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National Economy Challenge to
Insurers, Clients and Brokers:
What it Means to the Value of
Your Business
Presented by:
Lou Caltavuturo
Partner
March 19, 2009
Agenda
Introduction of Hales
Brief Touch on Macro Economic Climate
Overview of Underwriting Cycle & Broker Sector
Review of 2008 M&A Activity
Consolidation Forecast
Valuation Trends, Conclusions & Outlook
Questions & Comments
2
About Hales & Company
Hales & Company is one of the oldest and most experienced advisory and investment
banking firms solely dedicated to the insurance industry. Hales has twenty-five professionals
with offices located in New York, Harrisburg, Seattle, San Francisco, Chicago, Hartford,
Washington DC and Southern California.
 Merger & Acquisition Services
Hales advises clients from the early strategic planning states through the closing of a sale, merger or
acquisition. A comprehensive merger and acquisition strategy is customized to meet your financial and
non-financial goals and objectives.
 Corporate Finance Services
Hales assists clients in accessing senior debt, subordinated debt / mezzanine financing and equity to help
fund working capital needs, internal growth initiatives, agency perpetuation plans, ESOP financing and
mergers and acquisitions.
 Strategic Consulting Services
Hales provides clients with strategic consulting services to identify and evaluate strategic alternatives
designed to help agencies, both public and private, improve operations and enhance shareholder value.
 Valuation Services
As a leading financial advisory firm that only services the insurance industry, our experience, knowledge
and expertise is unmatched in determining an accurate and realistic value of your agency. Hales offers
benchmark and fully-compliant valuations, depending on the needs of the client.
3
Hales Ranking: Transactions and
Values
2005
2006
2007
2008
# of Deals
# of Deals
# of Deals
# of Deals
Company
Totals
Hales & Company
18
19
30
34
101
Marsh Berry & Company ¹
23
24
16
33
96
Mystic Capital ¹
7
16
20
16
59
Reagan Consulting ¹
13
1
5
18
37
Firm
¹
Source: SNL Financial - Deal value not available for one or more deals. Dollar amounts in millions.
Firm
2005
2006
2007
2008
Deal Value
Deal Value
Deal Value
Deal Value
Hales & Company
$243.4
$642.2
$461.9
$568.0
Marsh Berry & Company ¹
$150.4
$14.7
$29.8
$100.3
$7.0
$116.4
$39.5
$300.3
$41.2
$104.8
$34.4
Mystic Capital ¹
Reagan Consulting ¹
¹
n/a
Source: SNL Financial - Deal value not available for one or more deals. Dollar amounts in millions.
4
Representative Transactions
The Personal Lines Division of
has been acquired by
has been acquired by
Hix Insurance Associates, Inc.
acquired selected assets of
J ohnson & Muir, Inc.
2009
2009
2008
Hales advised Edgewood Partners
Insurance Center
Hales advised Meyers/Dining
Insurance, LLC
Hales advised Caruso Benefits Group,
Inc
has been acquired by
has been acquired by
2008
2008
Hales advised Insurance Masters of
Lancaster, Ltd.
Hales advised Baden Retirement Plan
Services
has been acquired by
2008
Hales advised Commercial Insurance
Services, Inc.
5
Representative Transactions
Fuller & O’Brien Inc.
has been acquired by
has been acquired by
has been acquired by
2008
2008
2008
Hales advised Fuller & O’Brien Inc.
Hales advised Confie Seguros
Hales advised Summit Insurance Group
has been acquired by
2008
Hales advised Agency Marketing
Services
a subsidiary of
acquired selected assets of
has been acquired by
has been acquired by
has been acquired by
Carl A. Curcio &
Associates, Inc.
ASCENSION
2008
2008
2008
2008
Hales advised Caruso Benefits Group,
Inc
Hales advised First Charter Insurance
Services
Hales advised Continental Special Risks,
Inc.
Hales advised Wm. W. George &
Associates, Inc.
6
2008: A Year to
Remember…or Forget
Recent Headlines on the Economy
 Unemployment Continues Unabated
Jobless rate tops 8% in February, the highest since 1983, representing 12.5m workers.
