Maryland Primary Agent - March 2015

MARCH 2015 | MARYLAND

AGENCY PERPETUATION TACTICS 3 CONSIDERATIONS FOR INTERNAL PERPETUATION AGENCY VALUATION MERGERS & ACQUISITIONS AND E&O

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IN THIS

ON THE COVER 12

INTERNAL PERPETUATION 3 considerations to reach your goal

ALSO 18

AGENCY VALUATIONS The big picture

IN EVERY ISSUE 2

Chair of the Board

3

Ask Our Experts

4

Preventing Errors & Omissions

6

Coverage Corner

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State News

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Primary Agent (ISSN 1543-3110), Permit # 638-620, Issue # 2015-03, 2015-02, is published monthly by IA&B Service Group Inc., a subsidiary of IA&B.

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Copyright 2015. All rights reserved. No material may be reproduced in whole or in part without written consent of the publisher. The information in this publication is general in nature and not intended to serve as legal, accounting, financial, insurance, investment advisory or other professional advice as to any reader’s particular situation. Users are encouraged to consult with competent legal, financial, insurance, investment advisory and/or other professional advisors concerning specific matters before making any decisions. We disclaim any responsibility for any decisions or actions by readers. Statements of fact and opinion in Primary Agent are the responsibility of the authors alone and do not imply an opinion on the part of the officers or the members of IA&B. Participation in IA&B events, activities and/or publications is available on a non-discriminatory basis and does not reflect IA&B endorsement of the products and/or services.

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CHAIRWOMAN OF THE BOARD’S MESSAGE

PERPETUATION PLANNING TAKES PRECEDENCE

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gency perpetuation. We hear it spoken about often … in trade publications that warn of an aging independent agent workforce.

At conferences (IA&B’s 2014 Executive Management Conference included) that pack seminar rooms. Between agency owners – and aspiring owners – who trade concerns and plans on the golf course. And, for those of us who hail from family-owned agencies, during holiday dinners when business undoubtedly slides into the conversation.

INSURANCE AGENTS & BROKERS 5050 Ritter Road | Mechanicsburg, PA 17055 800-998-9644 | IABforME.com

OFFICERS Chair of the Board

Diana M. Hornung Hanby, ACSR Vice Chair of the Board

Robert S. Klinger, LUTCF, CPIA Immediate Past Chair of the Board

G. Greg Gunn, CIC

MEMBERS Henry “Butch” Bradley, Jr. Forest Hill, MD

E. Stephen Burnett, CIC, ARM Wilmington, Del

When IA&B leadership and staff ask member agency owners what’s on their minds, perpetuation planning consistently lands near the top of their list. It’s a tall order to help such a diverse group of business owners with such a strategic and specific goal. But your association isn’t shying away.

Richard F. Corroon, CPCU

IA&B is committed to helping you navigate the often overwhelming path toward successful perpetuation. And this issue of Primary Agent magazine is an example. Review the Preventing E&O column on page 4 and the feature articles on page 12 and 18 for expert advice on what E&O considerations apply to the sale of an agency, how to appropriately value your book of business, and where to begin with planning an internal transfer of ownership.

John B. Hollister

You’ll find a common theme in the perpetuation-focused articles in this publication … planning well in advance. Don’t let the sale of your agency sneak up on you. And don’t go it alone either. Look to your agents’ association in the months (and years) ahead for insight and advice. n

Wilmington, Del

N. Lee Dotson, CIC, AAI Wilmington, Del

Michael P. Ertel+ Columbia, MD Milford, PA

Jocelyn R. Howard-Sinopoli, CIC, CISR Butler, PA

Douglas A. Loesel, CPCU Erie, PA

Michael F. McGroarty, Sr. Pittsburgh, PA

Crag S. Mader

Gambrills, MD

Ann Gallen Moll, CIC Reading, PA

Mark J. Monroe

West Chester, PA

Joseph R. Pastor, CPCU, AAI Oil City, PA

Richard M. Rankin, CIC Lancaster, PA

Until next time,

April E. Ressler, CIC Altoona, PA

Scott C. Rogers, CPIA* York, PA

Diana M. Hornung Hanby Chair of the Board

Glenn R. Strachan

Ft. Washington, MD

Lawrence A. Wilson, CIC, CPIA, CPCU, ARM** New Castle, Del.

J. Marshall Wolff, CIC, CPCU Easton, PA

* Pa. IIABA National Director ** Del. IIABA National Director + Md. PIA National Director

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Ask Our Experts

Question: We want to set up a program where we offer a movie ticket to anyone who comes in for a quote. Is that OK?

Answer:

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t depends on the state where you intend to make the offer. Generally, state laws include an insurance rebating prohibition. There are, however, variations both in the language and in the interpretation of what is permissible and what isn’t.

MARYLAND Yes. In Maryland, the program contemplated would be permissible, since an allowance is made in the law for gifts that are under $25 as long as 1) there is no obligation to purchase and 2) the gift is either educational or promotional material, or articles of merchandise. Note that the maximum allowable previously was $9.99, but it was increased to $25 in 2009.

PENNSYLVANIA No. In Pennsylvania, the program described would be a violation of the Producer Licensing statute and its “Inducements prohibited” provision.

