Case study: Western states insurance Agency

W J Jacobs
21485569

Executive Summary:

Western States Insurance agency has a well developed strategy and manages to execute it
acceptably. By looking at their financial performance, they managed to turn around the company
from a loss maker to a profitable business. They also managed to double the amount of agencies
and the revenue of the company in eight years. They perform well above the industry norm, but
somewhat below the peers in comparison in certain areas. The net profit in relation to the revenue
is the current largest concern.

This as such does not necessarily cause a concern, but changes should be made to address the
reducing net profit margin. The three strategies presented in the case is unfortunately not feasible,
and at best they will be able to achieve $ 70m in turn over. The option to merge with a company of
similar size or acquire it, will not realize especially as a result of the larger companies targeting this
market and having a competitive advantage to WSI in the ability to negotiate and offer the acquired
party a better solution. WSI runs the risk of becoming a target for these companies once listed.

The advice rendered to the management of WSI is to continue a strong presence in the acquisition
market, while noting the pressure put on the resources and managing it carefully. By using the
positive internal growth rate, an exponential growth pattern in acquisitions van be continued as long
as there are available agencies to acquire and rather allow BCBS – MT to list when the investment
is showing sensible return.

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Case study: Western states insurance Agency
W J Jacobs
21485569

Case: Western States Insurance (WSI)

1. Question 1: Business model

WSI business model consist of a corporate strategy, which mostly implies growth through
acquisitions and a business strategy looking as follow:

A combined base of broad differentiation and best cost provider:

1. Providing exceptional products and services.
2. Offering linked solutions to protect and grow clients' assets with insurance, risk
management, financial management and employee benefits.
3. Maximizing the value of the total client relationship.
4. Using its status as a regional insurance agency with over a hundred million in annual
premium volume to form strategic alliances with insurance carriers.
5. Recruiting top calibre producers and managers.

They claim that their customers had the convenience of "one-stop-shopping" for a broad range of
insurance, employee benefits, and related services that complemented the company’s healthcare
benefit plans. So basically they have a core healthcare plan, to which quite a number of additional
products are linked. They make use of a variety of sales efforts combined into one, by offering non-
stop insurance shopping, via the convenience of the internet and providing it at the lowest possible
cost due to the ability to underwrite certain of their own policies and having a good background
administrative system.

At Corporate level they endeavour to increase their foot print by buying other smaller companies.
This means they have two different customer bases:

One is the clientele they have it the different agencies and the other is the smaller businesses they
are trying to purchase. By purchasing well established regional businesses, they not only increase
their market share, but also keep the local flavour, allowing clients to maintain the original
relationship, look and feel, but with much better admin support.

Identification of their business model:

 Moves to diversify the companies’ revenue base and enter altogether new industries or
businesses
o Additional products connected to the client insurance demand
o Internet facilities to offer clients the ability to obtain quotes
o Entering other geographical areas
 Actions to respond to changing industry conditions

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Case study: Western states insurance Agency
W J Jacobs
21485569
o Addressing increased sophistication of the client and its demands
o Increased pace of the business environment called for an exceptional back office
admin function.

 Fresh offensive moves to strengthen the companies long – term competitive position and
secure a competitive advantage.
o Acquisition of smaller business units in other regions
 Efforts to broaden/narrow the product line, alter the product quality or modify the customer
service
o Mostly done on the customer service, especially turn around times of applications
and claims
 Efforts to alter the geographic coverage
o Acquisition of smaller business units in other regions
 Efforts to integrate backward and forward
o Maybe not a direct effort of WSI, but the group aims to grow significantly enough to
do their own underwriting
 Actions to capitalize on new opportunities
o Providing training to increase the skill levels of all the staff members and especially
the newly acquired agencies.
o Unique product development for certain areas
 Defensive moves to counter the actions of competitors an defend against external threats
o Maintaining a low cost base and providing excellent service through a well
developed back office.
 Moves and approaches that define how key functions and activities are being managed
o Specific protocol and procedures set up to follow throughout the acquisition
process
 Actions to improve short-term profitability
o Improved liquidity and reduced debtors days

2. Question 2: Competitive forces:

The five forces model of competition, developed by Porter, indicates the following for the insurance
industry which WSI participates in:

1. Rivalry among competing sellers:

According to WSI this is very competitive (strong force) due to the diversity of competitors and
the high degree of differentiation of products and service. It most probably means that due to
their diversity of products, they find themselves in the playing field of quite a number of non
related firms. It also means that, due to the variety of service providers, customers have ample
options to choose from, allowing the ability to shop for the cheapest rates. There are very few

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Case study: Western states insurance Agency
W J Jacobs
21485569
large players who actually possess a dominant position the market in the regions. Primary:
Banks, Insurance agencies and secondary the larger players in the field also targeting
acquisitions. Their four main rivals, in the acquisition area, as per peer comparison are:
Marsh and McLennan
Aon
Brown & Brown
Arthur Gallagher

The fact of the matter is that Brown and Brown is in a position to acquire WSI and Aon is again
in a position to acquire Brown and Brown. Thus, although a similar market – WSI is in a
dominant position in its region and not really playing the same field as the peers. WSI’s target
companies for acquisition was less than $ 2m and preferably less than $1m in revenue, mainly
due to their current capital base, but also as a result that the other players acquire the larger
agencies and are in a better position to make a better offer. This obviously reduced the
population for acquisitions as well as increased the complexities of finding the right agency for
acquisition.

2. Firms in other industries offering similar products.

Banks are the major competitors from other industries, on the one side, offering client certain
insurance products as part of a package deal and on the other, the acquisition side, banks also
offered agencies better price to revenue ratios.

Strength of the competitive forces: .:

• High degree of product and service differentiation. (reduce the strength)

• A variety of agencies and their products (health, property, home, business, life, automobile,
etc) increase competition, for WSI finds itself in the playing field of many companies.
(Increase the strength)

• Banks offering insurance products as part of a package deal (increased strength)

3. Buyers

WSI has two main streams of buyers: individual, or corporate. Currently their product mix
consists of 75% corporate clients, meaning that they provide for competitor firms as well and
deal with low margins.

• Individual clients are smaller in percentage, but via the Internet they are able to access
quite a few varieties of quotes to compare. (increased strength)
• WSI supplies link solution to its clients which differentiate them from their competition
(decrease the competitive strength)

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Case study: Western states insurance Agency
W J Jacobs
21485569
• Corporate clients make package deals and can force large discounts (increased strength of
force)
• Market are linked to geographical area and trust-based relationship (increased strength)

• Customers have a variety of options to choose from and shop around (increased strength)

4. Suppliers

In the case of WSI, suppliers can be seen as underwriters and companies like WSI who are
able to provide administrative assistance. For a company to become a supplier they have to
build critical mass and companies too small to underwrite their own policies struggle to reach a
size which allow them to negotiate good terms with underwriters.
Strength of forces for supplier power, e.g.: (underwriters)
 With WSI currently being relatively small, the force is strong.

 The bigger the agency, the higher the possibility for increase in profits from
underwriting and consulting or providing administrative assistance. WSI is currently
improving in this field, thus a weakening force.

5. Potential new entrants

Mention was made that it is difficult for a new firm (or established firm from another region) to
enter a region. The main reason for this is noted as the agency’s name recognition, which was
limited to its established markets.
Strength of forces:

• Very difficult to enter the market; requires professional qualifications, establishing network
with larger insurance underwriters and capital investment for acquiring office space,
furnishing it, purchasing computers and hiring of employees. (weak force)

• The amount of premium offered by different role agencies are highly competitive and a
down fall for many competitors and new entrants (weak force)

• Although it is difficult to begin, technology changes bring along opportunities for more
effective and productive service. (strengthening forces)
Over-all the Porters model indicates a strong competitive force with firms in other industries, i.e.
banks being the strongest and threat of new entrants being the weakest.

3. Question 3: Driving forces of change:

Some of the most common driving forces are: Changes in the long-term industry growth rate,
Increasing globalisation, Emerging new Internet capabilities and applications, Changes in who buys
the product and how they use it, Product innovation, Technological change and manufacturing
process innovation, Marketing innovation, Entry or exit of major firms, Diffusion of technical know-

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Case study: Western states insurance Agency
W J Jacobs
21485569
how across more companies and more countries, Changes in cost and efficiency and Growing
buyer preferences for differentiated products instead of standardised commodity product.