Pace of job loss expected to stabilize but economists forecast 10% unemployment by yearend. Roughly 4.4m jobs were lost since December 2007 - construction and manufacturing
sectors hit hardest
 Foreclosures on the Rise
Nationwide, nearly 291,000 homes received at least one foreclosure-related notice last
month, up 6% from January. While foreclosures are highly concentrated in Florida, the
problem is spreading to states like Idaho, Illinois and Oregon as the U.S. economy worsens.
Over 8.1 million foreclosures predicted over the next 4 years. In addition, 7.5 million other
homeowners have “underwater” mortgages, expected to exacerbate the issue
 Household Wealth Declining
US households lost $5.1 TRILLION, or 9%, of their wealth in the last three months of
2008, the most ever in a quarter. For 2008, household wealth dropped $11.1 trillion,
or about 18%. Not reflected are stock market losses which could add trillions more
 US Retail Sales Fall Less than Expected
In December 2008, retail sales saw the worst monthly decline in the past 4 decades. Retail
sales declined 0.1% from January, better than the 0.5% drop that economists had expected,
but nonetheless returning to negative territory after a surprise 1.8% gain in January
8
Recent Headlines on the Economy
 Banking System in Crisis
In 2008, there were 28 bank failures. By February, 2009, there were 14 failures
and at the current rate, nearly 100 institutions - with a combined $50 billion in
assets - will collapse by year's end.
 GDP Falls through the Floor
US GDP contracted by 6.2% in 4Q08, double the number that was previously
expected - the largest drop since 1982. Despite this, the US Dollar continues to
show a strong stance with a upward bias. Despite problems in the US economy,
capital continues to fly into the US at break neck pace.
 Global Trading Declines Sharply
The combined value of US exports for July through November 2008 dropped 18%
from $398 billion to $326 billion – two-thirds of this drop was imports. Japan, the
world’s second largest economy, posted a 27% decline in November, the largest
slide it ever recorded
 Madoff, AIG, Citi, GM…..
Need I say more.
9
Insurance Sector Performance:
Property / Casualty
 Elevated uncertainty in capital availability, the
economy and 2008 losses could boost
premiums slightly – but not much
Price cuts in commercial lines in 2007-2008 are likely to resist rapid
reversal in 2009
 Forecasts peg industry combined ratios to reach
102% in 2009 and drop slightly in 2010
Assuming normal catastrophic losses and excluding unexpected shocks
 Premium growth forecast is nearly 4% for 2010,
up from a relatively flat 2009
Experts assume an improving economy with GDP growth near 2% in
2010, up from -1.3% in 2009
10
Annualized P&C Rate Change
MarketScout Annualized Monthly P&C Product Rate Change (Composite - All Lines)
40%
30%
20%
10%
0%
-10%
-20%
Annualized Monthly P&C Product Rate Change
Source: MarketScout
11
Insurance Sector Performance:
Life
 Long-term trends for the life industry look
favorable – short-term challenges ahead
Demographic trends (Baby Boomer retirement) will increase the
retirement products and long-term care insurance and wealth
management products
 Generations X & Y entering life phase with the
greatest insurance needs
Need for more careful retirement planning and innovative products
 Other challenges: economic slowdown,
healthcare inflation, volatile equity markets
The sub-prime meltdown, by and large, had relatively minor impact on the
insurance industry but recent market turmoil will challenge the investment
and hedging skills of insurers and constrain growth for a few years
12
Health Insurance Premiums
Insurance Premiums