Even though the scenario only contemplates a quote and the value is limited to the price of one movie ticket, the relevant section of the law is broadly written. There is no threshold dollar amount that is acceptable, and even with no obligation to purchase, tying the gift to a quote is considered a quid pro quo.

DELAWARE Maybe. In Delaware, the Department of Insurance’s position is in flux. If you are contemplating any such program, we would encourage you to call us to discuss your scenario in more detail.

IF YOU DO BUSINESS IN MULTIPLE STATES The program needs to comply with the state where the insured is located and the policy is written. Make sure your program accounts for that, and either is not offered where prohibited, or contains proper disclaimers about applicability. n

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This month’s answer was provided by Claire Pantaloni, CIC, CISR, our industry affairs director. Catch Claire in our Human Resources Pitfalls special topic seminar, coming to the Delaware Annual Convention in June and locations throughout our tri-state footprint in the fall. IABforME.com/SpecialTopics

Have a question?

Ask our experts!

Rely on our experts to answer your most perplexing questions. Visit the Ask Our Experts section of IABforME.com (find the link in the website footer) to submit your question and review answers to other frequently asked questions.

Or email your question to us at IAB@IABforME.com. We look forward to hearing from you.

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PREVENTING ERRORS AND OMISSIONS

MERGERS AND ACQUISITIONS: SOME E&O WORDS OF WISDOM Utica National E&O Program

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he issue of mergers and acquisitions is a popular topic in the insurance news world. While there are many issues related to mergers and acquisitions to consider, there is a key – if not critical – one that doesn’t seem to get the attention it deserves: how your errors-and-omissions policy will address potential liability issues that can make a good deal a “nightmare” without the proper attention. While this is not an overly complex matter, it is also not all that simple. Bottom line, whether you are the buyer or the seller, proper planning and appropriate attention to detail are extremely important.

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CONSULT YOUR E&O CARRIER OR POLICY Mergers and acquisitions seems to be an area where there is a tremendous lack of consistency among all E&O carriers on the options available and the process that must be followed. While the policies typically provide the necessary coverage, the options regarding the number of years varies significantly from carrier to carrier. This definitely speaks to the need to plan ahead.

A good time to become educated on some of the significant coverage issues is as

MARCH 2015

soon as you start thinking about buying or selling. Any good E&O carrier “worth its weight” can provide guidance and direction based on your specific scenario.

For example, will the E&O carrier treat the transaction as an acquisition, or is it actually a merger? What additional information is needed? Will the carrier agree to provide the coverage based on the details of the transaction? Contact the underwriter, broker or agents’ association that played a fundamental role in the purchase of your E&O coverage and explain the situation. Don’t hesitate to ask all of the necessary questions.

Both the buyer and the seller should allow sufficient time for the development and providing of additional paperwork, copies of the proposed transaction documents, applications, etc., the E&O carriers may require.

WHEN YOU’RE THE BUYER It is best for the buyer to consider “asset-only” purchases, and not purchases of any liabilities of the agency going out of business. This is one of the many areas where an attorney is needed to ensure the buyer is fully protected.

The traditional approach is to have your E&O policy endorsed to provide coverage for the “new” agency.

The coverage, referred to by many E&O carriers as a purchased-entity endorsement, will provide protection against errors made by the “new” agency starting with the effective date of the acquisition.

An additional issue that must be vetted is for the buyer to know the finer details of his or her own E&O policy, including whether that policy contains a “retro date.” While liability for any claim may rest with the seller (the agency purchased), purchasing agencies (the buyers) are often still sued under the theory that the new agency purchased the liabilities of the purchased agency.

The presence of a retro date may preclude defense to the purchasing agency for an otherwise defensible claim. There may be a premium charge for the purchased entity coverage as this varies from one E&O carrier to another. In some cases, there will not be a charge as some E&O carriers look to address this “additional exposure” at the next renewal.

Lastly, the purchasing agency should look into either obtaining tail coverage for the purchased agency or potentially require the purchase of tail coverage as part of the deal. This is designed to ensure there is E&O protection should a problem develop. Look to secure (or require) the 10-year tail option if it is available.

WHEN YOU’RE THE SELLER If you are selling your agency, contact your E&O carrier and advise it of your plans. Don’t hesitate to ask questions regarding cost, options, timeframes, etc.

This is an important decision and should be carefully planned.

One of the many important issues is to understand the “known loss provision” in the E&O policy. If you are selling your agency and are aware of any actual unreported claims or situations that could lead to a claim, it is vital that these are reported to your E&O carrier to lock in coverage. Failure to report these real or potential claims has significant potential to result in a lack of coverage.

The seller should secure an optional extended-reporting-period endorsement (a/k/a “tail”). Even after a sale, the nowdefunct agency is still at risk of being sued. In addition, while the law often protects the right of claimants to seek the personal assets of the agency’s former owner, an attempt could be made, thus making the tail coverage and the defense it will afford that much more important.

The purpose of this optional tail is to provide an additional period of time after the expiration of the policy for which valid claims will continue to be accepted, provided the wrongful act occurred before the end of the policy period.

