The Impact Of Clusters On Agency Value


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In this document, Chris Burand addresses the question of how an agency’s value is affected when it doesn’t own any company contracts because it’s part of a cluster. 

Historically, independent insurance agencies have owned two intangible assets: Their customer lists and their company contracts. Few valuations separate the values of the two, since they are integrated. Some company contracts increase an agency’s value (although not by 100%, as is sometimes claimed), while others do little for value, or even decrease it if the contract isn’t easily transferable. This might happen, for example, when an agency writes a material amount of business through a company that says it will pull its contract if the agency is sold. Such issues are usually considered in a valuation, but separate values are not generally calculated. 

What happens to an agency’s value if it doesn’t own any company contracts? I’m not talking about an agency using a broker model, in which the agency represents just a few companies and works through MGAs for most of its markets. In such a situation, the relatively lower agency commissions and minimal contingencies are easy to identify and factor into valuations. But how is an agency’s value affected when it doesn’t own any company contracts because it’s part of a cluster? 

As with all good valuation answers, the answer is, “It depends.” To learn the effect of not owning any contracts, we have to look at how the cluster affects profit, growth, and risk, which are the three keys to all valuations (together with the buyer’s or appraiser’s perception of these factors), and the quality of the agency’s balance sheet. 


Many agencies join clusters and give up their contracts to consolidate volume and thus increase contingency income. They assume that if they double volume, that they’ll more than double their contingency bonuses. However, an analysis of 12 regional and national companies shows that on average, the contingency increase is far less dramatic. For example, for an increase from $2 million to $4 million in written premium (at a 50% loss ratio), an agency would increase its contingency bonus as a percentage of written premium, all else being equal, from 1.35% to 1.52%. In a cluster of two agencies, each agency would receive just half of this 0.17% increase, which equals only about $3,500. Agencies considering a cluster should review their contingency contracts carefully to be sure that they’ll earn enough extra money to make clustering worthwhile. 

According to the latest GPS Study (The Academy of Producer Insurance Studies, 2002), the national average contingency income for agencies with less than $500,000 in revenue represented 3.77% of their revenue. For agencies with more than $2 million in revenue, contingencies are only 4.7% of revenue — just one percentage point more than the smaller agencies. From a written premium perspective, $500,000 in revenue at 12% commission requires $4.2 million in premium, while $2 million in revenue at 12% commission requires $16.7 million. To get that extra point of contingency bonus, an agency must quadruple its volume. If a cluster is involved, the bonus is still split between owners. 

Unless significant planning and negotiation lead to material gains, expectations might greatly exceed reality. On the other hand, for very small agencies, contingencies can increase significantly within clusters, simply because the agencies might now qualify for them. 


Cluster arrangements don’t necessarily affect growth in a particular direction. I’ve seen cluster arrangements reduce growth significantly because the integration was so poor and company management philosophies were so divergent. I’ve also seen growth increase when the agencies and companies involved were good matches and the cluster was planned properly. 


The risk associated with an agency that doesn’t own its company contracts has a great effect on agency value. For example, consider a member of a cluster that desires to sell itself outside the cluster, but doesn’t own its contracts. If a prospective buyer doesn’t represent the same companies, what’s the risk that the sale will mean losing a number of accounts? Will as many buyers even be interested in buying such an agency? 

This is a major problem with many clusters in which a holding company owns the company contracts, rather than the individual agencies (which is the usual requirement of insurance carriers). In most cases, the seller can’t get full price when the buyer is an agency representing other companies. (A possible exception might be if a good producer comes with the deal). An alternative would be to sell to the agency’s cluster partner — if the partners are interested, can afford the price, have the required staff/production capacity (this can be an issue if the buyer is a one-man shop, which is often the case with clusters), and want to get bigger. 

Even if a sale among cluster partners is acceptable to all parties, cluster agreements often don’t address such a transaction adequately, and agreeing on a price can be a big issue. This could lead to serious trouble for the seller because a deal might not be workable among partners, while the selling agency might have limited value outside the cluster. At this point, the seller is often trapped. 


A good balance sheet enhances value, and a poor one diminishes it. In clusters, the balance sheet can have an effect similar to that of a buy-sell agreement. The balance-sheet value for most agencies depends primarily on three factors: Cash, accounts receivable, and accounts payable. Within a cluster, accounts receivable and accounts payable for all members are usually run through a central account held by the holding company (even if the holding company owns the company contracts, all members remain responsible for all other members’ payables). The way most cluster agreements are written, when one member gets behind on its payables, all members are responsible for all other members’ company and customer liabilities. What happens when a seller learns that another member has spent too much of its customers’ money, putting the cluster out of trust? In this situation, no buyer will pay full value. 


Franchise clusters, because of their size and the extra benefits they provide, are slightly different, but the basic problems still exist. At some point, the parent organization will have significant power over an agency’s ability to sell. Unfortunately, most agreements don’t cover this key issue — a point that might or might not be acceptable, depending on the situation. 

Balance-sheet questions also apply to franchise clusters. I strongly encourage all agencies considering joining any kind of franchise cluster to examine the franchise’s balance sheet, including audit statements for off-balance-sheet liabilities, before signing the agreement, and annually thereafter. 


The sad fact is that because very few accountants and attorneys have an adequate understanding of insurance agencies, they’re not qualified to organize clusters without professional help. 

If some form of a cluster is best for you — and it definitely is for some agencies — make sure that the negative effect of a poor cluster agreement doesn’t outweigh the benefits of clustering.

Chris Burand can be reached at Burand & Associates, LLC, PMB 345, 1829 S. Pueblo Blvd., Pueblo, CO 81005, (719) 485-3868, fax (719) 485-3895, e-mail [email protected], or Web site
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