(Indexed Health Premiums - 1988 Base Year)
600%
500%
400%
300%
200%
100%
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
1988
0%
Sources : Kaiser/HRET Survey of Employer-Sponsored Health Benefits, KPMG Survey of Employer-Sponsored Health Benefits,
and Health Insurance Association of America
13
Health Insurance Premiums
Average Increase in Health Insurance Premiums
Vs. Other Indicators
20.0%
18.0%
18.0%
16.0%
14.0%
12.0%
8.5%
8.0%
8.2%
6.0%
13.9%
12.9%
11.2%
10.9%
9.2%
7.7%
5.3%
4.0%
2.0%
6.1%
Workers' Earnings
2007
2006
2005
2004
2003
2002
1999
1998
1996
1995
1994
1993
1992
1991
1990
1989
1988
Health Insurance Premiums
1997
0.8%
0.0%
2001
10.0%
2000
12.0%
14.0%
Overall Inflation
Sources: Kaiser/HRET Survey of Employer-Sponsored Health Benefits and Bureau of Labor Statistics
14
Net Written Premium Growth
Net Written Premium Growth
18.0%
15.3%
16.0%
14.0%
12.0%
10.0%
10.0%
8.4%
8.0%
6.0%
5.0%
3.9%
4.0%
2.0%
2.7%
1.9%
0.5%
0.5%
0.0%
-0.3%
-2.0%
1999
2000
2001
2002
2003
Sources: Insurance Information Institute and Fitch Ratings
2004
2005
2006
2007
-0.2%
2008(Est) 2009(P)
15
Public Broker Organic Growth
Public Broker Median Organic Revenue Growth
12.0%
10.0%
8.0%
6.0%
4.0%
2.0%
0.0%
-2.0%
2003
2004
2005
2006
2007
YTD Q308
Median Organic Revenue Growth
Source: Company press releases and SEC filings
16
Public Broker EBITDA Margins
Note: Enterprise value is calculated as Equity Value + Total Debt + Preferred Stock + Minority Interests – Cash & Cash Equivalents
Sources: Thompson Financial, SEC Filings, and Reuters
17
Review of 2008
M&A Activity
Acquisition Activity
2007 The Year of the Perfect Storm
2008 The Year of Consolidation
2009 The Year of Uncertainty
Economic and financial pressures – the impact?
Product rates – do we move into a hard market?
Organic growth rates – will they begin to move up?
Change in capital gains rate – 2009 or 2010?
Change in healthcare distribution – what to expect and when?
Supply versus demand – will we reach equilibrium?
Carrier pressures – will they continue?
Will the credit and capital markets ease?
19
Announced Transactions
Total Number of Announced Transactions
Number of Announced Transactions
350
300
250
60%
200
150
35%
45%
35%
47%
47%
45%
100
45%
50
46%
53%
53%
46%
36%
38%
30%
22%
49%
60%
49%
22%
21%
0
Total
2004
224
2005
216
2006
264
2007
279
2008
307
188
Source: Insurance M&A Insights – 2009 Annual Sourcebook
20
Composition of Acquirers by Type
Distribution by Acquirer Type (# of Transactions)
Distribution by Acquirer Type (Amount of Deals)
350
300
250
200
35%53%
35%
150
100
50
0
45% 49% 47%
47%
25%
53%
46%
49%
53%
45%
45%
68%
60%
60%
22%
22%
21%
22%22%
22%
19%
18%
13%
2004
2005
2006
2007
2008
Insurance Brokers
117
106
158
167
208
Insurance and Other
57
62
51
62
58
Banks
50
48
55
50
41
188
Source: Insurance M&A Insights – 2009 Annual Sourcebook
60%
49%
46%
36% 29% 38% 19% 30%
60%
21%
21
Most Active Acquirers: 2008
Listed by Number of Announced Acquisitions in 2008
Company
Brown & Brown, Inc.
Arthur J. Gallagher & Co.
Hub International Limited
BB&T Corporation
National Financial Partners Corp.
Wells Fargo & Co.
USI Holdings Corporation
LTC Global Solutions, Inc.
Ascension Insurance, Inc.
Bollinger, Inc.
National Investment Managers Inc.
Aon Corporation
Apex Global Partners, Inc.
Confie Seguros
HCC Insurance Holdings, Inc.
Hilb Rogal & Hobbs Co.1
Total Most Active
Total 2008 Acquisitions
Percent of Most Active Acquirers to Total
Number of
Acquisitions
41
26
16
10
8
8
7
5
4
4
4
3
3
3
3
3
148
307
Percent of Total
Acquisitions
13.4%
8.5%
5.2%
3.3%
2.6%
2.6%
2.3%
1.6%
1.3%
1.3%
1.3%
1.0%
1.0%
1.0%
1.0%
1.0%
48.2%
48.2%
1
Willis Group Holdings Limited acquired Hilb Rogal & Hobbs Co. in June 2008.