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While virtually all claims-made policies contain this provision, there is, once again, a tremendous lack of consistency as to the available options. Some policies only allow an additional oneyear “tail.” Other policies may only allow options up to three years. Still others provide up to 10 years – or even an unlimited period. The charge for this additional coverage comes with a hefty premium charge, so plan for this expense.

Two-hundred percent (200 percent) of the last full annual premium for a 10-year tail is common. You only have one time to make the decision, and this is not a cost that can be financed, so make sure you have the resources available.

DOCUMENT RETENTION IS STILL AN ISSUE Whether you are the buyer or seller, it is also important to understand the importance of document retention of the purchased agency’s files. Should an E&O claim develop (and they definitely have), having access to the file and the various documents is critical. Those files should be retained as if the agency was ongoing.

Looking to buy or sell? Consider the E&O issues early on and include your E&O carrier and an attorney in the discussion. This is crucial to ensuring that the process goes as planned. n

The Utica National E&O Program supplied this article. Our sales center is the exclusive agent for the Utica E&O program in Delaware, Maryland and Pennsylvania.

For questions regarding this article or your E&O coverage, contact IA&B at 800-998-9644 or IAB@IABforME.com.

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COVERAGE CORNER

PRODUCT LIABILITY IN PENNSYLVANIA Jerry M. Milton, CIC

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hould local governments and school districts, unlike individuals and businesses, enjoy limited immunity from lawsuits? This is the question that had to be resolved by the Pennsylvania Supreme Court in November 2014.

On Jan. 12, 2007, Ashley Zauflik sustained catastrophic injuries when a bus driver for the Pennsbury School District applied the accelerator instead of the brake as he shifted the bus into gear, causing the bus to run off the road onto a sidewalk and run into a group of 20 students. Ms. Zauflik, a 17-year-old junior, was the most seriously injured.

Her injuries included, among others, a

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crushed pelvis and leg, resulting in an above-the-knee amputation of her left leg.

On Nov. 29, 2011, all of the defendants, except the Pennsbury School District, were dismissed. Pennsbury School District, like all other school districts, is considered a local agency and is granted immunity from liability under the Tort Claims Act. There are limited exceptions to the act which permit a lawsuit against a local agency, including negligent operation of a motor vehicle.

The district admitted liability for Ms. Zauflik’s injuries pursuant to the motor vehicle exception of the Act and agreed MARCH 2015

to tender the statutory limit of liability of $500,000. Ms. Zauflik refused, and the case of Zauflik v. Pennsbury proceeded to a jury trial as a challenge to the constitutionality of the Tort Claims Act. She argued that the $500,000 cap on damages violated her rights, including equal protection provisions of the state and federal constitutions.

On Dec. 5, 2011, the jury returned a verdict in favor of Ms. Zauflik for over $14 million ($14,036,263.39 to be exact). Following the filing of post-trial motions, the trial court judge upheld the cap on damages provided by the Tort Claims Act and reduced the award

to $502,661.63, which included delay damages. In his decision, Bucks County Judge Robert Mellon said he had no choice, but “there is no dispute that the circumstances of this case create an unfair and unjust result.”

Ms. Zauflik appealed, and the Commonwealth Court affirmed the trial court’s decision, which resulted in the $14 million judgment being reduced to $502,661.63. In their decision, the Commonwealth Court blasted the Pennsylvania Supreme Court’s upholding of the $500,000 cap in previous decisions, but affirmed the trial court’s decision on the basis that it had no choice but to do so.

The case was then appealed to the Pennsylvania Supreme Court. The Court had empathy for Ms. Zauflik, who suffered life-changing injuries. “The facts here are tragic, involving a school student who suffered grievous injuries caused by the uncontested negligence of the school district’s employee,” wrote Chief Justice Ronald Castille. But he said the law had previously been upheld on appeal (see: Ayala v. Philadelphia Board of Education and Smith v. City of Philadelphia).

He further suggested that it may be better for the legislature to address the “complicated public policy questions.”

In a three-justice concurrence, Justice Max Baer said the cap is now so low that it may have the practical effect of being a barrier to the right to a jury trial.

“Simply put, plaintiffs’ counsel cannot responsibly agree to enter an appearance in a case where there will be no, or a minimal, return to the client because of the costs and fees necessary to secure a successful result,” Baer wrote. The $500,000 cap has not been changed in more than three decades.

Despite their empathy for Ms. Zauflik and concern over the cap limit, on Nov. 20, 2014, the Pennsylvania Supreme Court found that Pennsylvania’s $500,000 local agency limit of liability under the Tort Claims Act was constitutional.

One critical issue: Had the Pennsbury School District outsourced the school bus operations to a private company, as many other districts do, most legal analysts and judges involved in this case believe the cap would not apply.

Judge Mellon stated: The district chose to run its own private busing company by hiring drivers, purchasing and maintaining vehicles, and planning bus routes.

Had Zauflik been injured in another school district that chose to outsource its transportation to a private company, Zauflik would likely be able to recover the full amount of compensation.

Ms. Zauflik’s attorney, Tom Kline said she was very disappointed in the justices’ decision, “but we are already at work to get this fixed for the future Ashleys by getting the law changed.”

