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How the Hard Market Is Impacting Agency Values

Some of the impacts of the hard market can have a positive impact on agency valuation, while others will work to depress values. Understanding these will help navigate uncertain times.
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how the hard market is impacting agency values

For many insurance agencies, the hard market yields a double-edged sword. Some of the impacts of the hard market can have a positive impact on agency value, while others will work to depress values. Understanding these impacts will be key to helping navigate these uncertain times.

The Insurance Risk Management Institute (IRMI) defines a hard market as “the upswing in the insurance market cycle, when premiums increase, coverage terms are restricted, and capacity for most types of insurance decreases." The net effect is that insurance is more expensive and harder to obtain.

Carriers can experience pain and profit loss due to economic, political or climate factors, or a combination of each. When carriers move to counteract the impacts of these factors and bolster their profitability, a hard market ensues. Some factors we're seeing currently include stock market decline that is driving down investment returns, a regulatory environment that is not friendly to carriers, and increasing frequency and severity of losses.

These factors will often change the carrier's appetite for writing business in certain sectors, the fee structures they negotiate with agencies, and its underwriting appetite.

When the market hardens, we are likely to see higher premiums, a refocus on underwriting with strict criteria, reduced capacity and markets for insureds and less competition among carriers, ensuring higher premiums throughout the market.

Positive Impacts of the Hard Market on Agency Values

There are two main positives. The first positive impact is that most agencies will likely see premium increases due to the rate increases from carriers. An increase in premiums goes hand-in-hand with an increase in commissions and annual revenue. This will result in overall premium growth that is not being driven by new business production.

The second positive factor is that the hard market makes it more difficult for clients to shop their coverage with competitors, as rate hikes are distributed fairly evenly. Therefore, retention rates should be higher than normal for an agency.

Negative Factors of the Hard Market on Agency Values

There are also significant negative impacts for agencies. First, the increase in claims. The cost of claims and the loss ratios will have a negative impact on the profitability of the business. This will make it difficult for agencies, as the typical level of profit-sharing they've received in the past few years will diminish substantially. Many agencies are looking at no profit-sharing at all. This could result in a loss of agency revenue of 6%-10%, likely decreasing the overall value of the agency—especially if this trend continues for two or more years.

Second, due to the financial strain and increased loss ratios that carriers are experiencing, they are taking action to lessen the burden of their financial stress that impacts agencies. In addition to introducing new underwriting restrictions and tightening what new business is written, carriers are also now decreasing the commission structure with their new agency partners. This will have a long-term impact on agencies as they experience a permanent loss of revenue. For example, when the market stabilizes, agencies will likely be making 12% or less on renewal business, versus the more commonly expected 15%. Since rates will not be increasing at the same rate when the market softens, this will result in a loss of revenue.

Additionally, underwriting restrictions are making new business growth incredibly difficult. While retentions are steady, organic growth is likely to be stagnant or slightly down because of the tight underwriting market. Even agencies with a strong organic growth culture will have difficulty matching the growth of prior years due to the underwriting restrictions.

It's also important to acknowledge the strain and stress that the current insurance climate has on agency staff. The pressure that agency staff members are experiencing is real. The result is that agencies are having to do more to retain their talent and avoid burnout—and doing so while their profits are being suppressed. While this may be short term, all these items have a cumulative effect on profitability.

Agency profitability is one of the key metrics in determining its valuation. While the long-term effect of the hard market on agency valuations remains to be seen, the short-term effect is a mixed bag.

Craig Niess is director of business planning and valuation at IA Valuations.

The information provided in these documents is general in nature and shall not be construed as personal legal, tax or financial advice for your situation. Please to discuss your personal situation. 

Published with permission. Copyright ©2023 by IA Valuations and Ohio Insurance Agents Association (OIA). All rights reserved. No portion of this document may be reproduced in any manner without the prior written consent of IA Valuations or OIA. In addition, this document may not be posted as a link on any public or private website without the prior written consent of IA Valuations or OIA. 

Monday, December 18, 2023
Perpetuation & Valuation