As many agents know, Agency Consulting Group, Inc. performs hundreds of agency valuations each year on behalf of internal valuations, adding partners, mergers, acquisitions, sales, ESOPs, and court cases throughout the United States.
Since we have done valuations for over 25 years, we have become Expert Witnesses in State and Federal venues on this subject. We also adapted our valuation programs to a usable format for insurance agencies and market an Agency Valuer Program for only $750. This permits the financially adept insurance agency owners to cast their own internal valuations on their and other insurance businesses. Best of all, if an agency finds it too onerous to process their own valuation, the cost of the Agency Valuer can be credited against our standard valuation service should you conclude that using a professional would be preferable to “operating on yourself”. Call us at (800) 779-2430 to order this product, but read the rest of this article first.
One of the questions that we get from many agents learning how to value their own agencies is regarding the concept of Agency Risk Factors that form a discount factor to the raw value of an agency.
There are two forms of risk factors that must be considered in the construction of a final Agency Risk Discount Factor, 1) the Time-Value of Money (also known as the Risk-Free Rate) and 2) the Inherent Agency Risks.
The first Risk Discount factor is always the time-value of money at the time that your valuation is done. This is also called the Risk-Free Rate. We use a variety of means to determine the current time-value of money, but you are relatively safe using the 10-Year Treasury Bill rate as published on line daily and regularly in the Wall Street Journal. This factor defines the expectation of erosion of the value of the dollar over time. $1,000 paid to you today has inherently more buying power than $1,000 guaranteed to be paid to you in one year and even more than $1,000 promised to be paid to you in two, three or more years from now. If you sell something to someone for $1,000 per year for three years payable at the end of each year, and the time-value of money is 10%, the current (present) value of the three thousand dollars is a touch less than $2,500 discounting the payment at the end of the first, second and third years. As an example, the 10 Year Treasury Note rate as of 1/21/2020 is 1.779%.
While the first Risk Discount factor is relatively objective, the next one is not. Specific agency risk factors are defined as the unique risks within the agency that increases or decreases the value of the agency over time due to inherent conditions within the specific agency. Many valuers attempt to attribute average Risk Discount factors to the stock market indices related to the recent average sale of insurance businesses to and from publicly traded companies. We believe that this falls into the category of Valuation Voodoo similar to believing that because an agency in California (whose specifics conditions you do not know) was sold for twice its revenues, that an agency in Iowa or Vermont (or any other agency) should also be valued at twice its revenues. In a simple analogy, relating the value of your agency to those of recent publicly held corporation sales and purchases is like equating the value of a national chain hamburger restaurant to that of the local burger joint in your town. The only thing they may have in common (we hope) is the fact that they use beef in their burgers.
The Risk Factor Matrix that we use in our valuation process (and is included in the Agency Valuer) provides you with almost 200 specific risk factors separated into 17 major risk categories that add or subtract risk from the value of an agency. While the recent “average” risk discount in agencies has been about 15% (inclusive of time-value of money and normal risk factors in agencies with no extraordinary exposures or issues), specifically working through the Risk Factor Matrix permits us to determine how high the risk to value is in your agency (or in the agency you are valuing).
The 17 major categories that we assess in our valuations are:
- Profitability
- Revenue Growth
- Account Concentration
- Carriers and Markets
- Compensation
- Specialization
- Retention
- Performance vs. Industry
- Organizational Structure
- Succession Plan
- Personnel Quality
- Receivables
- Training & Pro Development
- Size and Stability
- Liquidity
- Automation and Other Agency Systems
- Marketing & Sales
If you analyze the positive and negative risks associated with each of these categories when you do the Due Diligence portion of your agency valuation, you will better be able to gauge the relative risk in your agency (or in the agency you are valuing) in forming the discount factor for your valuation.
Another way of viewing the Risk Discount Factors is defined by the actual method of determining the value of an insurance (or any other kind) of business. The value of any business is its future earnings potential of the business over a reasonable period of time as defined by the person creating the valuation. That’s why value can be different for different people valuing the same business. For instance the value of a business to its existing owner who has ten years before retirement is properly defined by its historical trends of revenue growth, expense change, profits and earnings (profits after taxes) carried for ten years into the future. That’s how much the owner reasonably expects to generate from his business during his remaining productive business life. The Risk Discount Factor taking into accounts the variants in the 17 categories, above, defines the chances of his achieving the projected earnings stream from the trending exercise.
Existing owners use this method to define the amount of life insurance needed to protect the owner and his/her family from financial exposure if something happens to the owner during his remaining tenure at the agency. It also defines the minimum he should consider in the sale of his agency to provide him the same return as if he continued in the business for his remaining productive work-life.
However, if the owner is seeking imminent retirement, the method of defining the future earnings potential of the business must include the changes projected by the conversion of ownership from the current to the next agency owners. Projections of future earnings potential change based on the specific conditions of the potential agency successor or perpetrator. Risk Factors will also change based on the conversion from old to new owners.
As you can see, Agency Valuation is a combination of Science (trending analysis) combined with “Art” (the definition of logical risk factors that determine the chance that the earnings potential will be achieved). Some agents have simple enough conditions (mostly on-going agency operations with little or no change to ownership and trending conditions) that self-valuation is possible. The Agency Valuer is perfect for them to identify their own ownership interest. Other agents have trend changes that require more analysis than available to most agents and changes in Risk Discount that should be done by an objective third-party valuer experienced and knowledgeable about insurance agency conditions and values.
Please call us at (800) 779-2430 to discuss your agency valuation needs or specific Risk Factors that may contribute to greater or lower values for your agency.