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2015 Q3

Third Quarter 2015

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Large Agency Values Hit 7-Year High / Small Agency Values Decrease

In reviewing the Third Quarter 2015 Allstate Agency Value Index results there are two points of interest which require further discussion:

The value of agencies under $2Million in Earned Premium dropped significantly.
The value of agencies with over $2Million in Earned Premium spiked significantly, hitting a high not seen since 2008.

Allstate Agency Price to 12MM Earned Premium Ratio (National Average)

$0 to $100,000

$100,001 to $200,000

$200,001 to $300,000

$300,001 and up

Simple Average

Low

High

2000
N/A
N/A
N/A
N/A

0.202

0.117
0.262

2001
N/A
N/A
N/A
N/A

0.209

0.133
0.311

2002
N/A
N/A
N/A
N/A

0.197

0.119
0.255

2003
N/A
N/A
N/A
N/A

0.199

0.147
0.254

2004
N/A
N/A
N/A
N/A

0.236

0.157
0.393

2005
N/A
N/A
N/A
N/A

0.259

0.175
0.398

2006
N/A
N/A
N/A
N/A

0.298

0.188
0.402

2007
2.37
2.65
2.92
3.01

2.96

1.21
4.56

2007
N/A
N/A
N/A
N/A

0.292

0.121
0.456

2008
2.32
2.41
2.74
3.13

2.71

1.45
4.06

2008
N/A
N/A
N/A
N/A

0.271

0.145
0.406

2009
2.14
2.35
2.50
2.78

2.46

0.82
3.97

2009
N/A
N/A
N/A
N/A

0.247

0.082
0.397

2010
N/A
N/A
N/A
N/A

0.24

0.106
0.353

2010 1st QTR
1.94
2.29
2.52
2.91

2.39

1.06
3.53

2010 2nd QTR
2
2.27
2.47
2.8

2.37

1.17
3.16

2010 3rd QTR
2.22
2.26
2.5
2.74

2.43

1.42
3.31

2010 4th QTR
1.94
2.33
2.49
2.76

2.41

1.95
3.28

2011 4th QTR

N/A

0.231

0.12

0.366

2011 1st QTR
1.78
2.36
2.49
2.73

2.47

1.2
3.57

2011 2nd QTR
1.99
2.37
2.41
2.53

2.33

1.2
3.66

2011 3rd QTR
1.89
2.16
2.45
2.7

2.25

1.5
3.66

2011 4th QTR
2.05
2.23
2.45
2.52

2.34

1.62
3.37

2012 4th QTR

N/A

0.229

0.127

0.336

2012 1st QTR
1.87
2.2
2.41
2.54

2.3

1.47
3.07

2012 2nd QTR
1.84
2.27
2.4
2.56

2.3

1.46
3.29

2012 3rd QTR
1.96
2.22
2.33
2.59

2.28

1.27
3.24

2012 4th QTR
2.14
2.21
2.43
2.55

2.39

1.53
3.36

2013 4th QTR

N/A

0.247

0.107

0.349

2013 1st QTR
2.1
2.15
2.38
2.51

2.3

1.28
2.95

2013 2nd QTR
N/A
1.99
2.3
2.57

2.34

1.88
3.07

2013 3rd QTR
2.19
2.18
2.39
2.68

2.5

1.59
3.07

2013 4th QTR
N/A
2.2
2.48
2.74

2.5

1.07
3.49

2014 4th QTR

N/A

0.264

0.107

0.352

2014 1st QTR
1.74
2.32
2.35
2.7

2.38

1.07
3.16

2014 2nd QTR
N/A
2.43
2.47
2.76

2.62

1.73
3.52

2014 3rd QTR
N/A
2.52
2.54
2.77

2.66

1.97
3.45

2014 4th QTR
N/A
2.43
2.54
2.79

2.69

1.94
3.52

2015 1st QTR
N/A
1.99
2.45
2.66

2.5

1.69
3.35

2015 2nd QTR
1.48
2.4
2.5
2.85

2.54

1.34
4.31

2015 3rd QTR
1.26
2.04
2.71
3.05

2.55

1.26
3.66

Use the arrows to see agency values over time.

