Rough Notes • May 2024 • INSIDE MATTERS

There is no denying that agencies are feeling the pressure to grow. Some are dedicated to organic growth, which has its own unique challenges; others ponder the acquisition opportunities that may arise.

We receive many questions about how this process works, and what information should be considered when considering an acquisition or merger. The acquisition siren song is alluring, and the primary benefits seem clear to those who want to scale quickly, including but not limited to:

• “Instant” increase in commission income
• Increased volume with existing markets
• More market options
• Increased potential for contingent income
• Depth on the bench–potential to add talent
• Expanded territory and penetration
• Viable means for seller’s heirs to perpetuate, due to the owner’s untimely death or disability While these are worthy goals, many acquisitions don’t result in the expected return to agency buyers. In fact, most acquisitions tend to benefit the seller more than the buyer.

Often, buyers as well as the seller are unfamiliar with the basic steps of the detailed process required to eliminate surprises and ensure a positive outcome. This is understandable because the seller will likely go through this process only once. Preparation and attention to detail are critical.

From a best practices standpoint, it doesn’t hurt for any agency to understand and review these components from time to time. It can certainly help an organization interested in either acquiring an agency, or being acquired, to appreciate the scope of information and effort that might be involved.

Important note: We always recommend engaging a qualified agency valuation expert, who will also work closely with your competent legal counsel and CPA throughout the journey. The information provided here is by no means complete or comprehensive, nor does it guarantee any particular result; its purpose is to provide agencies with an introduction to what might be reviewed during the acquisition process.

Once the tentative first steps have been completed establishing that there is a potentially willing buyer and willing seller, the vetting/evaluation process can begin in earnest. Initially, this will include at least preliminary questionnaires and requests for information as well as mutual NDAs (non-disclosure agreements).

Maintaining strict confidentiality is paramount to avoiding loss of critical staff or accounts while still exploring the possibilities. Requested information will include a full and formal review of all financials, operational information, client files, and more.

All of the following components also contribute to an agency’s overall culture. The biggest challenge in combining agencies, whether buying or merging, is that of combining cultures. Developing a detailed “snapshot” of an agency’s data also gives the seller invaluable insights into its overall culture–and whether it will be a match with the buyer’s approach to doing business.

At the very least, it will help the buyer to identify areas of potential conflict, and understand and address them prior to finalizing a sale.

The seller will be asked to provide the most current versions of the following reports:
• Financials–five years plus most current
• Chart of accounts
• Aged accounts receivable
• Bank account reconciliations
• Detailed listings of balance sheet items (fixed assets, etc.)
• In-force insurance policies, plus five years of currently valued loss runs Much like the insurance underwriting or loan application process, the more complete and “clean” the information provided, the more positive the outcome for both the buyer and seller.

In addition, the buyer will want to review the following in the seller’s agency management system:
• Status of accounts payable reconciliations
• Carrier statements
• Validity of A/R (accounts receivable) amounts
• Direct bill reconciliations, including method for accounting for direct bill revenue
• Processes related to cash receipts, cash disbursements, and revenue recognition

This is by far the broadest component of agency review, as it includes so many areas of responsibility. It is important that you and your team carefully review all aspects of operations for any agency you are considering acquiring.

Client files. The seller should review complete client files, including all policies and documentation for at least the buyer’s top-ten revenue-producing accounts. An additional 20 accounts pulled randomly should also be reviewed in each department (commercial lines, personal lines, and benefits/life).

If client file information is stored anywhere except in the agency’s management system, this should be outlined by the seller (for example, items stored in paper files, ancillary systems, shared “neighborhood” drives, unattached email, Outlook™ client folders, unprocessed mail folders, desktop icon folders, and/or additional client underwriting or marketing files maintained by producers or servicing staff in paper or electronic form, etc.)

This can provide some insights into agency workf lows and automation level, as well.

Account stratification. Reports should be run by department, arrayed by commission size, and tiered by descending revenue category levels ranging generally from >$10k to <$500 for commercial lines. Personal lines tiers may run from >$2.5k to <$150. Reports should include policies per account. Questions to ask for each report:
• What percentage of revenue is concentrated in the top 10 accounts?
• What percentage of overall accounts is in the lowest tiers?
• What is the number of policies per relationship in each department?
• How many commercial lines accounts >$10k revenue have been lost over the past five years? Personal lines and/or benefits accounts >$1,500 revenue?
• What is the five-year overall retention rate for the agency? Each department? Each producer?
• Are any major accounts currently at risk of non-renewal?
• Are any book rolls currently underway?
• What percentage of accounts is monoline? Of those, what percentage is placed in E&S (excess and surplus lines) markets?
• What percentage of personal auto accounts is written with low (<$250k/$500k/$250k) or compulsory liability limits?