Source: Insurance M&A Insights – 2009 Annual Sourcebook
22
Most Active
Insurance Brokers Acquirers
Listed by Number of Announced Acquisitions
Brown & Brown, Inc.
Arthur J. Gallagher & Co.
Hub International Limited
Hilb Rogal & Hobbs Co.1
USI Holdings Corporation
Willis Group Holdings Limited
Aon Corporation
Bollinger, Inc.
National Financial Partners Corp.
BISYS Group, Inc.2
Alliant Insurance Services, Inc.
AmWINS Group, Inc.
Marsh & McLennan Companies, Inc.
AssuranceAmerica Corp.
Beecher Carlson
Total Most Active
Total 2000-2008 Insurance Broker Acquisitions
2000-2003
72
53
20
33
5
6
1
9
0
13
5
3
2
0
0
222
319
2004
22
17
7
9
6
10
4
0
0
1
2
2
4
2
0
86
117
2005
15
11
10
4
9
11
5
2
2
0
0
1
0
1
2
73
106
2006
11
11
11
7
10
3
7
5
5
3
2
2
1
2
2
82
158
2007
29
22
21
8
8
3
4
4
5
1
1
2
1
2
1
112
167
2008
41
26
16
3
7
1
3
4
8
0
1
1
1
0
1
113
208
Total
190
140
85
64
45
34
24
24
20
18
11
11
9
7
6
688
1075
69.6%
73.5%
68.9%
51.9%
67.1%
54.3%
64.0%
Percent of Most Active Acquirers to Total
Percent of Total
Insurance Broker
Acquisitions
17.7%
13.0%
7.9%
6.0%
4.2%
3.2%
2.2%
2.2%
1.9%
1.7%
1.0%
1.0%
0.8%
0.7%
0.6%
64.0%
1
Willis Group Holdings Limited acquired Hilb Rogal & Hobbs Co. in June 2008.
2
Acquired by Crump Group, Inc., a wholesale brokerage owned by J.C. Flowers & Co., in May 2007.
Source: Insurance M&A Insights – 2009 Annual Sourcebook
23
Influence of Banks
 Back to basics for banks – financial meltdown, preserve capital,
return on investment, loan losses, inability to cross sell effectively
 Total number of transactions continue to decrease from historical
levels – however, top banks are committed – Wells Fargo & BB&T
Overall, committed banks have been very successful in
insurance distribution owning 12 of top US brokerage firms
 Banks will continue to divest of insurance distribution over time –
BNC Corp, Bank of America, Webster, Commerce, Union Bank of
CA (over $500 million in revenue sold over the past 2+ years)
24
Most Active Bank Acquirers
Listed by Number of Announced Acquisitions
2004
3
4
5
2
1
0
1
0
1
1
0
0
1
0
0
19
50
2005
1
4
0
3
1
2
0
1
1
0
1
0
0
4
1
19
48
2006
1
5
2
2
0
1
2
0
0
0
2
2
1
1
4
23
55
2007
4
8
1
0
0
1
5
1
0
1
1
0
0
0
0
22
50
2008
10
8
0
0
0
0
0
2
0
1
1
0
1
0
0
23
41
Total
46
45
20
11
10
10
9
8
8
8
8
7
7
7
7
211
517
Percent of Most Active Acquirers to Total
38.5%
38.0%
1
Acquired by Huntington Bancshares in July 2007.
2
Wells Fargo & Co. acquired Wachovia Corporation in October 2008.
3
Acquired by Spanish bank Banco Bilbao Vizcaya Argentaria, S.A. in Feb 2007.
4
Acquired by Susquehanna Bancshares in November 2007.
39.6%
41.8%
44.0%
56.1%
40.8%
BB&T Corporation
Wells Fargo & Co.
BancWest Corporation
Sky Financial Group, Inc.1
F.N.B. Corporation
Wachovia Corporation2
Northeast Bancorp
BancorpSouth, Inc.