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1. The Value of Agencies Under $2Million in Earned Premium Dropped Significantly:

Before we look at the cause of this decrease for smaller sized agencies, let’s review the demographics of the agencies PPC LOAN financed in the Third Quarter with Earned Premium under $2Million:

63% of agencies with less than $2Million in EP did qualify for ADB
37% of agencies under $2Million in EP did not qualify for ADB

ADB Qualifying Agencies Sell for 2.23 Times

Agencies that qualified for ADB represented 63% of the small sized agencies PPC LOAN financed in the Third Quarter of 2015 (agencies with less than $1.5Million in Earned Premium). These ADB qualifying agencies sold for an average multiple of 2.23 times, well above the overall average for this size group. Certainly, the value received by Allstate agency Buyers participating in the ADB program is substantial, and a portion of this value translated into a higher multiple for agency sellers who are transitioning an agency that will qualify for ADB.

AGENCY DEVELOPMENT BONUS (ADB)

ADB offers a lucrative bonus payment system which pays a commission rate to new agents of up to 43% for new business written. Any agent doing a scratch start-up all the way up to purchasing a $750,000 Earned Premium agency qualifies for the full ADB dollars. Purchasing $750,001 to $1.5 million in Earned Premium qualifies for 80% of ADB and provides significant additional cash flow that can be used to reinvest in agency growth.

Non ADB Qualifying Small Sized Agencies Sell for 1.46 Times

On the flip side, those agencies with under $2Million in Earned Premium, but not qualifying for ADB sold for a multiple of just 1.46 times in the Third Quarter of 2015. Based on these results, it is easy to conclude that agency Buyers have a strong preference to purchase a small sized agency with one caveat: if they can participate in the Agency Development Bonus program.

The Odd Duck ($1,500,001 to $1,999,999 in Earned Premium)

Those small agency sellers hit the hardest in the Third Quarter with regard to the value were those selling an agency with Earned Premium between $1,500,001 and $1,999,999. These agencies do not qualify for ADB, and rightly or wrongly the market of Allstate agency Buyers has determined two things about these odd sized agencies that narrowly miss qualifying for ADB:

If I don’t grow this sized agency I won’t make much money
A business that has $160,000 in top-line revenues prior to paying staffing costs, advertising, rent, and insurance among other necessary business operating costs will not be very profitable on paper and will require revenue growth for the business owner to feel good about their investment.

It’s hard to grow this sized agency without cash flow assistance
As mentioned above, these odd sized agencies don’t quite have the cash flow (assuming a 10% new & renewal commission rate) to aggressively pursue growth from the cash flow of the business. Absent ADB monies, growth of these sized agencies will need to be achieved through infusing personal savings into the business or borrowing working capital. This realization by approved agency Buyers is certainly a driving factor in the low multiples these Odd Duck agencies are selling for.

The ADB program was designed to infuse capital into those Allstate Agency businesses operating with thin margins or negative cash flow. My observation is that this program has been successful in yielding premium growth for both Allstate Insurance Co. and agency owners alike. I cannot make a statement as to how profitable this program has been for Allstate Insurance Co., but it certainly has led to significant premium growth for both scratch start-up agents and small agency Buyers alike.

Based on my long tenured participation in the Allstate market and my continued observance of Allstate Values and cash flow I believe Allstate Insurance would be wise to consider offering some level of ADB to those agencies with $1,500,001 to $1,999,999 in Earned Premium.

How is Regional Management Handling these “Odd Ducks?”

The evidence shows support for my labeling of these sized agencies as “Odd Ducks.” In fact, almost every region in the country agrees with me as they continue to execute “split book” transactions for agencies with Earned Premium of $1,500,001 to $1,999,999, to ensure the Buyer(s) qualify for ADB. Splitting books into strategic slices is the best way for regional management to incentivize agency purchase to join the ranks at Allstate Insurance Co. by providing them an opportunity that qualifies for ADB.

