This is, by far, the most common question we are asked at individual client agencies and during Q&A sessions at conferences and seminars in which ACG is involved.
Every year we provide a general answer in the pages of the PIPELINE. For the past five years the agents haven’t liked the answer. The value of insurance agencies has declined from 25% to 50% for the average agency from 1988 to 1992.
Please notice that this statement refers to the “average” agency. “Average”, in this statement does not refer to average size. It refers, instead, to the mind-set of the owners, the way it uses its automation capabilities, the way it administers its operation, the way it sells insurance and other factors that separate the dynamic insurance agency from the passive agency.
I am going to break down and refer to values in terms of multiples of commissions. We do not value agencies with ANY consideration of multiples of commission. However, we recognize that the multiple is a convenient gauge for agency owners, so we will convert the values generated into multiples for simplicity in this article.
Agency values are determined by two straightforward measures and two complex measures. The straightforward measures are the hard worth of the business, the value of its hard assets (furniture, equipment, buildings, cars, computers, etc.) and the current value of its estimated future earnings. After all, the real value being purchased by your successors are represented by things that are worth dollars now (hard assets) and sufficient future earnings to support the purchase and profit the new owner.
While we would all like to think that there is abundant potential for additional income in our agencies (that we, ourselves haven’t penetrated), this is a part of the “soft” value of the agency, called Goodwill by the IRS. This is one of the complex measures of agency values. The other complex measure used by agency valuers is Risk Factor. The risk factor is a composite of all of the inherent risks associated with your agency’s operation. When we value agencies, we use no fewer than 150 risk points to add or reduce the agencies overall risk factor. This is an unpublished list used by our consultants to measure agency risk. Short-stopping your next question, No, we will not publish the risk factor list. Our reason is that answers and records can be doctored to present a better picture than in actuality. Our risk factors are judged on site, through telephone interviews and questionnaires and through objective analysis of agency records. In this way we can be fair and objective to agency owners, buyers and sellers seeking fair market valuation of their businesses.
Your primary questions at this point should be why have agency values declined in the last few years and how can I judge my agency’s value.
The reasons for the decline are complex. They include (but are not limited to) the following:
* Reduction in commission rates by companies
* On-going soft market reducing premiums (compounding the problem created by the commission changes)
* Declining contingency income due to reduced contingent contracts combined with higher loss ratios (premiums have decreased, claims have not)
* Reduced interest income resulting from ever-increasing direct billing combined with lower investment return and the general market conditions
* Continued encroachment into personal and commercial lines by direct writers. The more competitors the less market share we get to keep – and they are selling more aggressively and performing better than us!
* Generally poor sales ability by independent insurance agencies. We have trained our staff (and clients) that price the only factor. Trained, professional sales staff in the exceptional agencies belie this issue by their continued success – Just read about them in any of the IIAA, PIA and other trade journals
* Lack of Strategic Planning and succession planning. Flying by the seat of our pants doesn’t enhance value. Not knowing who will operate your agency should something happen to you increases risk factors.
So how do you estimate a quick value to your agency? Obviously, we would prefer you to call us. Our valuations are objective and stand the tests of the IRS. But you may not be ready for that. You may simply want a quick guide to your value. O.K.
First, calculate the Net Worth of your business’ balance sheet. That is you hard asset value. This is accomplished by subtracting intangible assets (like goodwill, expirations, covenants, loans to officers (not being repaid)) from Owner’s Equity. Yes, it can be(and often is) a negative number. Most agencies in the U.S. choose to empty their coffers to benefit the owners each year. In this way the net worth is very small (or negative).
Next, calculate the average earnings of the last five years as percentage of revenue. Your next step involves some projections. project your revenue stream for the next five years by projecting forward your historical performance for the last five years. If you feel that the historical performance is not reflective of future performance, change the projections – but footnote the changes (so you can verify whether or not these changes take place in the future). Calculate the expected earnings of the next five years by multiplying the average earnings percentage by each year’s revenue expectations. This total combined (for better or worse) with the Net Worth is a fair estimate of your value.
Of course, we consider individual issues within our calculations. You may do the same. However, begin with empirical data before adding subjective input to change value estimates.
Good Luck. Call us if you have questions or would like a full valuation done for your agency.