With the rapidly changing healthcare environment, Blue Cross/Blue Shield (BCBS-MT) is
concerned about our over reliance on this segment. Rapid changes in this environment was not
defined, but increased cost of medication and hospitalization as such, as well as social demand
due to rapid increasing poverty in certain areas, called for government intervention in providing
health care.

PEST analysis (a way of classifying the driving forces):

Political
Nationalization of the healthcare can present a serious risk for the group. Pressure on government
to make available cost effective health care benefits, may cause a regulated market, causing
reduced margins.

Economic
Expanding economy will provide for asset acquisition while that will provide for the necessity for
insurance. Medical cost inflation calls for more emphasis on effective medical aids. The Insurance
industry is at a mature stage of the product life cycle, and more prone to suffer during the economic
crisis. Poor economic conditions cause lapses in policies, and smaller take up of new products.
Increased growth rate of suppliers and reducing demand for these products, can put downward
pressure on revenues.

Social
Increased pressure from the community to provide free medical care and health benefits puts
pressure on this market. Changes in the demography or different demographics of different regions
will call for differentiated strategies.

Technological
Improved internet communication open potential clients up for quotes from agencies beyond the
borders. Also puts pressure on the admin function to operate well to ensure customer satisfaction.
New ways of internal communication are developed, giving companies the edge when it comes to
client administration.

The strongest forces currently are demographic and technological. Entering new markets, means
learning to know your client, while having increased resources to service them, will ease the
process. The company at the forefront of technology and research and development, will stay
ahead.

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Case study: Western states insurance Agency
W J Jacobs
21485569
The impact of the above driving forces will impact negatively on the margins of participants, but not
if they are able to provide specialist products which are sought after.

4. Question 4: SWOT analysis:

SWOT ANALYSIS:

STRENGTH

 Powerful strategy of acquiring market dominance in geographical environment

 Strong revenue growth from $9. 5M in 1998 to $26M in 2003

 Maintaining the look and feel of localized branches, keeping clients comfortable with
change

 Well established technological base as well as infrastructure.

 Excellent back office support structure

 methods, human resources, types of training programs and support to companies

 Good customer service due to skilled staff and strong admin support

 Can provide a wide range of products at more favorable rates than smaller independent
agencies.

 Well worked out front office, marketing and client support services for agencies

 Low debt ratio and strong financial support base from the holding company

WEAKNESSES

 Shortage of skilled agency recruitment members and an absence of a dedicated team for
this purpose.

 Do not have as much to offer to larger companies than for smaller companies

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Case study: Western states insurance Agency
W J Jacobs
21485569
 The absence of scale benefits of larger companies, means that the scope to acquire new
agencies is much smaller.

 No brand recognition and trust-based relationships when outside of its current geographical
area

 Lack of trust of localized agencies to allow WSI to purchase them, seen as outsiders

OPPORTUNITIES

 Use of the strong financial position of BCBS-MT to reach the strategic goal

 Increase brand recognition outside geographical area, via BCBS-MT

 BCBS-MT could launch its own underwriting and reinsurance services

 Supplying back office and internal support to smaller agencies on contract basis as way to
familiarize them with WSI and vice versa. This can simplify the acquisition process.

THREATS

• Changes in economic climate, reducing the base for policy sales

• Risk of service and support to existing branches decreasing as the company acquire new
partners

• Take over by larger insurance agencies

• Changes in health care system and over reliance on this segment

• Depletion of the number of possible candidates for acquisition.

5. Question 5 Financial performance:

WSI revenue more than doubled from 1998 to 2002 and the net profit increased by $ 1.87m from a
loss of $ 588k to a profit of $1.28m. Expected y.o.y growth in revenue for the 2003 forecast is 23 %
in revenue and 4% in net profit. These are all positive indicators, showing that the WSI strategy is
well executed.

Compared to the previous year with the respective figures being 29% on revenue and 31% on net
profit, the expected performance for 2003 does not seem all that well though. There is no real

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Case study: Western states insurance Agency
W J Jacobs
21485569
correlation between new acquisitions and revenue and profit growth (although it is difficult to tell
when the contribution of the acquired agencies kicked in). The net profit margin is still higher that
the industry, but is is clear that WSI now lacks size, because the net profit of the peer group is
higher.