Compass Bancshares, Inc.3
Cullen/Frost Bankers, Inc.
Regions Financial Corporation
Community Banks, Inc.4
First Financial Holdings, Inc.
First Niagara Financial Group, Inc.
Tompkins Financial Corporation
Total Most Active
Total 2000-2008 Bank Acquisitions
2000-2003
27
16
12
4
8
6
1
4
6
5
3
5
4
2
2
105
273
Source: Insurance M&A Insights – 2009 Annual Sourcebook
Percent of Total
Bank
Acquisitions
8.9%
8.7%
3.9%
2.1%
1.9%
1.9%
1.7%
1.5%
1.5%
1.5%
1.5%
1.4%
1.4%
1.4%
1.4%
40.8%
25
Bank Insurance Divestitures
Most Recently
Reported
Revenue
$ in Millions
Business
Insurance
Ranking Prior
to Sale
Year Divesting Bank
Divested Agency
2006
Citizens Financial Group
Citizens Clair Ins. Group,
Brewer & Lord, and Feitelberg Ins.
45
21
Hub International
2006
UnionBancorp
Union Bank Insurance Group
NA
NR
Hometown Bancorp
2006
Sterling Financial Corp.
Corporate Healthcare Strategies
6
NR
Former owner of Corp.
Healthcare Strategies
2007
Zions Bank
Grant-Hatch & Assoc., ZionsDirect, and
Zions Ins. Agency
6.6
NR
The Leavitt Group
2007
Capital One Financial Corp.
Hibernia Insurance Agency
(Hibernia Corp.)
18
64
Hub International
2007
BNCCORP
BNC Insurance Services
19
NR
Hub International
2007
Alabama National BanCorp.
ANB Insurance Services
4
NR
S.S. Nesbitt; subsidiary
of EBSCO Industries
2007
Bank of America
Banc of America Corporate
Insurance Agency
66
27
Hilb Rogal & Hobbs
2007
Commerce Bancorp
P&C, employee benefits and specialty
lines of Commerce Ins. Svcs.
94
23
Group led by Chairman,
George Norcross, III and
President Michael Tiagwad
2008
Webster Bank
Webster Insurance
26
64
USI Holdings
NA – Not Available
NR – Not Ranked
Acquirer
26
Influence of Private Equity Groups
 Illiquidity in the capital markets – difficulty in obtaining capital
 Cost of capital has increased significantly
 Leverage ratios have been reduced – impacts financial model
 USI, Hub International, Alliant Insurance Services, Ascension all
backed by PEGs will continue to acquire
 Pricing differential disappeared during 2008
 Will continue to play a role in consolidation – just reduced, back
to historical norms
27
2009 & Beyond:
What Does All This Mean
to Your Business?
Factors Shaping Consolidation
 Product pricing and the rate environment
 Organic growth rates
 Influence of banks and private equity firms
 Potential change in capital gains rate
 Need for talent and “age” factor
 Carrier pressure on small agencies
 Changing supply vs. demand curve
29
Supply Versus Demand
Are We Moving Toward Equilibrium?
Buyer Demand Has Decreased
 Public broker multiples
 Fewer PEG acquirers
 Fewer bank acquirers – of the major acquirers, Wells Fargo is
concentrating on integration of Wachovia
 Several national brokers have slowed acquisitions – HRH
acquired by Willis, National Financial Partners (NFP) financial
problems
 Active acquirers more cautious on pricing
30
Supply Versus Demand
Are We Moving Toward Equilibrium?
