The soft market will reward real growth

When an insurance agency is sold, the price is a negotiation over what the business is really worth, and the side that better understands that value usually wins.

Buyers have always held that edge, because valuing agencies is their core business, and the past five years made it far more dangerous for sellers. The hard market grew nearly every agency’s revenue automatically, so the value many owners have in mind reflects rising premiums more than their agency’s own performance.

Now commercial rates have been falling for eight straight quarters, and buyers are pricing every deal on whether an agency’s growth was earned or simply handed to it by rising prices. An owner who cannot answer that question is negotiating over a number only the other side understands. The way out is to learn what the agency is worth on its earned growth alone, before any buyer attaches a price to it.

The deal market already shows how expensive that blind spot has become. Agency mergers and acquisitions just posted the slowest first half in a decade, yet the analysts who track those deals report that valuations remain high for the best agencies. Both trends come down to the same thing: Acquirers can afford to be selective now, and they are paying top prices for agencies that can prove their growth was earned while discounting everyone else. The firms doing the buying have entire teams making that judgment on every book they evaluate.

Through the hard market, that gap in insight cost owners very little, because rising premiums papered over nearly everything. In a soft market, it is the difference between selling at the top of the range and settling for a discount.

The hard market compounded the problem by distorting what owners believe about their own agencies. Analysts who study agency values say most of the industry’s recent revenue growth came from pricing rather than new business. The arithmetic behind that is simple: When an account renewed with a 12% premium increase, commission income rose 12% without anyone selling a thing. That let an agency that was quietly losing customers post nearly the same growth as an agency winning them. It also inflated the number in many owners’ heads, a figure often set at the hard market’s peak or borrowed from what a competitor sold for in better times.

Industry growth is slowing

Now growth across the industry is already slowing, even at the top-performing agencies, and those mental valuations are aging fast. The owners still relying on them are exactly the sellers a well-prepared buyer hopes to meet.

Even owners with no sale planned are exposed to this shift, because in this industry the timing of a sale is decided by circumstance as often as by choice. A partner’s health turns or a top producer walks out with a book, and the owner is suddenly selling in whatever market the cycle provides. The aggregators/consolidators, the firms built to buy agency after agency, understand this, and their approaches keep coming even as deal volume falls.

What has changed is how much homework now sits behind each one. An owner who already knows what the agency is worth, and what is dragging on that number, can take the call from a position of strength or decline it without a second thought. An owner who hears the number for the first time from the buyer has conceded the most important ground before the negotiation begins.

The tempting alternative is to wait out the cycle and sell into the next hard market, and rates will harden again eventually. But the carriers cutting prices today are profitable and well capitalized, the combination that has historically kept soft markets running for years rather than quarters. An owner within a decade of exiting cannot assume the calendar will cooperate. Waiting also does nothing to change the question itself, because the buyers who learned to separate rate from real growth in this cycle will keep separating it in the next one. The only thing that improves an agency’s answer is better retention and new production, and that work takes exactly the years an owner would otherwise spend waiting.

For all its pressure, the soft market gives owners an honest reading of what their growth is really made of, and time to act before a buyer runs the same analysis. That time is best spent establishing what the agency is worth today and how much of its growth survives without rate. The renewal cycles ahead can then go toward repairing whatever the analysis finds, while pricing still cushions the top line. Buyers will keep paying top prices for growth an agency earned, in this cycle and the next, and the owners who get those prices will be the ones who knew their number first.

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Scott Yenor is the chief executive of Dealade. Contact him at scott.yenor@innfeedback.com.