Some highlights of the financial analysis: (Refer to Annex A for detail):

Revenue and profit trends 1998 to 2003 and projected to 2008

80,000,000
y = 7E+06e 0.2064x
70,000,000
R2 = 0.9804
60,000,000
50,000,000 Net revenues
40,000,000 Net Profit
$

30,000,000 Expon. (Net rev

20,000,000 Linear (Net Pro
10,000,000 y = 419641x - 966876
- R2 = 0.9501
-10,000,000 05 j)

06 j)

07 j)

08 j)

j)
04 t )
99

00

20 0 02
98

01

20 p ro

20 p ro

20 p ro

20 p ro

ro
20 e s
19

19

20

20

(p
(
2

(
(
03

It appears as if revenue is growing exponentially and net profit linear. This is a concern, because,
although it is good to use revenue as target for IPO, itYear
does not make sense if it comes at a price.
What has to be noted is, to accomplish the $100 million revenue mark by the end of 2007 will
require year-on-year revenue growth of at least 40%. From the above graph the exponential trend
indicates that if $ 70m is possible. Both the projections in the above graph has a higher than 95%
accuracy.

Peer Performance Ratio`s (2002)

Marsh & Brown & Arthur Peer Industry
WSI Mcle Aon Brown Gallagher Avg Avg
Profit Margin 9.08% -0.97% 5.79% 19.82% 5.10% 7.44% 4.27%
Asset turnover 1.01 0.72 0.36 0.58 0.47 0.52 0.48
Return on assets 6.10% -0.70% 2.11% 11.58% 2.42% 3.85% 2.05%
Equity multiplier 2.56 3.64 5.64 1.95 4.43 3.92 2.92
Return on Equity 15.59% -2.55% 11.91% 22.59% 10.73% 10.67% 5.99%
Dividend Payout ratio 0.00% 32.99% 15.28% 124.10% 43.09% 27.36%
Internal Growth rate 11.26% -0.70% 1.43% 10.88% -0.58% 2.24% 1.51%

Return on Assets (ROA)

The ROA increased from a negative of -6.18% to 6.10% in 2002. Better than the peers and
industry. Both the asset turnover and return on asset ratios are well above the market and peer
average.

Return on Equity (ROE)

The ROE of WSI increased from a negative ROE of -30.65% in 1998 to a positive ROE of 15.59%
in 2003. The ROE is well above the peers and the industry. Excellent.

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Case study: Western states insurance Agency
W J Jacobs
21485569

The gross profit percentage

WSI gross profit percentage increased slightly from 35.57% in 1998 to 37.63% in 2003. This is a
good sign. No discounting on products is done to gain market share.

The profit margin

WSI “profit” margin increased from -6.18% in 1998 to 7.84% in 2003, but at a much slower rate than
revenue increase. With the gross margin increasing slightly, it means that the cost of acquisitions is
higher than anticipated, maybe as a result of the premium paid for acquisitions. The profit margin of
key rivals in 2002 was 7.44% comparing to the 9.08% which WSI achieved. This is well above that
of the peers and industry.

Liquidity and cash reserves:

The cash ratio improved reasonably from 1998 at only 0.21 : 1 (available cash to accounts payable)
in 1998 to 0.37:1 in 2002 but is still well below acceptable norms. The current ratio (current assets
to current liabilities), however provides comfort in improving from 0.98:1 in 1998 to 1.35:1 in 2003
indicating a good improvement in liquidity. The operating cash flow of WSI also increased from
$1 641 703 in 1998 to $7 609 574 in 2003 this implies that the cash generated by operating
activities increased with 78.43% in only 6 years. This despite investment in new agencies indicates
excellent execution of acquisition strategies.

Leverage and gearing:

The debt to equity ratio improved from nearly 4 to 1 in 1999 to 1.56 in 2003. Although this is a
healthy position from a finance perspective, a debt ration of approximately 3, should reduce the
cost of capital significantly (given that external finance is cheaper than shareholders funds. Using
the 33% deposit and 67% long term loan base for financing acquisitions, makes perfect sense. By
repaying debt, growth will be hampered.