In the First Quarter of 2015 Allstate Agency Value Index I used the example of a $1,957,000 Earned Premium agency that was split to allow the buyer to participate in ADB. Despite stronger cash flow for the Buyer, “Split Books” transactions require the nuisance of finding two Buyers and having to negotiate two separate sale prices and two separate purchase agreements. If agencies sold with $1,500,001 to $1,999,999 in Earned Premium were approved in some capacity to participate in the ADB program, I strongly believe it would eliminate the need for split book transactions (and the hassle of two separate transactions) and values of agencies of this size would increase.

The chart above shows the average sales multiple for all purchase opportunities discussed in this edition of the AAVI, and the chart certainly drives a few points home:

Agency Buyers love the opportunity to purchase a small sized agency (less than $2Million in EP), only if it qualifies for ADB.
Agencies with over $2Million in Premium continue to sell for very healthy multiples and are not in need of assistance from the ADB program from a cash flow or valuation perspective.
The “Odd Ducks” with Earned Premium from $1,500,001 to $1,999,999 hold the lowest value of all agency buy/sell opportunities.

All across the country, Allstate Agency Purchasers are turning down the opportunity to purchase a $1,500,001 to $1,999,999 Earned Premium agency (the “Odd Duck”) to purchase a small sized Allstate Agency with less revenue. They are doing this not because they prefer a business with less revenue, but because they view the ADB program as their gateway to growing their business beyond the “Odd Duck” purchase opportunity they turned down.

2. The Value of Agencies with over $2Million in Earned Premium Spiked Significantly

Agencies with Earned Premiums of $2Million to $3Million realized a multiple of 2.71 in the Third Quarter of 2015, a high that has not been realized since 2008. This increase in value is driven by Existing Agency Owners leveraging the equity in their existing agencies to make a strategic purchase at a very high multiple. When looking at the sales multiple for this size group excluding existing agency owners purchasing a satellite, the multiple paid by Outside Buyers is 2.45X – a value right in line with historical averages. As has been discussed in the past, a market that allows both Existing Agency Owners and Outside Buyers to make purchase offers is going to be good for Allstate Agency Values.

Agencies over $3Million in Premium sold for 3.05 times in the Third Quarter, an accomplishment that has also not been matched since 2008. This is especially impressive as the entire pool of Buyers were new to Allstate (Outside Buyers). Contributing to this gain in values is the exceedingly high number of very large agencies sold in the Third Quarter of 2015. In fact, 75% of the agencies transitioned in this size group were over $4Million in Earned Premium and an amazing 38% were over $5.0Million in total Earned Premium. Large agencies were certainly available for purchase in the Third Quarter of 2015, and agency buyers did not haggle over price.

Percentage of Agency Sales by Size Group

$0 to $100,000

$100,001 to $200,000

$200,001 to $300,000

$300,001 and up

2007 1st QTR

N/A

2007 2nd QTR

N/A

2007 3rd QTR

N/A

2007 4th QTR

N/A

2008 1st QTR

N/A

2008 2nd QTR

N/A

2008 3rd QTR

N/A

2008 4th QTR

N/A

2009 1st QTR

N/A

2009 2nd QTR

N/A

2009 3rd QTR

N/A

2009 4th QTR

N/A

2010 1st QTR

N/A

2010 2nd QTR

N/A

2010 3rd QTR

N/A

2010 4th QTR

N/A

2011 1st QTR

N/A

2011 2nd QTR

N/A

2011 3rd QTR

N/A

2011 4th QTR

N/A

2012 1st QTR

N/A

2012 2nd QTR

N/A

2012 3rd QTR

N/A

2012 4th QTR

N/A

2013 1st QTR

17%

28%

27%

28%

2013 2nd QTR

N/A

21%

38%

41%

2013 3rd QTR

15%

26%

52%

2013 4th QTR

N/A

25%

42%

33%

2014 1st QTR

15%

58%

21%

2014 2nd QTR

N/A

17%

29%

54%

2014 3rd QTR

N/A

43%

52%

2014 4th QTR

N/A

36%

61%

2015 1st QTR

N/A

12%

41%

47%

2015 2nd QTR

22%

44%

30%

2015 3rd QTR

32%

27%

36%

Use the arrows to see agency values over time.