Workflow.
• Review all workflows by department– who does what?
• Is there a written procedures manual?
• What percentage of accounts was remarketed over the past year?
• Are any items still received in paper mail? If so, what are they?
• Obtain five-year history of E&O (errors and omissions) claims, including currently valued loss runs.
• Review your E&O policy contract, including named insured, limits, retention, and ERP (extended reporting period) provisions.

Tech stack. It is important to understand the level of automation and the specific technology solutions that are currently in place. This can vary by department and use of technology can also vary by individuals within departments. Information that should be collected:
• Agency management system and version in place, including scanning/ document management
• Cloud/IT agreements/contracts
• List of hardware including any local servers
• Scope and level of encryption. Are all devices, including cell phones, iPads, and computers, provided to remote employees including producers, encrypted? Are all emails encrypted?
• Detailed list of all ancillary software licenses in use
• Website. Is it informational only, or is it interactive in any way? Who owns the URL?
• Vendors/service providers for all systems (network security, management system, email, phone, imaging, fax, etc.). Review all contracts.

This is the most important factor in identifying potential economies of scale, and how the book of business might be absorbed/managed moving forward.
• How many locations does the agency have? How far apart are they? How far are they from the home office?
• Revenues handled per account manager
• How are accounts divided/ assigned for servicing?
• Job descriptions for each position on organizational chart
• Any employees working remotely, or any combination of in-office/ remotely?
• Any positions not currently filled?
• Any work outsourced? Review workflow and any outsourcing contracts to determine scope and cost.

Human resources.
• Are human resources functions outsourced?
• Is there an employee handbook? Does it contain an Internet policy?
• Review HR files. Have any employee complaints of any nature been filed in the past? Are there any EPL (employment practices liability) issues currently being reviewed, investigated and/or litigated?
• Look for any potential liability regarding overtime not paid to non-exempt employees, including account managers; any employees “working off the clock,” especially when working remotely; and any account managers answering after-hours calls, emails, or text messages on agency-provided or personal cell phones.
• Any employment contracts/book ownership agreements/non-compete/ non-piracy agreements?
• Provide a current benefits summary and any profit-sharing information, for instance 401(k), etc.
• Office hours/holidays/f lex time/ time-off policies?

Compensation.
• Salaries/compensation for all employees
• Any bonus plans/performance-based compensation plans in place?
• Verify pro forma information for current owners.
• Producer commission percentages for new and renewal—review all contracts.
• Any other commission/remuneration being paid to any employees?
• Any perks being covered by the agency for any owners/employees? For example, car allowance, cell phone, mileage reimbursement, educational reimbursement, club/ association memberships, etc.
• Independent contractors—review all contracts. Any 1099/independent contractor contracts/agreements in place? Any book of business ownership components?

• What are the current agency sales goals? For each producer?
• How much new business revenue has the agency written over each of the past five years? Each producer?
• Determine the level of producer involvement in servicing if possible.
• List top 10 carriers/wholesalers for each discipline and revenue/premium volume with each.
• Any carriers who would not do business with the buyer?
• Any sub-brokered business (with other agencies/individuals)? Need copies of any written contracts/ agreements
• Run report showing current level of use of MGAs (managing general agencies) and wholesaler placements.
• Review all carrier contracts, including five-year contingency history.
• Review all broker agreements.
• Review all canceled agreements in the past five years.
• Determine current marketplace status for any niches/specialties/ programs.

Once this information has been digested—and if the sale is completed— you are now ready for part two: implementation. Your work has just begun!

Cheryl Koch is the owner of Agency Management Resource Group, a California firm providing training, education and consulting to producers, account managers and owners of independent agencies. She has a BA in Economics from UCLA and an MBA from Sacramento State University. She has also earned several insurance professional designations: CPCU, CIC, ARM, AAI, AAI-M, API, AIS, AAM, AIM, ARP, AINS, ACSR, AFIS, and MLIS. Mary M. Belka is owner and CEO of Eisenhart Consulting Group, Inc., providing management and operations consulting to the insurance industry. She also is an endorsed agency E&O auditor for Swiss Re/Westport. A graduate of the University of Nebraska, Mary holds the CPCU, ARM, ARe, RPLU, CIC, and CPIW designations.