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Agency-Owner Retirement - An Ongoing Process

By Patricia A. Borowski, CPIW, CAESenior Vice PresidentPIA National Agency owners and agency carriers have used the phrases, "retirement for the agency-owner principal" and "perpetuating...
April 18, 2004

By Patricia A. Borowski, CPIW, CAE
Senior Vice President
PIA National
Agency owners and agency carriers have used the phrases, "retirement for the agency-owner principal" and "perpetuating the agency" as interchangeable.  However, these are two entirely different things that both groups get confused, and for which both groups have differing needs. 

For agency carriers, their overriding focus is getting agency owners to construct an exit plan that assures the successful continuation of the agency-business, one of their successful business partners.

For the agency owner, their primary focus is structuring the deal that gives them the best financial result for their retirement, even when this depends on receiving that retirement income from the continuing agency.

Unfortunately, focusing too much on one or the other can cause problems for both purposes and goals.  Especially when offered by carriers, too often, seminars and information offerings on this subject focus on only one or the other primary agenda. Agency-owners attend, and come out a bit confused or dissatisfied because their needs have not been met.

There are three clear examples of this confusion.  First, both agency-owners and carriers treat retirement as a short-term single event.  Second, the vast majority of the accounting and financial information provided in these seminars is overwhelmingly focused on the business accounting requirements of the agency-business that the seminars suggests to be continued. Finally, the use of general commercial valuation methods (i.e., P&L, balance sheet) is not a valid method of determining agency value for either seller or buyer. 

Both our insurers and PIA member agency-owner principals must understand, approach, and practice retirement as a process that has different stages and segments that need to be established over a longer time frame. The actual retirement event might unfold over a three-year period. But the retirement process, i.e. preparing for it, paying for it and dealing with taxes, will take place over a far longer period of time for both the retiree and agency.

Even when executed with all the right planning, the retirement process for the PIA agency-owner is a far more complicated process than it is for any insurer to decide how continue their corporation, or for any insurance executive to decide how and execute a "package."

PIA members' plans must be flexible and frequently re-evaluated to take into account the constant changes in business and tax conditions. 

One aspect to the retirement process that is important but often overlooked is the total impact that all of the changes will have on an individual's life. While there is a wide variety of methods agency-owners should consider from the perspective of their financial and agency business affairs, the fact remains that retirement means moving out of one phase of life and into another.

Take Charge of Your Future

Although there are professionals and resources available to help, success and well being in retirement is solely in the hands of the agency-owner principal, and no one else.  PIA members should invest the kind of time, planning, attention, and financial capital in their retirement as they do their day-to-day business affairs.

Having worked with PIA members over the years in this area, there are a couple of particular aspects I would underscore, to be sure they include in their planning that are generally overlooked, regardless of the size of the agency the owner is leaving. 

The most imperative is flexibility of planning - as opposed to "at-the-moment" planning. One should not arrive at the office one morning and say, "It's a nice day, I think I'll retire in two years," figuring that's enough time to handle all the details as they come up. Nor should a member construct a plan ten or seven years in advance and truly "lock it in."  Neither is flexible and both can end the same way, less than a satisfactory result.

Flexibility includes regularly reconsidering all the retirement plan options available.  What looks like a great deal today may not be so either for the retiring owner or the continuing agency or agency buyer when the time comes - or that new option might not even be available, allowable or as affordable anymore when the time comes.   

Tax law is now constantly changing, along with "new ideas" and configurations to consider.  Many of these changes have provided options that are easier and more flexible to manage, allowing PIA members to more thoroughly customize their plans to their circumstances.  However, as creative accounting took off in the 1990s to fuel these many "innovative" tax concepts for corporate use in acquisitions and buy-outs, as well as individual retirement use, a large number of these have failed to produce the promised results, come with expert price tags that are too high compared to the corporate savings/individual gain that they produce, or have been shutdown by IRS' successful legal actions.

Further, it can't be said too often that changes in the marketplace can wreck havoc with any agency's game plan and values. While not always possible, it is helpful if the plan can account for such possibilities in some way, by either delaying or extending the retirement process for the owner, or restructuring the payment size or schedule for the continuing agency upon which the retiring owner relies.  For all these reasons, flexibility in a plan is a must!

Retirement is a Process

Too often I hear PIA members advise that "they are handling" these matters directly, because they've done them successfully for years in their agency and personally.  The question I always ask is, "Great, and how many times have you retired before?"  The reality is that for 99% of PIA members, this is the first and only retirement they will have, as it should be.

Retiring is not "business as usual" or as you has practiced it for your agency corporation.  It is a monumental event in anyone's life, and it requires a lot of attention.

Think of your retirement as being equal in significance to the wedding of a daughter. It requires coordination among many players.  You spend money to be sure everything turns out right.  Another example of the method for you to consider is the service that you offer your insurance clients based upon: Don't do it yourself, leave it to your insurance professional agent that looks after your interests while you tend to your life.

Likewise, the retirement process demands specific expertise that you must hire. You'll require experts to handle a broader range of tax, legal and accounting issues than most PIA members face during their day-to-day agency operations.  These experts also bring a level of objectivity that is useful.

Organizing the tax strategy for both "the deal" and income tax filings are very different for the retiring owner than it is for the acquiring agency owner.  Deciding how best to manage "taking" the "sales" income, i.e. capital earnings income, from the agency - and coordinating that with when and how much of the other retirement investments that will mature and trigger payments to you at any given time - are very different than deciding how to take personal income from your ongoing agency as an active principal. Failing to include these other experts most times means that retiring agency-owners significantly short themselves by either not getting enough income from "the deal," or inadvertently creating a far greater tax liability for themselves when receiving the proceeds from the deal.

