Agency Consulting Group, Inc. performs hundreds of agency valuations each year on behalf of internal valuations, or in preparation for: adding partners, mergers, acquisitions, sales, ESOPs, and in court cases throughout the United States. Because we have performed hundreds of valuations and prepared valuations for over 25 years, we have become Expert Witnesses in State and Federal venues on this subject.
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.
Thousands of agents in the U.S. have participated in our Valuation Seminars and understand that the value of an agency is inherently its FUTURE EARNINGS POTENTIAL for whoever is valuing the agency. That’s why three different people can look at the same agency and end up with three quite different values – and each of them is correct under the circumstances of that appraiser at that point in time. But RISK DISCOUNT still puzzles many agents.
The Risk Discount you apply to an agency’s earnings potential will define what chance there is of the agency actually achieving the projected earnings potential. For instance, if I had a government entity insured with a 10-year guarantee of renewal we could readily project the earnings potential of the agency. And the risk factor would be very low since that guarantee exists. But rarely will this happen.
We project our earnings potential based on historical trends into the future with consideration of expected changes. But what happens to our projections if the lead producer dies or retires? What happens if the slow and soft insurance economy experiences a ten or twenty BILLION hit (i.e. Sandy) and hardens overnight to increase rates? These are the types of risk factors that must be assessed when defining any form of discounting of potential earnings to present a viable value on an insurance agency.
There are two forms of risk factors that must be considered in the construction of a final Agency Risk Discount Factor, the Time-Value of Money also known as the Risk Free Rate and the Inherent Agency Risks.
The first Risk Discount factor is always the time-value of money at the time that your valuation is done. 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 weekly in the Wall Street Journal and online. This factor defines the expectation of erosion of the value of the dollar over time. One thousand dollars 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.
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 appraisers 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 have in common 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 Value, 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 average risk discount in agencies range between 12% and 20% 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 low or high the risk to value is in your agency or in the agency you are valuing.
Although Agency Consulting Group, Inc. analysts and consultants have decades of experience to use to apply discounts based on individual agency conditions, you can do the same thing IF you understand your own or any other agency sufficiently. We look at each factor in the categories, below, and assess whether there would be a positive or negative implication of that factor and category based on the conditions inherent in the specific agency that we’re reviewing. Yes, some risk factors actually decrease, rather than increase risk (i.e. having a vibrant team of young, well managed producers and employees vs. few or unmanaged producers or staff members who are nearing their own retirement). The level of risk assigned is the art behind valuation when calculating how much risk to potential earnings is generated by each condition uncovered.
The 17 major categories that we assess in our valuations are:
1. Profitability
2. Revenue Growth
3. Account Concentration
4. Carriers and Markets
5. Compensation
6. Specialization
7. Retention
8. Performance vs. Industry
9. Organizational Structure
10. Succession Plan
11. Personnel Quality
12. Receivables
13. Training & Pro Development
14. Size and Stability
15. Liquidity
16. Automation and Other Agency Systems
17. 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.
We also adapted our valuation programs to a usable format for insurance agencies and market an Agency Valuer Program for only $500. This permits the financially adept insurance agency owners to cast their own internal valuations on their and other insurance businesses. Best of all, for the majority of agencies who know they need valuation but are willing (but not able) to conduct their own valuations, the cost of the Agency Valuer is credited against our standard valuation service should you conclude that using a professional would be preferable to “operating on yourself”. 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.