There is no simplistic formula that can be used to determine a fair market value for the
business of a practicing life insurance agent. Such a valuation would be a function of
many factors. The formula would differ for each variation of life insurance practices.
Unlike in the property and casualty insurance business, very few sales of life insurance
agencies have taken place in Canada. Thus, the wealth of historical data and valuation
practices provided by P&C agency sales is unavailable to life practitioners.
In developing a business valuation procedure for life agents to follow, it is practical to
examine some case examples.
Case 1 — Value of an agent’s client files
Recently, a managing general agent within a
particular company has purchased other agencies within his sponsoring company with the
approval and support of that company. The purchaser possessed a distinct advantage in
buying agencies within his own sponsor’s organization since he had a clear
understanding of their value based on knowledge of the life insurers contract and product
mix. This type of purchase is possible for an independent agent as well as those agents
more closely tied to a single company.
The purchase price was established as four times lifetime renewals plus an adjustment for
the balance of first year commissions. The purchaser believes this simple formula will
allow him to pay for the business in six years because his profit will come from servicing
clients of the purchased agency with new products and services.
Financing this type of purchase is a major problem. Because most agent contracts do not
guarantee renewal commissions, banks are reticent to advance funds to finance such
purchases. Additional security unrelated to the expected cashflow of the arrangement is
usually a condition for bank financing.
If a cash buy-out is not possible, consideration might be given to funding the purchase
from future profits, for example, over a period of 10 years. Commissions would have to
be transferable to the buyer immediately so the cooperation of the life insurance company
is required in this type of transaction.
An adaptation of this may help some agents overcome prospecting problems. Agents
leaving the business or retiring might be approached with the idea of using the simplified
formula to selling their block of business.
Case 2 — Value of a personal practice
Another individual has recently examined the
purchase of personal practices that are going concerns which also carry a certain amount
of goodwill value. These practices are mainly incorporated agencies.
He recommends breaking the valuation process into a number of steps:
1. Assess the contract — ownership of “rights or things;”
2. Assess the value of any fixed assets;
3. Assess the value of renewals and then discount them assuming 10 percent interest
on the purchasing power of money;
4. Assess persistency taking the value of “hard renewals,: i.e., lifetime renewals,
and then discounting persistency at the rate of 10 percent per year;
5. Assess overall cash flow and expenses, grow profit over the past 5–10 years;
assess whether the cash flow is firm, totally dependent on the present owner or
institutionalized; and determine whether the present staff will stay on.
Other areas of investigation include the willingness of the present owner to stay on under
an “earn out agreement,” the retention of the business and the reliability of its
profitability.
If the examination of all these factors results in a favorable assessment, the individual
would apply a capitalization rate of 8–10 times the present value of a diminishing stream
of income discounted for persistency and expected rate of return.
The purchase should be made with income, not capital.
A recently published book by Ian Campbell entitled Valuation of a Private Enterprise
expands on this formula and is recommended for those who wish to become involved in
the acquisition or sale of a
personal practice.
Case 3 — Value of a small incorporated business
Assuming the contracts of a small
incorporated agency specify ownership of “rights or things,” other factors must then be
considered in the agency valuation process. For example:
1. Are there any fixed assets? Does the business own the building and office
equipment?
2. Are there any long term liabilities such as mortgages or leases?
3. What is the cash flow of new and renewal business?
4. Does brokered business exist? If so, what is the history of brokerage production
and loyalty? Are the contracts held by brokering agents vested and assignable?
5. What do financial statements indicate?
6. Should the purchase be of the “assets” rather than the “shares?”
7. Can a performance-related contract be established whereby the seller will remain
for a period of time to keep the business flowing, especially the renewals?
8. What is the real value of renewals? Lifetime compensation has more value. Level
compensation on group insurance plans has more value if there is a consultant who
controls the group business and who is prepared to remain with the agency.
9. If the agency sells pension, RRSP or other forms of deferred compensation, is
there someone on staff who controls this business? If so, the business has more value. If
not, it is extremely vulnerable.
10. Has the agency sold a large volume of money products? If so, caution should be
exercised. The purchase value of the money product block of business could be affected
by whether it is “system based” supported or whether compensation payable is asset
based, i.e., based on a percentage of accumulated value.
11. Does the agency possess product lines or application, such as charitable giving,
second-to-die contracts or insurance sold to back up annuities, which may have better
than expected persistency?
Each of the above questions must be dealt with separately. Generally speaking, however,
the formula developed in Case 2 could be applied to each line of business evidenced in
the small incorporated agency.
Case 4 — Valuing a multiple lines operation
It is speculative to comment on the value
inherent in multiple lines operations and even riskier to deal with the valuation procedure
where these practices are combined in one company. However, it may be fair to say that a
business which is made up of a combination of these different types of practices (life,
group life and health, pension and property & casualty) would be valued differently than
any one of them taken separately.
The combining of different specialties should have a positive effect on the overall value
of the business because the different areas generate business for each other. Persistency is
also better with a multi-line client.
It is difficult to be specific about the enhancement of the value of a life practice when
combined with other specialties. However, if a life practice is worth 2.5 to 4 times its
level repeating commission flow, then it is suggested that a minimum 25 percent
premium should be added to the purchase price if the life practice is being sold as part of
a multi-lines agency.