Spend the money for and force the coordination of tax, accounting and retirement planning experts who work for you, as both the agency-owner and a retiring individual. As an agency owner, you and the corporation are one. But when retiring, you are moving from acting as a corporate entity into being a lone individual. The trick here is to manage both the corporate and very personal transition without coming apart.

"The Art of the Deals"

The number of options that agency owners must weigh for perpetuation plans and structures has dramatically changed. Traditionally, agencies thought of perpetuation in two categories: pass on the agency to their child/children or sell to a third party. Further, it was assumed that planning was really only required for the first option.

Few agencies in today's economy will be fortunate enough to sell their business for walk-away cash on the barrel-head no matter whether "selling" to a third party or internally.   Most, retiring agency-owners dependent upon some form of over-time-payment formula from the ongoing agency to receive all their monies from the sale of their agency.

Meanwhile, the continuing agencies that are paying out "the deal" will continue to face the business-expense pressures for balancing the investments that they must make to support the continuing competitiveness, growth and profit of their agency-business versus the thinner margins of gross and net earnings realized on the business produced.  More regularly, ongoing agency-owners will need to periodically secure commercial lines of credit and/or capital loans in order to afford the infrastructure/capital needs of the agency, including acquisition of other books or agencies.  So, learning how and being able to manage more debt load on the continuing agency are realities facing the ongoing owners.

These economic realities are many times overlooked or not seen at all as a related whole by agents in their perpetuation considerations - whether as the retiring or continuing agency owner.  If a retiring agency owner is depending upon the P&L performance of the current agency owner to support and receive their retirement payments - then it stands to reason that ALL agency owners better understand retirement debt load-to-ongoing agency-costs and develop a companion business plan for the agency that permits the continuing agency business to achieve both.

The current and near future market factors requires perpetuation planning actually be several plans that must be complementary and constantly reviewed and updated. These several plans must be coordinated to successfully achieve a common goal: keep the agency profitable and growing while paying the retiring agency-owner his money.

The Perpetuation Planning - A Five-Plan Process In Brief

Buy-Out Plan

The first plan is the more traditional one for perpetuation. The two major questions that drive the considerations for this plan are: when do you want to sell, and over what period of time do you expect payments to be completed? With those areas answered, the agent must learn about the many variety of formulas that are available for their consideration and use. The selected approach may be more liberal if the agency is being passed-on within the family or current corporation. But this is also a plan that must also be worked out even for sale to a third party.

Investment Plan

Second, there must be an investment plan established for the agency. This is particularly important for succession plans. What financial instruments, for what amount and how triggered must the agency establish and invest in now to assist it affording the future payment schedule of the retiree? Such an approach better manages the pure debt load an agency takes on when it "purchases" the business. The maturity dates of these vehicles should trigger with the various payment stages of the sale.

Business Plan

Third is a sound business plan. Many selling agents avoid this plan entirely, believing it is up to the new owners to figure out how to pay for the sale. Perhaps, one can do that when all the money is received up front. However, with staggered, time- payment plans, selling agents have a very vested interest in being sure that a solid business plan exists allowing the agency to grow, set aside capital for future investment in the operations, meet debt obligations, and still make their payments to the seller.

Personal Financial Plan

Fourth is a more comprehensive and aggressive personal financial program that supplements the agency-owners' retirement. For most agency owners, the sale of their business is the greatest (and for some, sadly, the only) source of retirement income. Agency owners preparing to retire should not count on the proceeds from the agency's sale being as great a portion of their retirement nest egg as could owners of the past. Just as baby boomers working for corporate America have been warned that company pensions will not supply all financial needs after their retirement, a larger portion of an agency owners' retirement income must come from other investment sources they establish prior to selling the agencies.  This is in part due to changed economic dynamics we've outlined for the ongoing agency, but a greater part is the increasing pure cost of retirement itself.  Agency sales values cannot be expected to keep or outpace the increase in medical care, general cost-of-living and the like.

Experts & Review Plan

Last, PIA National strongly recommends that agents making these plans work with qualified experts. Agents should outline what they'd like to accomplish and then work with an agency valuation expert and their CPA to design a program that will deliver the expected results.

Having an outside expert that can look at the agency and the options in a dispassionate manner is valuable.  One thing, IRS requires that valuations of assets be done by qualified professionals with industry accepted methods using current values, and that professional must engage in that practice regularly and for the type of business being evaluated.

Perhaps more importantly, the distance from "the heart" that a professional brings will better help you appreciate when your goals for the outcome require you to take the deal or walk away from the table.  Knowing when to walk or take it for either retiring or purchasing owner demands that both owners understand what real agency value is at that time and in their area, how best can it be exploited, how fast and in what ways and by what type of purchasing agency business plan.

Once developed, members must view this plan as a work in process that is constantly affected by dynamic factors and financially re-evaluated.

PIA & Our Next Steps

Over the next year, PIA National will be working with PIA affiliates to create the "fill-ins" for agency perpetuation programs, offering the holistic information that PIA members must have for their most serious of business and life considerations. This will integrate and expand upon the sections from the PIA-CCEO The Value Difference Agency Planning Series that already addresses business model considerations and options for agency owners, whether retiring or ongoing.

In addition, we will be asking you, our PIA members, about the issues that concern you regarding perpetuation and the retiring process, as well as how your association can help you successfully manage what should be one of the most positive changes in your life.

Your agency is your future, financial security. Plan for it to be bright.

Patricia A. Borowski is Senior Vice President of PIA National.