is the key to survival.  It is critical that an agency focus on a these eight key success factors.

2. Marketing – Not placement, like we use the word in the insurance industry, but marketing your agency in the broader sense. Segment the market for your production efforts, looking for areas where you can focus on value added services, expertise and differentiation mechanisms, while using the reach of the electronic world we live in to lead your targeted clients to your agency.

3. Market Access –  In terms of expanding revenue, the increasing prevalence of Market Access Aggregators (MAAs) has kicked off a world of ‘haves’ versus ‘have-nots.’  Perhaps the single greatest disruption of recent years and originally thought of as cluster style operations, some of these entities provide back office operations and infrastructure for their members.  Others are merely the equivalent of a commission club, engaging with the carriers in a form of green mail.  Nevertheless, they typically contribute significantly to augmenting top line revenue through enhanced contingent commissions, overrides and core commission levels.  Unless your agency generates annual revenues in excess of $5 million, or focuses on specialty lines, it is likely you will have a net cost gain by participating in some form of MAA.

4. Compensation and Benefits – If the agency Compensation and Benefits ratio to overall revenue exceeds 60% you will not be able to generate sufficient EBITDA margins for long term success.  Don’t ‘staff for growth’.  Look hard at your productivity measures and the spread between revenue per person and compensation.  Earn the money before you pay it out / take it out and recognize that as an agency principal, you pay yourself last.  All too many times we see producers / owners who buy their book of business or another shareholder’s equity, yet insist on maintaining their compensation level to the detriment of reinvesting in the agency.

5. Occupancy Costs – Don’t build or occupy your own personal Taj Mahal.  While image is important, if occupancy costs are trending up beyond 4-5% of overall gross revenue you’re paying for vanity rather than efficiency.

It is imperative to focus on growth to survive in today’s insurance landscape.

6. Producers – Constantly recruit and invest in talent.  Avoid the ‘have book, will travel’ syndrome of producers who move from agency to agency every few years.  Proactively manage producer compensation to an overall ratio of not more than 35% of the overall book.  However, you must weight new business compensation more heavily to ensure organic growth and prevent a book of business from settling in to a plateau.  Set a minimum account size, below which you will not pay renewal commissions. Cull those accounts based on size and use them, along with redirecting profit, to fund new producers.  But it is still imperative to test and enforce validation.  An unmanaged producer will starve themselves and keep everyone in the agency hungry with time wasting, unqualified, practice quoting.  If the compensation structure is self-correcting relative to validation, agency principals will save themselves from endless difficult conversations.

7.  Acquisition Intelligence – Beware of acquisitions that aren’t accretive to value. Everyone wants to talk about buying other agencies; it’s fun, it’s exciting and it causes a stir.  However, if you are using your operating cash flows to subsidize the purchase, ask why.  It can be for a legitimate reason like adding talent, acquiring a carrier to which you don’t otherwise have access, or preventing competition from establishing a beach head in your geographic area.  All too often though, agency owners get caught up in the auction excitement of the moment and end up paying more than they can afford.  Strategic buyers will frequently pay more than a financial buyer because they have found a way to wring value out of the acquisition.  In contrast, a financial buyer will have to make the acquired book pay for itself out of its earnings.  For a financial buyer, if it takes more than 7- 9 years of cash flow to pay for the book, too much is being paid.

8. Intergenerational Perpetuation Plans – Lastly, we all reach a point where our agency, or our equity in the agency is sold or transferred.  Unfortunately, many agents view this as a sign of failure, rather than the culmination of a successful career where a liquidity event harvests the value they have built over their years in the business.  It is okay to harvest!  If you don’t deal with it, your estate will!

There will always be a larger whale, higher up on the food chain, willing and able to swallow you up. So if legacy is important to you, it is imperative to stagger talent and equity by age.  Typical perpetuation transfers take 5 to 7 years to fund so if you want to preserve the independence of your agency, you need to build internal talent with an age spread and financial capacity to deal with one segment of ownership at a time…. that’s typically all an agency can afford.

Clearly, agency scale has become ever more important in our industry. There are many larger fish swimming in your waters.  Make certain you use your location on the food chain to your advantage, and focus on these key elements to grow strategically.

Peter R. Milnes, CPCU, CIC is CEO and Co-founder of Optisure Risk Partners, an insurance and risk management firm.  Peter has been directly responsible for more than two hundred transactions over the past three decades.