For an insurance agency there are just a few critical valuation drivers necessary to build up the value of the firm. Although they are easy to identify, they are not always easy to turn around. The following is a summary of these key valuation drivers.
Profitability
The profitability of any agency is directly related to compensation costs. These expenses are typically two-thirds of revenue. Therefore, low productivity and overstaffing will lower profits and thus lower the agency value. The quickest way to increase agency value, then, is to eliminate overstaffing. It is important, however, not to just downsize but to “right-size.”
A firm’s success partly depends on how well it can coordinate efforts and effectively manage personnel. With a streamlined organizational structure, talents of the best individuals are utilized, service activities are delegated to the least costly, qualified employee and salespersons are supported with good technicians, which frees up their time to sell to prospects.
Producer Contracts and Compensation
There are many excuses not to have a producer contract. They are expensive to draft. They cause ill will between parties. They are easily broken, etc. All of these excuses have some element of truth in them. The important point is that the lack of producer contracts will lower the agency’s value, because an agency with no contracts increases the risk associated with the firm’s continued earnings potential.
All producers should sign a producer agreement that establishes book ownership as well as compensation. The latter is important in determining the relative value of firms. Check with an attorney to create a non-solicitation agreement with producers, should he or she ever leave the firm.
The compensation must be reasonable for the services performed and affordable, so a profit can be realized for the owners and managers. Generally, a well-run firm cannot afford to pay an average renewal commercial commission of more than 30 percent if it hopes to generate a 15 percent to 20 percent profit margin. Firms can pay more than 30 percent for new business to motivate producers to bring in new accounts, but then they’re cutting into their profits the first year to do so.
Producer/Client Relationship
Many owners and producers see virtue in the fact that they know all their clients and have an excellent relationship with each one. There is a difference between knowing your clients and having your clients depend on the owner or producer for most things.
Agencies whose clients are tied to the owner/producer are less desirable to a buyer than an agency whose clients don’t have a strong bond to the owner/producer. Or at least there is also a strong bond between the client and the service staff in high value firms.
Book of Business Mix
The mix of business in an agency–commercial lines, personal lines, employee benefits, etc.–seems like it should be a valuation driver. A good mix of business makes for a very stable agency. Currently, the marketplace is hot for specific lines–employee benefits and commercial lines. Program or niche business is always popular. Personal lines, although profitable, does not seem to drum up the same level of interest. Keep in mind however there are lots of buyers and thus a variety of interest.
Effective Sales Management
Buyers are most interested in firms that show growth. The inability to grow is usually an indication of problems within the agency. Agency value increases with good steady growth and high retention of existing accounts.
Markets and Relationships
Good carrier relations can make the difference in the firm’s ability to survive market cycles, reach growth objectives and increase the firm’s value. The importance of this valuation driver has been decreasing the past few years. It is still very valid for buyers who are relatively small (perhaps under $5 million in revenue). It is not usually a factor in acquisition by regional and national brokers.
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http://www.insurancejournal.com/magazines/southcentral/2005/04/04/features/53915.htm