Insurance Agency Valuation Rule of Thumb [Complete Guide]
Insurance agencies are notoriously difficult to value. First, you may not balance incoming premiums with future insurance claims, which could ruin the agency.
Secondly, predictable cash flows from insurance operations can take years to realize.
Such difficulties make an insurance agency valuation rule of thumb necessary. However, it's not all roses and smiles.
Will you accurately evaluate your agency? Will you underprice it or discourage potential buyers because of overpricing?
Since using a rule of thumb to determine the value of an insurance agency can be misleading, Exitwise offers you a tailored solution. Connect with us to help you hire M&A experts for a better-informed valuation.
What is a Rule of Thumb Business Valuation?
A rule of thumb business valuation refers to a company appraisal based on a generally accepted principle for the industry, which assumes businesses in that industry are largely uniform.
A rule of thumb is an experience- or common sense-based general principle considered approximately precise, even though it may not be correct scientifically.
While rules of thumb are common worldwide, they are not necessarily universally applicable because every business is a unique entity in its industry.
What is the Insurance Agency Valuation Rule of Thumb?
When valuing insurance agencies, the most prevalent rule of thumb is to apply a multiplier to the company's total annual commissions, usually a 1.0x to 1.5x multiple.
For better-performing insurance agencies, the total annual commission multiplier can be as high as 3.5. Medium-sized agencies can command a better range of 1.3x to 1.9x.
It's important to note that this multiplier applies only when selling the book of business itself but not the whole agency.
The commission multiplier thus answers the question, “How much is an insurance book of business worth?" rather than what the entire agency is worth.
As with most other rules of thumb, the commission multiplier for valuing an insurance agency is flawed. The rule is based on gross revenue or income and doesn't account for expenses.
Recently, valuers and insurance agency owners have been shifting away from this simplistic 1x - 1.5x revenue multiplier. The favor is shifting to EBITDA multiples and customized professional valuations as the new rules of thumb.
Where Did This Rule Of Thumb Methodology Come From?
The term “rule of thumb" is said to have first appeared in 1685 in James Durham's posthumous compilation of sermons. Durham mentions the use of guesswork and rule of thumb or personal judgment rather than Square and Rule, a more concrete approach used in construction.
Coming back to the insurance agency valuation process, it's not easy to pinpoint the exact origins of the 1.0 - 1.5x commission multiplier.
Most rules of thumb originate from widespread observations, hearsay, real-world transactions, and experience.
Pros of Using a Rule of Thumb to Value an Insurance Agency
Despite its shortcomings, there are also some advantages to valuing your insurance agency using the rule of thumb business valuation method:
Valuation Speed: The commission multiplier rule of thumb is a straightforward calculation that doesn't require extensive financial modeling and analysis. You can quickly calculate the value using your annual commissions and a derived multiplier.
Ease of Understanding: The idea of applying the commission multiple is easy to grasp, even for agency owners without extensive financial expertise.
Cost-Effectiveness: Compared to a full or professional business valuation, the rule of thumb is significantly cheaper or cost-free. Cost efficiency makes it ideal for smaller businesses or initial assessments.
Useful for Pre-Sale Decision-Making: The rule of thumb valuation acts as a starting point and helps determine if it's worth pursuing a deeper valuation. If the valuation is significantly above your expectations, it can be a sign that it's the right time to sell your insurance agency. If it's too low, you can improve the value first.
Wide Industry Recognition: The method is usually accepted by valuers, lenders, and investors. This acceptance can help streamline financing, investment, partnership, or M&A negotiations because the valuation serves as a shared common language.
Methods of Valuing an Insurance Agency
As mentioned, insurance agencies take more work to value. Valuers use a combination of different methods to arrive at an accurate figure because each method has its flaws.
You can use the market valuation, income-based valuation, and asset-based valuation. The 1.0 - 1.5x commission multiplier method also applies.
Let's delve into each method.
1. Commission Multiplier
Suppose an insurance agency has total annual commissions of $630,000 from its annual policy sales.
The agency’s value would be:
Agency value = Total annual commissions x Multiplier
$630,000 x 1 = $630,000 (using the 1.0x multiplier)
$630,000 x 1.5 = $945,000 (using the 1.5x multiplier).