Steve Cozen, who represented the Pennsbury School District, said the legislature might move to change the

limit but will have to balance changing demographics and other factors against the pressure on governmental treasuries.

“You’re going to have a really healthy dialogue on both sides about that issue,” Cozen said. “I think that was really what this case was all about. We’ll see whether or not anybody takes their arguments to the General Assembly and see what the General Assembly does with them.”

I don’t know about you, but I’m betting the General Assembly will address this issue and very likely increase the Tort Claims Act limit of liability of $500,000.

To how much? I certainly don’t know.

But again, if I’m betting, I would say $1,000,000. However, I wouldn’t be surprised if it was higher – say, $2,500,000 or $3,000,000.

Y’all take care! n Jerry M. Milton, CIC, teaches and consults on industry issues. The legal profession recognizes him as an expert on insurance coverages. He also serves as our education consultant, working with our CISR, CIC and continuing education programs. Catch him at one of our upcoming seminars: IABforME.com/MyTraining.

MORE FROM MILTON IF YOU love learning from Jerry (and who doesn’t?), be sure to catch him at our upcoming POWER HOUR webinar, where he’ll present on the coverage considerations for home-based businesses.

POWER HOUR – THURSDAY, APRIL 16 AT NOON IABFORME.COM/POWERHOUR

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STATE NEWS

STANDARDIZING HEALTH INSURANCE PRIVACY REQUESTS The Maryland Insurance Administration (MIA) released a Request for Confidential Communications Form. The move is part of state regulators’ response to recent HIPAA-conformity legislation (Senate Bill 790) with additional consumer protections for health insurer communications.

IS A 100 PERCENT COMMERCIAL CONDO REQUIRED TO CARRY A FIDELITY BOND? Unless it can claim an exemption based on its small size, the answer is yes.

Under Maryland law, condominium associations, homeowners’ associations and cooperative housing corporations are required to carry fidelity insurance to cover any internal mishaps (read: fraud, dishonesty or criminal acts) by their employees, agents or directors and officers. This fidelity insurance can take the form of a bond.

While most of the insurance requirements regarding Maryland condos apply to those that are residential in whole or in part, the fidelity requirement applies to all condos, including those that are entirely commercial. The 2010 clarification amendment was inserted in a separate section, and we confirmed its applicability with the Attorney General’s office.

To claim an exemption, the smaller associations must have four or fewer units, and three months of gross annual assessments must be worth less than $2,500.

The form, which is accessible from the MIA website, allows individuals to request that their health information be sent to an alternative location if they feel that they could be endangered by the disclosure of their protected health information. This protects the individual from having the information sent to a spouse, partner or parent.

Agents may want to verify with their health carriers if any procedures will be affected by use of the form. In addition, using this opportunity to remind all agency staff of the applicability of HIPAA and the caution needed when handling any health information would go a long way in avoiding any inadvertent release of information. www.MDinsurance.state.md.us

IABforME.com/resource-center/condo-MD/after-287

WELCOME NEW MEMBERS LOWE TILLSON INSURANCE & ASSOCIATES INC. Rockville, MD

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MARCH 2015

PAC IN PLAY Our ability to host this event was only possible through AgentPAC. In order to make more events like these possible, we need your help. AgentPAC dollars are used to support the campaigns of and build relationships with those who share our common interests and goals.

IABforME.com/AgentPAC

AGENT APPOINTED AS NEW INSURANCE COMMISSIONER Gov. Larry Hogan poses with IA&B Service Group Vice Chairman Bob Klinger, of Klinger Insurance Group in Germantown, at our industry-only reception.

AGENTPAC HOSTS RECORD-BREAKING FUNDRAISER FOR GOV. HOGAN We made inroads with Gov. Larry Hogan this winter at an insurance industry-only reception hosted by IA&B, as well as the Maryland Health Underwriters Association (MAHU) and the Maryland chapter of National Association of Insurance and Financial Advisors (NAIFA-MD).

The reception was a great show of strength to Hogan and his team on behalf of insurance producers throughout the state. The event raised over $100,000, a record for an insurance industrysponsored fundraiser. The Annapolis Yacht Club provided the setting for over 100 members of the insurance industry to mingle, talk shop and build rapport with the new governor.

A familiar face (and insurance agent) returned to the helm of the Maryland Insurance Administration this winter.

Former Insurance Commissioner Al Redmer, Jr. was appointed to the position

by Republican Gov. Larry Hogan.

Redmer last served as Maryland’s insurance commissioner from 2003 to 2005 during Gov. Bob Ehrlich’s administration. Prior to that, he was a member of the Maryland House of Delegates from 1991 to 2003 where he served as House Minority Whip.

Formerly, Redmer managed the Redmer Insurance Group and owned the Redmer Financial Group.

Therese M. Goldsmith, who was appointed as insurance commissioner in 2011 by Gov. Martin O’Malley, stepped down as Hogan took office in January, four months before her term was up.

We’re looking forward to establishing and strengthening our dialog with the Maryland Insurance Administration on the heels of this change.

