Your family-owned agency has been in the insurance business sense 1868. It’s a source of great pride and a great sales tool. Everybody in town knows your name and the name of your agency. They know you’ve been here since before they can remember; just the sound of your name inspires trust in your community and in your original geographic area. Clearly, you’re very proud of your reputation as well as the success and longevity of your agency.
It is difficult to grow an agency at this time. But yours has been doing just fine. Your staff has a definitive focus on both customer service and the sale of new business. Neither seems to be a particular problem. Your parents raised you with good values and you run your agency with no feeling of entitlement. You’re reaching retirement age and you’ve begun to think about the long-term outlook for the agency and your children. You want to pass the agency on to them—it would be only fair; after all, they all currently work in the agency. But, as you start to look into it, you’re realizing that it is much more difficult to perpetuate your agency through your family then it is to sell to a third party. This blog post will, hopefully, explain why that’s the case.
In most agencies, the biggest plan is “where we’re going for lunch.” Agents don’t tend to do a lot of planning. But, insurance companies want you to have a business plan and they want you to sell more insurance. Why? Because we are their distribution entity. The agency is the interface between consumer and insurance company. From the viewpoint of the insurer, you are their sales team. To be frank, they don’t think of you much beyond that—they have the underwriting expertise and the ability to manage the book of business, and they don’t need you getting in the way.
If you are a mid-level manager in an insurance company you have thousands of policies to issue, thousands of claims to get settled, compliance issues to deal with on a daily basis, and about a million other priorities that need to be resolved in a timely fashion. You simply cannot do your job effectively without a business plan. Indeed, in your opinion, every business should have an effective business plan.
If you are an insurance agent you work spontaneously. When you get up and go to work in the morning you never know exactly what you’re going to encounter during the course of the day. You have renewals to process and a certain number of other items that you need to manage and you do have procedures in place to deal with those. But, in contrast to the insurance-company manager, your major priorities appear spontaneously and must be responded to with alacrity. It is because of this need for spontaneity that you believe business planning is unnecessary, if not impossible.
This difference in attitude creates a certain amount of friction in the relationship between insurer and agent. Neither side understands the perspective of the other. And it is this question of planning that, for the insurance agency, causes problems in business perpetuation issues.
If you are going to pass your agency on to a family member, you need to understand the tax complications and associated costs that arise from that. A sale to the family takes planning and time: time to build capital in the agency in order to finance an inter-family purchase; time to reduce the risk of the current agency owner.
Section 179 of the IRS code prohibits “insiders”—including family members and employees—from purchasing the assets of an insurance agency, presumably because of past abuses within the industry. Thus, it is unlikely that an employee, who is not the current owner, would have sufficient capital to make an outright purchase of the agency. However, as they are making a stock purchase—the only permissible route—they can purchase the agency piece by piece, through the purchase of the stock.
But, to allow for this staggered purchase, you have to gross up the money for the tax loading—in a stock sale, the purchase is not a tax-deductible expense; you can only deduct the purchase of assets. The difference is sufficiently great that I have seen agents who had a perpetuation plan in place actually sell out at the eleventh hour because of the unanticipated risk and costs involved. I believe this to be most detrimental to the long-term outlook for smaller businesses.
The tax difference typically precludes a smaller agent from passing on their agency to either an employee or a family member. Under the current system, there appears to be a 49% difference between selling an agency to an outsider, as an asset sale, rather than an employee or family member as a stock sale. Or, to put it another way—every dollar of agency value will actually cost a dollar and forty-nine cents if you choose to pass it along.