Knowing the value: tracking and recording expense detail helps an agency and a valuation analyst determine what the organization is worth to an outside buyer. (Property/Casualty: Selling Insight).

Most agencies will need to determine their value at some point in their life cycle. In doing a valuation, it is prudent to examine revenue to determine how vulnerability to nonrecurring revenue can be addressed. It also is wise to manage expenses that are not directly tied to selling accounts or servicing customers.

To arrive at an accurate figure, a valuation analyst needs to assess the sustainability of the agency's revenues and determine the ongoing expenses that an agency needs to maintain its operation.

In performing this analysis, there are many pro forma adjustments that a valuation analyst will make to eliminate both nonrecurring revenue items, as well as unnecessary expense items. Understanding the nature of these items and adjustments will help the agency owner better understand the value of the business.

Sustainable Revenue

Sustainable revenue can be defined as recurring revenue related to insurance sales and service. It includes property/casualty; employee benefits and life commissions, as well as fee income, contingent income and investment income. Nonsustainable revenue includes any nonrecurring revenue, such as first-year life commissions, fees for a one-time consulting project or bonus income for a book rollover. Another example might be commissions from brokered business, which may or may not be placed with the agency in any given year. Contingent income may not be sustainable at the same level if a key carrier pulls out of a market, if the agency loses key accounts with that market and cannot maintain its previous volume or if the agency's loss ratios increase with specific carriers.

To minimize the adjustments a valuation analyst may make to revenue, an agency can demonstrate its history of generating revenue. For example, an agency with a strong track record of producing new life commissions will have a greater chance of sustaining that income than one that relies on residuals. To lessen the effect of brokered commissions, an agency should limit the percentage of business it places through brokers and place more emphasis on the business it produces through its employee sales force.

Revenue also can be vulnerable if producer agreements are not in place or if producers have too much control over client relationships. To mitigate producer control, an agency should have strong employee agreements, which include noncompete and nonsolicitation clauses, even among co-owners. These agreements should be reviewed by legal counsel every 12 to 18 months to make sure they are up to date and in compliance with legislative changes.

Another way to lessen account vulnerability is to involve service people to a greater extent on key accounts: Have them visit the client, conduct coverage reviews or identify cross-selling opportunities for other producers. With this approach, the client would perceive the entire agency team--rather than an individual--servicing the account, and the account would likely remain with the agency if the producer departed.

Ongoing Expenses

Ongoing expenses are recurring expenses to support retaining and generating insurance-related income. These might include professional fees for changes to an employee-benefit program, maintenance expense for overhauling office equipment or producer commissions paid for nonrecurring life income. Nonrecurring expenses exclude unnecessary expenses, such as country club dues, automobile leases for nonemployee family members and season tickets to sporting events.

Since it is beneficial to remove unnecessary and onetime expense items when valuing an agency, keeping track of these items is critical. Some expenses, such as country club dues and season tickets, are easy to track and quantify. Other expenses, such as flying first class or staying in five-star hotels, will be more difficult to quantify. Additional expense items that should be tracked include dues, subscriptions, charitable contributions, professional fees and costs of outside services. These items often contain one-time business expenses.

The objective for a professional valuation analysis is to accurately identify sustainable earnings. This adjusted figure should accurately reflect the cash flows the business actually generates and what it would, therefore, be worth to an outside buyer. Recording and tracking expense detail will give an agency owner the ability to address any expense items with a professional valuation analyst.

Sharon Cunningham, a Best's Review columnist, is president of Business Management Group, a management consulting firm in Hartford, Conn. She can be reached at [e-mail].