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MIA RELEASES BULLETIN BANNING PRICE OPTIMIZATION Efforts by carriers to tie policy rates to an insured’s odds of “shopping around” have been deemed unfairly discriminatory by the Maryland Insurance Administration (MIA), according to a bulletin on price optimization released last fall. Price optimization refers to the “practice of varying rates based on factors other than the risk of loss, such as the likelihood that policyholders will renew their policies and the willingness of certain policyholders to pay higher premiums than other policyholders.”

The bulletin would apply to: • The practice by an insurer of partnering with a vendor (like Choicepoint/LexisNexis) and calling the policyholder to offer a better rate when that insurer is notified that an MVR is pulled by another carrier • The “retention model” or “longevity model” that would use various factors, including average age of the policy and/or average age of the policyholder to determine the likelihood of shopping the market and offer better conditions Since the bulletin’s release, we’ve learned that although some of these practices have been clearly visible and approved in past rate filings, the MIA, upon further consideration, has deemed them improper, and the previous filings will have to be amended. Although Maryland appears to be the first state to act on this issue, price optimization has been on the list of issues being discussed by the National Association of Insurance Commissioners for quite some time.

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PARTNERS PROGRAM

Listed below are those companies that strongly support the independent agency system and Insurance Agents & Brokers.

Thank you for your continued sponsorship.

WHAT IS IA&B PARTNERS? The IA&B Partners program gives company and allied businesses the opportunity to demonstrate their commitment of support to independent agents and receive maximum market exposure. As an IA&B Partner, you will also realize the benefits of IA&B membership to help you succeed in the insurance industry.

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Contact the Member Sales Center at 800-998-9644, 717-795-9100 or visit us online at IABforME.com to get started.

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Juniata Mutual Insurance Co

Travelers

PSBA Insurance Trust

Tuscarora Wayne Group of Companies

Selective

United Fire Group

The Philadelphia Contributionship

Zenith Insurance

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MARCH 2015

INTERNAL

PERPETUATION

3

considerations to reach your goal

By Brian H. Burke, ASA and Everett W. Shaw, ASA

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n our many years of insurance-agency consulting work at BHBCo, we don’t know of another subject that has been considered so important for so long by so many – and yet has had so many instances of failure – as internal perpetuation.

To be clear, we should say that failure does not usually involve a full flameout, where a purchase-and-sale transaction takes place and the buyers then fail financially and default … although there are some of those. More often, failure takes the form of agency principals wanting to keep the agency private, independent, and successful, stating their intentions loudly to important constituents – staff, carriers, and key customers – and then failing to make it happen. Normally, this ends in a sale to another firm and eventually a loss of identity. And sometimes dashed dreams and family traditions.

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In a vibrant, free-enterprise economy, it is natural for some businesses to fail and others to be swallowed up by competitors.

Many such stories are actually constructive in the long run. But in our judgment, those stories are too frequent – unnecessarily frequent – in the agency world. We say this because the independent insurance-agency business model is a really good one. When run right, agencies provide good protection and service for their customers, make good money for their owners, provide good jobs for their staff, provide profitable business for their carriers, and add energy to their communities. That’s why they are so valuable and why we have a never-ending sellers’ market for them. This is not the case of the neighborhood drugstore that could no longer compete with the national chains and had to sell for not much more than its inventory.

Independent insurance agencies are dynamic businesses, which, it turns out, have been helped by technology, not made obsolete by it, as some short-sighted pundits predicted a couple decades ago.

Then why the difficulties with successful perpetuation?

Why so many plans unfulfilled?

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Without that evidence of commitment and sacrifice, the agency’s perpetuation plans will end up all words and no action.

To advise agency principals on this subject, agency consultants need to be knowledgeable and experienced in three areas: people, finance and taxes. We’ll respond to the Why question in the context of these three.

PEOPLE The first requirement here is desire. Owners have to truly want to perpetuate internally. And prospective owners, usually producers and key managers, have to truly want to be buyers

MARCH 2015

and become responsible leaders. And this is more than just intellectual wanting. This means learning what needs to be done and committing to doing it.

The single biggest reason that many perpetuation plans are unsuccessful is senior people (the sellers) hanging on too long.

This is partly psychological – the Hamlet-like ambivalence, should I or shouldn’t I? – but from a consulting standpoint, it is also a matter of simple math. If perpetuators (the buyers) are going to take on the debt needed to make a purchase happen, they need to get going on that early enough for there to be sufficient time to pay it off and experience a period of being debt free.

We acknowledge that in the recent and current environment (2011-2015) the values of certain agencies have run up, and the big payday explains some of the outside sales that in previous years may have gone the internal-perpetuation route. That phenomenon is real but still the exception when we view the universe of agencies and do so with a broader timeframe.

On the buyer side of the People dimension, there are a lot of supposed perpetuators who would like to end up as principals as long as someone makes it all happen sort of free.

I’ll be willing to buy it, but first promise me the extra compensation to make sure that I have enough money after tax to meet the debt payments and with a margin of safety, so that this fussy business does not interfere with my time with the kids, my time at the Club, and my self-actualization time.

That is intellectual wanting, not commitment. We at BHBCo live in the real world and practice what we preach in our own firm, and we know that younger people usually don’t have a lot of spare money. They are paying mortgages, feeding babies, saving for college and the like. The point here, however, is that whatever can be done should be done, because without that evidence of commitment and sacrifice, the agency’s perpetuation plans will end up all words and no action.

