How you value your L/H book will impact perpetuation, profits, and cross-selling opportunities.
INTRODUCTION
A realistic valuation of your Life/Health book that’s fair to all parties forms an essential part of selling your P/C agency. Here’s why:
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The L/H book and its potential (including benefits and other non-P/C products) might be the most lucrative part of your agency.
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The success of the agency, even its survival, might well hinge on the development of its cross-marketing potential.
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Ignoring the value of the agency’s L/H book in a purchase can easily shortchange the buyer or seller — sometimes both. The buyer might lose by failing to identify and develop the L/H potential, or by overpaying. The seller could lose by failing to receive the true value of an important asset. I’ve seen many cases of both.
THE PROBLEM
The bad news: Conventional standards for valuing a book of business simply don’t apply to evaluating your L/H book.
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Premium volume. Each $1,000 of L/H premium might pay a gross commission of $20 (a renewal of 2%) or less, or $1,300 (a first-year commission of 130%) or more. Most lie somewhere between.
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Gross commission. This year’s first-year gross commission of $1,000 might become a renewal commission of $50, $20, or even zero, next year.
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Net commission. This year’s net commission (after expenses) is affected by built-in reductions in commission rates, but also by variables and unknowns in the true overhead and expenses — not to mention the true value.
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Cash flow. In my opinion, a significant part of the L/H book’s value hinges on the probability (or improbability) of developing the book’s potential, none of which is reflected in cash flow, commissions, or any other historical dollar data.
There’s no single formula. Life/Health books are made up of many more wide-ranging valuation factors than even a diverse P/C book, and no two L/H books are the same. It’s impractical to apply a flat percentage of anything to reach a fair valuation. Even a range of percentages say, one to two times commissions, as with some P/C books’ is grossly off base. My rule of thumb is that there’s no rule of thumb in L/H valuations.
THE SOLUTION
The good news is that experienced consultants can produce a realistic valuation that’s fair to all parties. As with other types of analysis, 10 experts might each give a rent valuation for a given book of L/H business. The overriding goal is to identify the probability that your book will produce X dollars in a given period of time, based on the potential income stream from both renewals and cross-selling.
FACTORS AFFECTING RENEWAL INCOME:
Age. If all your insureds average age 90 (an extreme used here to illustrate a point), the renewal factor would be very low. However, there might be a high potential for selling annuities, gifting of policies to children and grandchildren, life settlements, and perhaps other products.
Products. If the existing book consists largely of non-competitive and/or obsolete products, there’s a high potential for replacing them in-house with modern, competitive products. However, this potential might be crippled by Life carriers’ contractual restraints, ignorance, failure to identify product weaknesses, and/or reluctance to sell “change.” For example, some agents are punished for replacement or low persistency. If the book has remained unreviewed for years, it has both weaknesses and potential.
Economics
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Insureds. If their income levels, job security, and long-term prospects seem positive, then they’re more likely to renew. On the other hand, a negative outlook in these areas will diminish the potential renewal value of the book.
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Economic conditions. If the regional economy is healthy, renewals should likewise be strong (in the absence of other negative factors). But if jobs, business, and professional incomes are depressed, lack of affordability will hurt the renewal rate. Here, as elsewhere, a negative might conceal opportunities. If a book consists of high-priced products, selling them replacement products that perform just as well (or even better) at far lower premiums might be highly profitable. If not, market Life settlements to them.
Carriers. In this period of upheaval among insurers, a carrier’s make-up and philosophy can easily affect the value of an L/H book. Are its products competitive and does it want to be competitive? Are these products profitable? Is the company likely to remain unchanged in structure (mutual, stock, etc.) and financial strength? If it’s likely to acquire, be acquired, or merge, how might its philosophy and/or products change?
Do any problems exist in its producer contracts? How is its service to agents and to policyholders? Are claims (especially Health and benefits) to living payees a positive or a negative factor? Are class action suits or negative publicity likely to weaken the company?
FACTORS AFFECTING CROSS-SELLING INCOME
Unlike a P/C book, which has some practical ceiling for cross-marketing potential, I believe strongly that the re-marketing potential of L/H products is unlimited. I’ve never seen a L/H book even come close to reaching saturation (the point at which it doesn’t pay to market anymore, or where there’s simply nothing left to sell).
Experts who measure L/H books by historical data only (cash flow, present value of future commissions, etc.) might see no value in potential cross-sales. However, I maintain that this potential, when recognized and tapped, can become the most valuable part of such a book. Consider these examples:
A. Average age 35, hypothetically maxed out on potential sales of Life insurance (although it’s never true that no further sales of Life can be made in any given book). Some, but by no means all, of the major potential cross-sales include:
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Medical Expense
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Disability Income
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Critical Illness (a relatively new product)
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Annuities (including equity index annuities for the growth/investment-minded)
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Charitable contribution programs
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Referrals
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Securities and financial investments
B. Average age 65, hypothetically maxed out on sales of Life, Medical Expense, Disability, and retirement planning. Major potential sales include:
Note that A and B deal only with individuals. Professional and Commercial accounts offer too many additional potential sales to list here.
The key to unlocking this potential lies in the hands of agency principals and producers. Some L/H books (especially if part of a P/C agency) are neglected and remain infertile. Astute buyers sometimes get them for a song or even literally for nothing! They’re simply tossed in with the P/C sale (I’ve seen a number of examples). On the other hand, some buyers have paid inflated prices for a book that flops on them. It all depends on management.
CONCLUSION
A valuation of your Life/Health book should include all of the factors noted above, and place a weighted value on each. A valuation that’s fair to both buyer and seller should identify values separately on the current book and the potentials, giving reasons, and perhaps explanations and qualifiers on each. Its conclusion would be: “The current L/H book is worth $X as it stands. The potential value would be $Y under the following conditions …”
Although this article can’t be the last word on any specific valuation, or even as a generality, it can serve as a first step. With so many agency sales and mergers occurring and more on the way, every agency should focus on valuing its Life/Health book!