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It is worthy to note that 37% of agencies financed by PPC LOAN in the Third Quarter of 2015 had Earned Premium of less than $2Million. Historically, this number has been at or below 20%, and highlights the fact that PPC LOAN is more actively financing agencies that qualify for ADB. PPC LOAN has financed all sized agents since 2000, and our trend towards funding small book purchases indicates we are adaptive to the needs of the market.

Allstate Agency Value Ratios

Agency Price to New/Renewal Commissions

Agency Price to Total Revenues

2007 1st QTR

2.95

2.37

2007 2nd QTR

2.74

2.39

2007 3rd QTR

2.75

2.35

2007 4th QTR

2.49

2.18

2008 1st QTR

2.95

2.38

2008 2nd QTR

2.74

2.39

2008 3rd QTR

2.75

2.35

2008 4th QTR

2.49

2.18

2009 1st QTR

2.65

2.28

2009 2nd QTR

2.5

2.22

2009 3rd QTR

2.42

2.17

2009 4th QTR

2.37

2.17

2010 1st QTR

2.39

2.08

2010 2nd QTR

2.37

2.09

2010 3rd QTR

2.43

2.13

2010 4th QTR

2.41

2.09

2011 1st QTR

2.47

2.18

2011 2nd QTR

2.33

2.05

2011 3rd QTR

2.25

2011 4th QTR

2.3

2.06

2012 1st QTR

2.3

2.02

2012 2nd QTR

2.32

2.05

2012 3rd QTR

2.28

2.05

2012 4th QTR

2.39

2.11

2013 1st QTR

2.3

2.06

2013 2nd QTR

2.33

2.11

2013 3rd QTR

2.5

2.21

2013 4th QTR

2.5

2.19

2014 1st QTR

2.38

2.17

2014 2nd QTR

2.62

2.28

2014 3rd QTR

2.66

2.31

2014 4th QTR

2.69

2.32

2015 1st QTR

2.5

2.19

2015 2nd QTR

2.54

2.21

2015 3rd QTR

2.55

2.24

Use the arrows to see agency values over time.

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For those residing in a state where a good portion of the homeowners insurance is written through a third party brokerage company (primarily coastal counties), looking at the multiple of revenues may be your best measuring stick for agency value as it takes into consideration both Allstate and brokered (i.e. non-Allstate) revenues. Certainly, the brokerage book is a reliable source of renewal income and has a level of value that is not presented in the traditional multiple applicable to Allstate commissions.

Being the creator and author of the Allstate Agency Value Index has afforded me the opportunity to write countless articles and to travel on behalf of PPC LOAN to speak to both Allstate Management and the Agency force. In the process, I have learned of the issues often faced at loan closing, such as the restrictive covenant.

So, this quarter I have asked Jeff Horner to share his expertise in the area of interest rates. He has written an insightful article with many points to ponder when borrowing for your Allstate business. If you would like to discuss current interest rates with Jeff he can be reached at [email protected] or toll free at 800-456-2779.

Paul Clarke President of PPC LOAN Interest Rates… Friend or Foe?

The interest rate and the accompanying terms on your business loan can lead to a business's success, or if improperly structured, can lead to a business's demise. Utilizing debt, even at higher interest rates, can yield great wealth and substantial business gains. The rate of interest you are paying can be almost inconsequential, based on the quality of the investment opportunity at hand. However, when funds are borrowed to purchase assets at peak market value or when growth opportunity is limited, a good interest rate and the accompanying repayment terms can be vital. Let's talk about the role interest rates play in the Allstate insurance world:

1. PURCHASING POWER - Every Allstate agency purchaser looks at various factors, such as: What is the retention ratio? Is it a turnkey operation? Is the business profitable? How competitive is the product I am selling? Is the business growing or shrinking? One thing that is not at the forefront of agency purchasers' minds right now is interest rate and how it affects the ability to purchase. We have been living in an uber low rate environment for the past 7+ years and buyers haven't had to worry about interest rates. However, history clearly says this low rate environment cannot last forever. The Prime Rate of interest is currently sitting at 3.25%. Historically it is 6.75% in a good economy, meaning we are poised to realize at least a 3.5% increase in rates. Although the Prime rate in this example is used to price floating rate loans, we could experience an increase in fixed rate financing from somewhere around 6.0% up to 9.0%, or greater in the next 36 months. If you borrowed $1,000,000 today at 6.0% for 10-years, the payment would be $11,102 per month. Assume this is the ideal level of debt for the agency to service. An increase in the note rate from 6.0% to 9.0% would decrease your purchasing power from $1,000,000 to $875,000. At first glance it may appear that an agency purchaser must now come up with an additional $125,000 to close the gap in financing. In reality, the majority (if not all) of this pain will be felt by the Seller in the form of a lower purchase price. Based on this analysis, one could estimate that 12.5% of agency values are inflated due to the low interest rate environment in which we currently operate.
2. CASH FLOW IMPACT - Anyone looking to leverage an Allstate agency certainly wants the very best rate. Loan terms can impact an agency's cash flow, with monthly debt service serving as one of the largest business expenses. From an Agency owner or purchaser's perspective, the type of interest rate (fixed, balloon, or adjustable) plays a large role in the cash flow of the business and excessive levels of debt can hinder business growth.

1. - FIXED INTEREST RATE - A fixed-rate is when the interest is at a set rate that does not change throughout the life of the loan and the total monthly payment will remain the same. An ideal time to pursue a fixed-rate on a loan would be on a mortgage or extended business loan of ten years or more. For example, on a 30-year mortgage, a fixed interest rate is the most popular choice because regardless of how volatile rate movements become over time, your interest rate and monthly payment will not deviate.

1. - BALLOON RATES - Balloon rates create different thinking when it comes to managing debt. A balloon-rate is typically a shorter loan around five years and resembles a fixed-rate. However, unlike a fixed-rate, the principal of a balloon-rate is not paid off at the end of its loan amortization. At the end of the term, the borrower must determine whether they will pay the remaining principal or take on another loan. A few benefits of this interest type are: 1) lower interest rates, 2) lower monthly payments, and 3) at the end of the loan life, the borrower is able to rethink their debt repayment plan. A drawback for a borrower with a balloon-rate might be forgoing the peace of mind that comes with knowing that the rate and payments will not change. If the interest rate environment did rise at the end of the term, they could potentially face some unaffordable rates.

- ADJUSTABLE RATE - Another common interest rate is the adjustable or variable interest rate—when the rate of interest will vary over a period of time. The initial interest rate is fixed and set under the market rate, but after this fixed-rate period, the rate will adjust based on the market conditions. For example, adjustable interest rates are attractive for home buyers that plan to sell their home before the rate becomes adjusted, or for a borrower who plans to pay off their debt in a falling interest rate environment. However, if the interest rate market conditions increase, the borrower could see a significant rise in their monthly payment at an adjustment period.

Fixed-rates allow Allstate agency owners a simpler budget. For example, if a borrower has a fixed-rate on a ten year repayment term, they know that for the next 120 months the loan payment deducted from their commissions will not change. They don't have to worry about the potential rise of interest rates as they would with a balloon or adjustable-rate. The uncertainty of not knowing after a few years what their monthly loan payment will be is alleviated. It can be dangerous from a cash flow standpoint if monthly loan payments rise significantly, due to the affect it could have only other expenses the agency owner has, such as staff, office rent, marketing, etc.

The question then becomes, are Allstate agency owners with debt better off with a fixed and longer term repayment? Certainly, with rates at their historically low level and with increases on the horizon, the answer is yes. Floating rate loans at this point should only be pursued by those who have the capital to pay their debt load in full within the next 24-36 months (i.e. they are not rate sensitive). If your business focus is growth, lock in that low, fixed-interest rate loan, turn your attention to business management, and let your business interest rate be a friend not a foe.