Before moving on, let’s identify another culprit in the People category: carrier executives. This subject is really important and a full discussion goes way beyond the scope of this piece. But our story is not complete without its mention.

For as long as we have been advising agencies, their carriers (particularly the standard-market P/C carriers) have been saying how important agency perpetuation is to them. There are some exceptions in which agency execs are very helpful,

FINDING EXPERT HELP TO PERPETUATE SUCCESSFUL AGENCY perpetuation can require a decade of persistent planning. Whether you’re aiming for an internal transfer of ownership or an outright sale to a third party, gaining an expert opinion on your agency’s unique challenges and opportunities – and ultimately how to increase its value – can go a long way to ensuring success and minimizing headaches.

We’ve recently expanded our directory of consultants (including the authors of this article) to incorporate their business model and pricing range. Give it a read to see who may best be able to meet your needs, and check back as we amend the list in the weeks and months ahead.

IABFORME.COM/ AGENCY_PERPETUATION/CONSULTANTS

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From a planning perspective, the idea is to become informed about [tax rules] years before the final changeof-control transaction.

but too often the carriers’ actions, at the least, seem tone-deaf to the perpetuation needs of their agents, and in some cases seem outright hostile to the idea of continuity for other than the biggest agencies. We believe that many carriers will come to regret, or already regret, this strategy of systematically reducing the number of local firms, with their true local knowledge.

FINANCE The financial dimension of perpetuation planning involves valuation, cash flows, deal structuring and payment terms.

The subject of tax affects finance too, but it is treated separately below.

This article does not address agency valuation except to say this: Most sellers in a perpetuation plan want the transactions struck at fair market value. Even in close family situations that involve significant discounting or other such accommodations, most sellers want the analysis leading to the plan to be based on market value. That’s understandable, but there is one problem: Market values are based on the economics of actual purchaseand-sale transactions in which the buyers are other agencies that are usually able to bring about certain revenue synergies and expense synergies that are not available to inside buyers. And this is sometimes true on taxes as well, meaning that outside buyers of agency assets can often get tax deductions that inside buyers of stock (in the case of corporations) cannot. That is to say, without proper planning, perpetuation transactions at fair market value often cause financial strain right out of the blocks.

Besides just lowering the price, the way to deal with such issues is with prior planning. The most effective vehicle is to create ways for the younger buyers to earn equity, or the equivalent, for several years leading up to the final transaction, when control is transferred. If by the time of the final transaction the buyer (or group of buyers) already owns, say, 30 percent of the value, then the cash flows of the agency need only to pay for 70 percent of the value, which becomes a much more manageable proposition. This has the potential to work to everyone’s satisfaction if there is enough time and creativity for the 30 percent equity position (in this example) to be earned through performance.

The remainder of the financial piece involves structuring the payment terms on promissory notes such that they fit the particular agency’s cash flows; structuring retention or earnout arrangements that fit the particular agency’s book

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MARCH 2015

Without proper planning, perpetuation transactions at fair market value often cause financial strain right out of the blocks. of business; and finding the balance between purchase payments and postsale compensation/benefits/perks for the seller(s). It’s sometimes said that perpetuation sellers don’t always get the best price but they often get the best deal, meaning custom-fit to their needs and preferences.

Perpetuation debt is often a combination of notes to the seller and notes to a commercial lender. On the latter, we strongly recommend using one with experience in and an appetite for insurance-agency transactions. You don’t want an eager, local, loan representative trying to help the young buyers, only to get the loan rejected at the last minute by a bank loan committee or board that does not understand the value of an agency’s intangible assets.

TAXES The tax part of perpetuation is a matter of becoming informed of what is realistically available to buyers in the way of shelters (meaning deal-caused tax deductions) and the tax treatment likely to be applied to the proceeds received by the seller(s),

meaning the mix of capital gains and ordinary income, as affected by such things as the new Obamacare taxes and alternative minimum tax rules. From a planning perspective, the idea is to become informed about these subjects years before the final change-of-control transaction, because there are things the parties can do to manage the tax expense, which is just as important as managing any other expense that affects profits and cash flows. Last-minute deals are almost always more costly tax-wise than they need to be. And the rules differ in some important ways between family and non-family transactions.

In our consulting on this subject, we frequently advise parties to do the best they can to manage the tax expense but not to get themselves tied into knots trying to eke out every last nickel. That time, effort and expense is often better devoted to the business of the agency.

But those who are strongly driven by tax considerations might look into ESOPs in general; ESOPs for S corporations; and in family situations, a mixture of gifting, selling and deferred compensation.

CONCLUSION There are great rewards, financial and otherwise, to be derived from keeping an insurance agency independent and private for several generations. But as with most things, there is no free lunch.

Doing it successfully requires sincere commitment, frequent communication and lots of planning. n

Brian H. Burke, ASA, and Everett W. Shaw, ASA, both of the insurance agency consulting firm B.H. Burke & Co. Inc., authored this article.

