A book of business is a database of clients you have done business with. The book may contain information related to current or future potential clients. An insurance book of business is a record of client policies of an agent or agency. It’s important to properly evaluate the value of your insurance book of business. Especially when you want to buy or sell it. Moreover it’s important when acquiring a new business. With the right evaluation you get the advantage of fair transactions. You can also apprise the worth of what you are getting and take risks. Here we will discuss steps to evaluate the insurance book of business properly.
Properly Understanding the Worth of an Insurance Book
The more income an insurance book creates the more valuable the book is. There are a few more factors that play into its value. The ability to retain clients for future dealings and the growth of the book over time is also important. The more stable a portfolio is the more lucrative it is to the buyers. Book that has diversified policies in it will fetch a higher price for its worth.
Factors for Valuation
Annual Revenue
This is the primary metric for evaluation of any book. The annual income of a book is also known as renewal income. As the policies get renewed annually buyers find it as an attractive source of income.
Client Retention Rate
The higher the rate of retention is the lower the risk is for losing revenue. A portfolio with higher retention rate has a strong loyal customer base. Generally a 85% retention rate is a lucrative portfolio.
Variation of Policy
In any case diversifying a portfolio reduces risks. So in any case if one segment fails another can support the portfolio during tough times. So a mix of personal, commercial and life insurance policies is a good book.
Commission Rate
A book that fetches a higher commission rate is more valuable. Books that can earn 10-15% commission are of high value.
Growth Potential
If the book has future growth the buyers can sell the book later for a better price. This entices the buyers to get a book with better potential growth as the income increases over time.
Operational Cost
Books that have lower operational cost have higher value. With fewer employees and systems to manage the book becomes easy to maintain. This is an upside to the buyers.
Location and Market Condition
If your business is located in an expanding economic zone and has high demand for insurance policies then your book is sure to fetch higher value.
Valuation Methods
Revenue Multiples
It’s the simplest method to evaluate a book. The method involves multiplying the annual revenue by a factor. Usually the factor is around 1.5 to 3. The factors are based on retention rate, mix of policies and commission. For example a book earning $100,000 per year would have a value of $150,000 with a factor of 1.5.
EBITDA Multiples
If the book has larger operations and has operating costs, then it gets a bit tough to evaluate the book properly. Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) method is used for complex and large operations. In this method profitability is considered rather than the revenue. A book with an EBITDA of $100,000 with a factor of 2 would be valued at $200,000.
Discounted Cash Flow (DCF)
In this method cash flow in the future is determined. This method does not consider future cash flow to get an appropriate value. By using a discounting rate the real value is determined. This method requires growth rate, retention rate and operating costs, making it a complex method.
Determining the value of an insurance book of business requires details about revenue, retention rate and growth potential. With these key factors in mind you can choose the method of your liking to determine the value of your book. Based on the size of your operation the method for determination varies. So you should use what best suits your portfolio.