2. Market-Based Valuation
When you use the market valuation method, you compare and analyze the recent or current valuations of similar agencies in the same market.
The market-based approach helps you review the sale prices and multiples of other agencies to determine an average multiple you can use against a financial metric, such as your EBITDA or revenue.
For instance, if one of your competitors sold for $10 million and had $2 million in revenue, the business had a sale multiple of 5x. If you have an annual revenue of $3 million and use the 5x multiple, your agency could sell for $15 million.
Using the market-based approach may be tricky because you’re likely to forget that your agency has unique characteristics, which may make it more valuable than others you compare it with.
For example, you might have exceptional taxable goodwill or a unique selling point.
In the private insurance market, you may have difficulty obtaining the sale information of similar agencies. Through Exitwise’s detailed M&A advisory process, we can help you find such information more easily and quickly.
3. Asset-Based Valuation
Insurance agencies can determine their value by subtracting their total liabilities from their total assets.
Insurance agency value = Total assets - Total liabilities
It's important to remember that insurance agencies evaluate the total income they receive from their assets rather than their assets' value.
Some assets may not generate income over a long period. As such, the asset-based method is not commonly used to value insurance agencies.
4. Income-Based Valuation
The income-based method is based on an agency's projected future cash flow.
Most owners and valuers prefer this method during exit planning because it accounts for potential earnings and the time value of money, which buyers find more reliable.
You'll come across the discounted cash flow (DCF) valuation option under the income-based approach.
Most valuers prefer the DCF option because it projects future incomes, cash flows, and expenses and then discounts these cash flows to the present time using a favorable discount rate.
You can also find EBITDA insurance company valuations under the income approach, even though income and earnings mean different things.
EBITDA is short for Earnings Before Interest, Taxes, Depreciation, and Amortization. The after-tax net profit or income is the company's “earnings," while “income" usually refers to a company's gross income.
The EBITDA valuation is preferred because it is a more accurate representation of profitability over some time when you have removed your total operating expenses. However, it doesn't account for the cost of capital.
Insurance Agency Valuation Multiples
We’ve seen that the rule of thumb insurance agency valuation multiple is 1.0 - 1.5 times the annual commissions.
The commission multiplier can vary depending on the agency’s annual revenue:
An agency with a total commission revenue below $1 million typically has a 1.5x - 2.5x multiple.
An agency with a total annual commission revenue exceeding $1 million typically has a 3x - 3.5x multiple.
Using the EBITDA method, the value of the business will be a multiple of its EBITDA.
According to most valuers, insurance agencies have EBITDA multiples of 5x -7x, and some as high as 11x. Agencies with higher EBITDA can enjoy higher multiples.
The vice versa is also true:
Agencies doing less than $1 million in annual revenue typically enjoy 4x - 6x EBITDA multiples.
Agencies over $1 million in annual revenue typically have 5x - 7x EBITDA multiples.
Let's assume your agency has an EBITDA of $3,330,000 and that you choose to apply a 5x EBITDA multiple.
Your firm's worth will be:
Insurance agency value = EBITDA x Multiple = $3,330,000 x 5 = $16,650,000
Limitations of the Rule of Thumb for Insurance Agency Valuation
While it is advantageous, determining the value of an insurance agency using the rule of thumb method has several flaws, including:
Overlooking Business-Specific Characteristics: The method overlooks unique internal factors such as profitability, growth rates, revenue stability, and debt levels. It also ignores the diversity of your products or services, the strength of your team, market position, brand recognition, and customer loyalty. Overlooking these factors may skew the valuation.
High Risks of Undervaluation and Overvaluation: The rule of thumb relies on other companies' M&A valuations or sale prices, which may not accurately capture your company’s actual value. Undervaluation reduces your take-home, while overvaluation may lead to a longer time on the market because you'll likely scare away prospective buyers.
Lack of Specificity and Context: Rule of thumb valuations lack context and specificity since they ignore industry trends, market conditions, and buyer motivation. For example, they overlook a buyer's specific goal, such as market expansion, for which they are willing to pay more for a target agency. But if the rule of thumb estimates the valuation at a lower cost, you may end up settling for less value.