A certified business appraiser, Burke is the founder and chairman of BHBCo., as well as a director of InsurBanc. He is a frequent speaker and writer on business finance, ownership and management.

Shaw, also a certified business appraiser, is owner and president of BHBCo. Over the last decade he has conducted hundreds of valuations, has represented buyers and sellers in numerous transactions, and has been qualified as an expert witness. Learn more about their firm by visiting BHBCO.com.

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MARCH 2015

AGENCY VALUATIONS The big picture

Know your agency value long before it’s time to sell

By Mike Brady

Many insurance agency owners have long relied on an old formula for determining the value of their business.

“I don’t need a valuation,” one owner told me, “I know how it works. Everyone gets a multiple between one and two times revenue.” Interestingly, the following year that owner was surprised when a prospective buyer started looking at his company and things got more complicated.

IABforME.com | PRIMARY

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T

he first problem with the “one to two formula” is that it’s both true and false. Many transactions do end up valuing out at 1 to 2 times revenue. Depending on the size of your firm, that can be a very big range. Consider the difference between one and two times revenue for a $1 million agency. The difference is a million dollars!

So you need to ask yourself: Is getting more of the second million that you might have gotten worth a little time and money? Is your goal simply to get out – or to get out with as much money in your pocket as possible?

The second problem with the “one to two formula” is that using such a formula doesn’t mean that your business was fairly valued.

Buyers are generally pretty sophisticated today and will want to consider a variety of factors besides revenue. As a result, using a more sophisticated method can protect you, if you’re smart.

Here’s an example. An owner, 62, has an agency with a $2 million book of business. The owner wanted to sell and thought a multiple of revenue of 1.5 or higher would produce a sale price of $3 million to $3.5 million for the agency. He hadn’t done any prior homework or planning for this exit strategy. The transaction ended up closing for $2 million.

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Valuations are not just for transaction purposes. They identify risks and vulnerabilities while you still have plenty of time to address them.

WHAT ACCOUNTED FOR THE LOWER VALUE? Several very important factors played a role: • Two accounts made up 40 percent of the book, and one of those large accounts was a long-time friend of the owner with no loyalty to the acquiring agency; • The owner was not willing to stay involved going forward; • The agency’s other top producer did not have an employment contract; • Fifty percent of the book was with one carrier.

MARCH 2015

While it would be natural for the owner to feel disappointed or that he had been outflanked by a savvy buyer, perhaps the reality is different. Had the owner done more due diligence and gotten a thorough valuation, each of those costly – and very fixable – vulnerabilities would likely have come to light and been remedied before the selling process even began. In effect, his attempt to take an easier path cost him as much as a million and a half dollars.

This kind of mistake is much more common than most agency owners realize. We’ve seen it again and again. Unfortunately, there is no way to fix it later – or even during the selling process.

What’s done is done.

WHAT’S THE ALTERNATIVE? The smartest path is for owners to really know the value of their agency. Valuations are not just for transaction purposes. They identify risks and vulnerabilities while you still have plenty of time to address them. And they can educate owners so they are as savvy and prepared as the buyers who will be combing their books. The old saying is still true: It’s never too early to plan ahead. And it’s never too early to begin to build toward an exit strategy that maximizes your take-away.

CONFIDENTIALITY CONSIDERATIONS BEFORE YOU begin discussions with another agency about a transaction, it’s important to consider the confidentiality of those talks. After all, if the sale falls through, you don’t want that previously potential buyer to use or disclose what he or she learned about your agency during the negotiation.

Your IA&B membership grants you access to our sample confidentiality agreement. Pull it off of our website, run it by your attorney and/or agency valuation consultant, adapt it as necessary, and then rest assured that the discussions surrounding the sale of your agency will remain guarded.

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Considering multiple factors 3281 Summit Ad 7.25X4.625 beyond just the book of PropMan business dollar value will provide a far more accurate value and a larger reward for agency owners who have built their business over many years.

Even though your agency is likely the largest asset you own, most owners spend little if any time understanding what their agency is worth and how to increase the value.

Identifying areas that need to be addressed is good business and good for your sale price. After all, you probably spend most of your day identifying areas of risk that your clients should consider addressing, why not do the same for your business?

WHAT ARE THE PAYOFFS OF A VALUATION? Agency owners with a well-prepared and current valuation understand two things very clearly: 1) the real value of their agency; and 2) exactly where they can maximize that value when the change of ownership takes place.

In addition, valuations can play a role in planning and growth. Having a current valuation is not only a good tool for strategic planning (such as succession and continuity), but can also be used to help secure financing quickly for unexpected opportunities, such as to acquire talent or assets.

It’s quite common for a valuation to speed up financing by

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allowing your bank’s underwriters to quickly understand and verify the value of the agency. This speed can provide a first-mover advantage over competitors who are not prepared.

A skilled and thorough agency valuation can also assist you in both planning and growing your agency. This planning can be leveraged in increasing both the present and future value of your agency.

VALUING YOUR AGENCY Key factors to include when valuing your insurance agency: • Age and employment status of key employees, especially producers

HOW CAN YOU LEVERAGE YOUR VALUE? A thorough agency valuation, updated every few years, provides the proper foundation for planning, growth and the eventual sale of the agency – all good reasons for getting around to it now.

