Accounting Rules and Financial Engineering

Consider two agencies:

Agency A hires and develops a producer. 100% of the expenses are charged against revenue. This reduces earnings and earnings per share.

Agency B buys an agency in a straightforward, normal asset acquisition. Other than legal costs and a few other minor expenses, only 1/15^th of the cost goes against earnings and earnings per share.

For comparison, a producer generates $500,000 in commissions after five years. Producer compensation, training, and development cost an easy $500,000. First-year profits are therefore negative. Second-year profits are likely negative. The third year might break even. Hopefully, in the fourth and fifth years, profit is realized.

But if $500,000 in commissions are purchased for $1.0 million, and the profit margin is 20%, then the book is profitable from day one at $100,000 less $66,667 in amortization. If you are attracting investors, which approach generates the most earnings, is Agency A or Agency B smarter?

If the purchase price exceeds 3 times revenues, Agency A is doing better because annual amortization exceeds the cost of this particular producer. (And I realize I’m only considering five years, and I’m doing that for specific reasons I’ll address later.)

So how does it work when brokers and PE firms pay such high prices? They are using what is called “In Excess of Fair Value.” When they do that, they simply do not amortize some portion of the purchase price. Think about this relative to earnings. If you buy an agency and never amortize the purchase, all the revenue is free! There is no cost shown on the income statement associated with generating the revenue.

The amount typically not amortized by publicly traded brokers over the last five years has ranged between 35% and 70%, depending on the broker and the year. This is a lot of “free” revenue. In fact, for one publicly traded broker, using 2024 data, it increased earnings by 3.5% for the division doing the most acquisitions. That is a material increase in earnings.

A partial offset is that the more “free” revenue, the higher one’s profits, which is what these firms want to show investors and shareholders. However, that also means more taxes, which means less ability to pay dividends. The way around this is to reorganize in low-tax countries, which is what two of the publicly traded brokers have done. And because of some interesting tax rules, certain PE investors may not pay any meaningful taxes on the profits generated by acquisitions.

This does not mean cash flow is stronger because sellers must be paid something. Most deals now require sellers to take a material portion of their purchase price in the buyer’s stock. That stock is interesting because some buyers make sellers buy their stock completely blind.  In other words, they refuse to share any financial data, no audited statements, nothing. That should be illegal.

Much of the price is still paid in cash, so cash flow suffers unless some combination of higher cash profits or capital raises occur. Some buyers have borrowed immensely while others have raised equity instead, but their capital growth must exceed capital outlays, and without financial engineering or severe staffing cuts, paying high multiples makes it nearly impossible to stay ahead if new capital inflows beyond operating cash flow cease.

Accounting rules prevent this kind of financial engineering from appearing on only one side of the financials. Double entry is required. A book entry is typically made as a deferred tax asset or a deferred tax liability. These are balance sheet entries that do not affect earnings or earnings per share.

Now things get a little more interesting. When a buyer does not amortize their acquisitions, they must complete impairment reviews. In my opinion, buyers conduct cursory impairment reviews, and the accounting board needs to tighten this rule significantly. However, we have a situation in this industry where "cursory" should not be so cursory, for two reasons.

The first reason is how a few large firms are so successfully poaching employees and clients. I am going to use Howden here because quite a bit of published data exists. Brown and Brown reported on a January 27, 2026 analyst call that they had lost $23 million and 275 employees to Howden. Marsh McLennan has sued Howden for poaching 140 employees all on the same day. Marsh averages around $220,000 revenue per employee. My understanding is these particular employees were better than average, but I have no proof, so using $220,000, that is about $31 million in revenue. Multiply $31 million by Marsh’s stock price to revenue as of 12-31-25, which was 3.5 times revenue, and the value of those poached employees was approximately $108 million. These are just two examples of many.

If that book had been purchased for In Excess of Fair Value, the portion that was not amortized must be recorded as impaired. That impairment goes against earnings. Because it seems as though many of the poached employees had come with deals, I’m just guessing here that many buyout firms need to take impairments. Those impairments should also affect their valuations. If a firm loses $30 million in revenue, its value should be affected. (Interestingly, in early August 2026, a medium-sized publicly traded carrier announced a $460 million impairment but justified it as a paper loss--that's nearly a half billion dollars!)

But now we have the second development. The publicly traded brokers’ stock prices sank by about 10% on February 10, 2026, amid fears that a new AI-driven agency would decrease their revenue and profits. If a purchase was made on a $10 million book for three times, or $30 million, and even if only half was not amortized (it would likely be more than half), then 10% of $15 million, or $1.5 million, would be the impairment. The brokers alone pay in the billions annually. Even on $10 billion in purchased revenue, at 50%, the impairment is $500 million.

I have no doubt there will be arguments that I’ve oversimplified the situation, but financial engineering usually involves overcomplicating it. I think I’ve just brought everything down to basics.

This reality creates real problems that financial engineering covers. First, earnings do not correlate to paying for producers, and producers generate actual growth. Carriers excessively over-represented by such distributors should probably be looking for new sources of growth, as these distributors cannot afford to develop producers. Second, competitors should target accounts rather than people because accounts are vulnerable. And if you take people, take staff, not generally the producers. Take good staff and good producers will follow.

Third, carriers should focus their efforts and their monies on agencies who prove successful in actual producer development. Otherwise, kiss true organic growth goodbye.

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