Seller Supply Has Increased Significantly
 5-year impact of soft market has forced many firms to sell
 Pressures from carriers on small agencies
 Competitive market pressures
 Age of owners
 Shortage of producer talent
 Difficulty in perpetuating internally
 Potential change in capital gains tax
31
Why Is Agency Value
Important to Understand
 Represents largest personal asset for most agency principals
 Many agency owners do not understand the key drivers of agency
value
 Agency owners tend to believe too many “myths” in the marketplace
– need to separate truth from fiction
 Valuation should be used as a management tool
Proactive, progressive agencies use valuation to find ways to create
opportunities to build wealth and to make better business decisions
Reactive agencies wait to hear how others evaluate their agency
 Business decisions you make today have a direct impact on your
agency’s ultimate exit value
32
Types of Value Within an Agency
ECONOMIC
1. Profit (Free
Cash Flow)
2. Working
Capital
3. Present Value
of Future
Renewal
Streams
GOODWILL / INTANGIBLE
1. Underwriting Quality
2. Length and Stability of Relationships
(Retention or Persistency)
3. Product and Service Offering –
Breadth or Niche
4. Operating Proficiency and Quality of
Service
5. Tenure of Staff
6. Geographic Footprint – Size and Scale
7. Lack of Concentration
8. Historical / Consistent Growth
9. Distribution Outlets (Exclusive)
10. Brand Name Recognition
11. Technology
EVERY INTANGIBLE ITEM ULTIMATELY IMPACTS THE ECONOMIC VALUE
OF THE AGENCY, DIRECTLY OR INDIRECTLY!
33
Hales’ Recommendations for Best
Practices to Drive Value
 Target 25% EBITDA margins for P&C,; 30% for EB
 Target organic revenue growth rates 10% to 15% (2008 average 6%)
 Create a “Results” driven versus “Process” driven mentality
Assign responsibility, hold accountable, and reward appropriately
 Create a sales culture - An agency is a SALES engine first
Review organizational structure to ensure great service but allow
producers time to sell
 Review compensation strategies – commission rates and incentives
Emphasize and reward new business
Incentives for exceeding goals
Include all employees in incentive plans that are more “formal” versus
discretionary
34
Hales’ Recommendations for Best
Practices to Drive Value
 Reduce concentration risk in agency (clients, markets, production)
 Pursue a differentiation strategy unrelated to customer service
 Set up small account departments and eliminate commissions on accounts below a
certain threshold
 Use metrics to drive value (revenue per employee, new business goals, etc.)
 Communicate to your staff – goals and strategy, culture, revenue, retention rates,
expectations
 Hire slowly, fire quickly
 Convert producer owned books of business to agency books
 Use technology to your advantage
 Convert to anything else but a C corporation
 Engage in real strategic planning – use consultants
35
Valuations – Conclusion &
Outlook
Valuation - Conclusions
 Dangerous to judge own value on rules of thumb or market rumors
 Each agency has its own unique set of value drivers that ultimately
determine individual value
 Buyers rely on profitability, not revenue, to determine value
 Even for agencies with same revenue and EBITDA margins, other
variables can account for vastly different purchase prices (and
structures)
 Beauty is in the eye of the beholder – so recognize every buyer
looks at the same agency differently
37
Outlook – 2009 and Beyond
 Declining operating results of many agencies coupled with
lower multiples will result in lower pricing
 Increase in number of sellers
 Capital is scarce
 Decrease in demand
 Low organic growth rates continue at most agencies
 Trending toward historical pricing for most transactions
 Valuation gap between “average” agency and “high
performing” agency is spreading
 High performing agencies will continue to receive a premium
38
Supercharge Your Firm
Become a High Performing Agency
Low Performing Agencies
Reactive management (Culture of excuses)
Poor account retention
No sales management
No reinvestment of profits to fund new producers
Little true incentive compensation
Concentrations (Carriers, customers or producers)
Generalist book of business
Producer commissions paid on entire book of business
Low morale / high employee turnover
Ineffective use of technology
High Performing Agencies
Proactive management (Culture of accountability)
Over 95% retention
Sales management imbedded in culture
At least 4% - 5% of revenues reinvested in new producers
Compensation structured to drive everyday behaviors
Diversified balance of business with few concentrations
Highly specialized by industry, risk type etc.
20% + "House accounts" plus no commissions on small accounts under X%
Employer of choice - Low turnover - Easy to attract talent
Highly effective use of technology and information
39
Grow Your Business
“If you’re not growing you’re losing value”
Retaining people and clients
Driving “New Business” and “High Quality” Culture
Adopt a Specialization Focus – Drives retention and
sales
Acquisitions – This is a good time to be a buyer
Hiring Producers – Become the employer of choice,
but again, hire slowly
40
Q&A