National Economy Challenge to Insurers, Clients and Brokers: What it Means to the Value of Your Busi

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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
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Agenda

• Introduction of Hales
• Brief Touch on Macro Economic Climate
• Overview of Underwriting Cycle Broker Sector
• Review of 2008 MA Activity
• Consolidation Forecast
• Valuation Trends, Conclusions Outlook
• Questions Comments

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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.

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Hales Ranking Transactions and Values
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Representative Transactions
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Representative Transactions
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2008 A Year to Remember…or Forget
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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 year-end. 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

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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 worlds second largest economy, posted
  a 27 decline in November, the largest slide it
  ever recorded
• Madoff, AIG, Citi, GM….. Need I say more.

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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

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Annualized PC Rate Change
Source MarketScout
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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

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Health Insurance Premiums
Sources Kaiser/HRET Survey of
Employer-Sponsored Health Benefits, KPMG Survey
of Employer-Sponsored Health Benefits, and Health
Insurance Association of America
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Health Insurance Premiums
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Sources Kaiser/HRET Survey of
Employer-Sponsored Health Benefits and Bureau of
Labor Statistics
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Net Written Premium Growth
Sources Insurance Information Institute and
Fitch Ratings
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Public Broker Organic Growth
Source Company press releases and SEC filings
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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
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Review of 2008 MA Activity
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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?

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Announced Transactions
Total Number of Announced Transactions
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Source Insurance MA Insights 2009 Annual
Sourcebook
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Composition of Acquirers by Type
Distribution by Acquirer Type ( of Transactions)
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Source Insurance MA Insights 2009 Annual
Sourcebook
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Most Active Acquirers 2008
Listed by Number of Announced Acquisitions in 2008
Source Insurance MA Insights 2009 Annual
Sourcebook
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Most Active Insurance Brokers Acquirers
Listed by Number of Announced Acquisitions
Source Insurance MA Insights 2009 Annual
Sourcebook
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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 BBT
• 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)

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Most Active Bank Acquirers
Listed by Number of Announced Acquisitions
Source Insurance MA Insights 2009 Annual
Sourcebook
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Bank Insurance Divestitures
NA Not Available NR Not Ranked
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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

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2009 Beyond What Does All This Mean to Your
Business?
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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

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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

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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

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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 agencys ultimate exit value

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Types of Value Within an Agency
EVERY INTANGIBLE ITEM ULTIMATELY IMPACTS THE
ECONOMIC VALUE OF THE AGENCY, DIRECTLY OR
INDIRECTLY!
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Hales Recommendations for Best Practices to
Drive Value

• Target 25 EBITDA margins for PC, 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

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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

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Valuations Conclusion Outlook
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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

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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

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Supercharge Your Firm

• Become a High Performing Agency

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Grow Your Business

• If youre not growing youre 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

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Q A