Because there are far better methods of valuing an agency today than using the old multiple of revenue rule, we are convinced that considering multiple factors beyond just the book of business dollar value (see above) will provide a far more accurate value and a larger reward for agency owners who have built their business over many years.

• Dependency on large accounts • Dependency on a certain industry • Age, business life cycle of clients • Receivable issues • Quality of insurance markets • Overreliance on certain insurance markets • Historical profitability of clients for insurance markets • Agency location, number of offices • Employee quality and productivity • Technology platform, age of technology • Sales management • Brand and reputation • Cash/asset management • Office facility • Historical growth rate

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Keep in mind that a solid valuation can not only increase your options and a potential payout when you sell, it can also save you money, especially in taxes.

Once the valuation is completed, that value should play a central role in the owner’s corporate perpetuation and personal estate planning, and your advisers can put it to good use to minimize taxes. To ignore what is likely your largest asset makes little sense, yet many owners do just that. The tangible impact of not incorporating this planning into your agency will be largely felt when you exit the business, usually at the time when you can least afford it.

If you’re ready to sell, downsize, retire, or expand your services and products, talk with the business professionals at AAA Mid-Atlantic Insurance Agency.

We’d welcome the opportunity to discuss your desire or need for change—and how we can help you attain your goals.

Call:

Judy Dodds

Business Development Manager 302-299-4776 or email at: jdodds@aaamidatlantic.com

It’s never too early to plan ahead. And it’s never too early to begin to build toward an exit strategy that maximizes your take-away.

©2014 AAA Insurance

PITTSBURGH I-DAY

FRIDAY, APRIL 24TH, 2015 Doors Open at 8:00 AM You Must Be Registered to Attend.

I-Day Events Kick Off on Thursday for the Presidential Dinner and The Main Event on Friday Including CE, Exhibits, Luncheon with Speaker, and Cocktail Reception.

Owners who take the time to not only accurately determine the value of their agency today, and who do all they can to increase that value, are the smart owners who maximize that value. n Mike Brady is a partner of Brady Financial Group in Exton, Pa. and provides outsourced financial resources to help business owners identify and solve their financial and business challenges. His more than 20 years in the industry as both CFO of a top 50 regional broker and partner in Brady Financial Group provides him a unique perspective to the agent/broker industry.

The firm provides part-time or interim CFO services as well as engages on specific projects where management requires additional financial expertise. For more information, call 484-653-6280 or visit bradygrp.com.

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Visit www.insclubpgh.com or Call The Club Office (412.489.5626) to Register, Exhibit, Advertise, or For More Information

MARCH 2015

CLASSIFIED

My Events March & April 2015

DATE TOPIC

LOCATION

MARCH 3-5

Property & Casualty Licensing Study Course

Bethlehem, Pa.

9-10

James K. Ruble Graduate Seminar *Limited Seating* Ellicott City, Md.

9-12

CIC Commercial Casualty Institute

Erie, Pa.

11

CISR Elements of Risk Management

Mechanicsburg, Pa.

18

CISR Agency Operations

Pittsburgh, Pa.

18

CISR Commercial Casualty II

Reading, Pa.

24

William T. Hold: Writing Commercial Accounts

Philadelphia, Pa.

24

Insuring Contractors Seminar

Gaithersburg, Md.

24

DAIAB Company Appreciation Night

Newark, Del.

24-26

Property & Casualty Licensing Study Course

Mechanicsburg, Pa.

25-28

CIC Commercial Property Institute

Wilmington, Del.

7

William T. Hold: Policy Language Surprises

Baltimore, Md.

7

William T. Hold: Writing Commercial Accounts

Bethlehem, Pa.

8

CISR Commercial Casualty I

Mechanicsburg, Pa.

8

CISR Commercial Property

Erie, Pa.

9

CISR Commercial Casualty I

Pittsburgh, Pa.

13-14

James K. Ruble Graduate Seminar

Pittsburgh, Pa.

14

William T. Hold: Policy Language Surprises

Pittsburgh, Pa.

15

William T. Hold: Policy Language Surprises

Altoona, Pa.

16

CISR Commercial Property

Wilkes-Barre, Pa.

16

CISR Elements of Risk Management

Frederick, Md.

APRIL

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AD INDEX

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CISR Personal Auto

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E&O Risk Management Seminar

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CISR Commercial Casualty I

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E&O Risk Management Seminar

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ARI Insurance Company........................................IFC

22-23

Pa. & Del. National Legislative Conference

Washington, DC

Berkshire Hathaway Guard Ins Co.................21

27-28

James K. Ruble Graduate Seminar

Philadelphia, Pa.

28

CISR Commercial Casualty I

York, Pa.

Coastal Agents Alliance...........................................17

28

William T. Hold: Writing Commercial Accounts

Reading, Pa.

28-30

Property & Casualty Licensing Study Course

Philadelphia, Pa.

29

CISR Commercial Property

EMC Insurance Companies..................................10 Harford Mutual.................................................................23 IA&B Partners Program............................................11 Interstate Insurance Mngmnt Inc.................OBC Pittsburgh I-Day..............................................................24

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