The equity multiplier of WSI of 2.56 times is also below the peer and market average. This is an
indication of poor use of external finance. With a significantly higher ROE at 15.9% which is higher
than the peer (10.67%) and market (5.99%) average return on equity as a result of high ROA, the
internal growth rate can increase dramatically with higher leverage. This imply that WSI`s
management of cost and the generating of profits from shareholder investment is much better than
both market and peer management. (What needs to be noted is that no dividend payouts were
visible and that the balance sheet does not tie up with the income statement.

The above results indicate a good and healthy business with strong management strategies. In
addition the result also indicate that the secondary business model, which is to grow the business
through acquiring smaller insurance agencies, is a good strategy for WSI and its shareholders.
Unfortunately the acquisitions are not truly coming to the full and may need to be evaluated more
carefully

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Case study: Western states insurance Agency
W J Jacobs
21485569

6. Question 6: WSI growth strategy in 2002:

WSI’s growth strategy was communicated as an acquisition strategy, with the intention of
expanding the company’s geographical coverage and to expand into competitive capabilities. As a
result they would be able to vertically integrate backward in the value chain by reaching critical
mass to underwrite their own policies. Increasing the number of agencies served by the back office
functions should also result in reduced overhead cost, or at least reduced cost to income.

They are pursuing the benefits of scale and managed to grow the number of agencies as part of the
company from 8 to 16 in eight years. With the expected two additional sign-ups in 2003 it means
that 5 of the 10 acquisitions were done in two years. This is the rate at which growth should be
effected to at least reach the $ 50m mark by mid season 2008.

With two firms signed on in 2002 and a possibility of 3 in 2003, it appears as if the strategy is well
executed and judging from the revenue growth 2001 to 2002 of 29% and expected 23% growth in
2003, a similar conclusion can be drawn. The only problem appears to be the net profit growth,
increasing well in 2002, but deteriorating in 2003.

The big question will remain whether the strategy can be kept running and whether a point of
saturation is imminent.

Strengths of the approach are:

1. Increased geographical expansion
2. optimising the cost to income ratio
3. almost immediate returns on investments
4. building economies of scale

Weaknesses:
1. The hit rate for conclusion of a deal is very low and a great deal of cost and preparation
goes into this area.
2. Additional resources is required just to drive the strategy – this entails highly skilled and
costly personnel
3. The market they compete with for acquisitions are currently paying a premium for the
acquisition of similar agencies, causing a disconnection between purchase price and
contribution value.
4. After doing all the preparation, some agencies sell off to localized competitors as a result of
knowing them better

Other strategies would include mergers with similar companies, running the risk of WSI loosing its
identity in the process. They could opt for strategic alliances or partnerships, which would allow

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Case study: Western states insurance Agency
W J Jacobs
21485569
them to still capitalize on the scale benefit, but might cause them to loose face if the alliance partner
steps out of line, or maybe loose own clientele, should the alliance go sour.

They could also go for outsourcing strategies, mainly maybe to outsource their own service to
potential agencies - at a rate and in such a way start mining into the opportunities for a take over or
merger. That way they would save significantly on the cost of due diligence and recruitment.

7. Question 7: Recommendation:

This target revenue level would not only allow Western States to go public with a share issue, but
would also bring in the capital necessary to continue its growth through acquisition strategy, and in
turn allow Blue (BCBS-MT) to underwrite its own insurance policies.

The problem is however that no indication exists that WSI will be able to reach the target revenue.
At best, they will be able to reach R 70m, but it will have a detrimental impact on the resources
needed. There are already concerns from agencies that they do not want to loose the current
effective support system as a result of overloading.

The availability of skilled staff to fill the increased void between current skill levels and required, is
also a major concern. Apart form the obvious issues, factors like the availability of agencies
suitable for acquisition as well as the size limitation of the transactions will make it difficult to
maintain the strategy.

The current process is also not sufficient to allow the necessary growth. For the $ 100m mark to be
reached it will necessitate a doubling of the current revenue growth rate, meaning a doubling of the
current acquisition rate as well. WSI will run into serious reputational problems, and the reason
does not appear to be worth while. To do a IPO at a later stage an rather focus on maintaining a
steady pace of acquisitions, will allow them to grow their support systems in line with expectation
and avoid any unforeseen errors. They can still look out for a possible $50m size possible
acquisition candidate for when they approach the $ 50m revenue mark. It is achievable

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