Not Suitable for Niche or Specialized Agencies: Agencies that focus on unique subsectors such as captive programs, cyber insurance, and high-net-worth clients usually fall outside typical insurance industry benchmarks. A generic multiplier won't change their outlier status, and it may skew their valuation.
Avoiding Pitfalls in Rule of Thumb Valuations
The good news is that you can avoid these limitations or pitfalls.
Besides managing your expectations by not anchoring too much on a simplistic multiplier that may not apply to your agency, you can avoid the pitfalls by partnering with professional valuators.
Professional business appraisers provide accurate valuations that consider both internal and external qualitative and quantitative factors. They also consider the purpose of the valuation.
They understand the industry and market nuances better and can apply different appropriate valuation methods for a more comprehensive view.
At Exitwise, we can help you overcome the pitfalls of the rule of thumb method by putting you in contact with specialized M&A experts.
Check out our certified professional business valuation services to discover the true value of your business, know the best time to sell, and boost your confidence during negotiations.
Insurance Agency Valuation Calculator
We acknowledge that valuing an insurance agency can be intimidating, and you'll need all the help you can get. Exitwise’s online calculator can help you estimate the valuation of your private insurance company on the go.
Our calculator considers your industry and sub-industry, revenue types, total yearly revenues, annual EBITDA amounts, and one-time expenses. Using the information you provide, it calculates your agency's value and shows revenue and EBITDA multiples.
You can buy our Custom Valuation Report for a more accurate valuation based on your agency’s unique characteristics.
Frequently Asked Questions (FAQs)
Have any questions about valuing an insurance agency? Let's discuss some below.
What is the Typical Insurance Agency Profit Margin?
Insurance agencies are typically not high-profit investments. According to Investopedia, most only realize 2%—3% net profit margins.
Seasoned agencies with large market shares can enjoy higher net margins from lows of 3% to highs of over 12%.
According to Dojo Business, a customized business plans company, insurance agencies enjoy average net profit margins of 5% - 10%.
Can the Size of an Insurance Agency Affect Its Valuation Rule of Thumb?
The size of an insurance agency can affect its valuation rule of thumb. As we have seen, agencies with higher annual commission revenues can value using higher multiples of up to 3.5x.
How Do Geographic Location and Market Position Impact Insurance Agency Value?
Your agency’s location and market position can raise or lower its value.
Consider these three scenarios to put this into context:
Agency X operates in a rural town. The market here is small, meaning smaller and fewer commissions. The agency offers only a few essential products like life, auto, and home insurance. Even though the agency owns the entire market here, its value remains low because it’s small.
Agency Y operates in an urban area with a larger market and more commissions. Its product offerings are more and may include travel and health insurance alongside basic insurance plans. Competition is high, but the agency commands a sizable market, and its value is high.
Agency Z is located in a metropolitan area. The competition is stiff here, but the population is higher, and the company has a good client base. Z can diversify into high-cost products, such as commercial and corporate policies. The agency’s valuation is much higher.
What Role Does the Insurance Product Mix Play in Agency Valuation?
An insurance agency that balances personal, commercial, and corporate insurance products well can attract a higher valuation.
A good product mix means high commission rates, more policies per client, lots of potential for cross-selling, and a decreased tendency of customers to switch insurance companies.
All these aspects can increase the value of the agency.
How Are Staff Experience and Qualifications Considered in Valuations?
A staff with high qualifications and experience levels can raise an agency's value. Buyers and valuers consider the quality of management and compensation rates.
Better quality of management means the buyer doesn't have to worry much about the company’s ability to sustain itself after the purchase. They will be willing to pay more for the company.
Buyers may also consider the accreditations and licenses your staff members have. Those with more licenses and industry accreditations can help increase the purchase price.
Conclusion
Since insurance agency valuations can be overwhelming, applying a rule of thumb is an easy option to determine how much your company is worth.
However, the rule of thumb method has problems, so you’ll want to consider other valuation methods, such as market, asset, or income-based approaches.
We can help you choose and work with an M&A team that will evaluate your agency accurately using detailed approaches and recommend the maximum possible sale price.
Talk to us at Exitwise for help forming your expert team of M&A advisors, lawyers, tax accountants, and wealth managers to get that dream valuation.
