Strategies for Maximizing the Value of Your MGA

Posted on January 24, 2012 and updated February 16, 2012 in Buying or Selling a Book of Business, Life Insurance Canada News 11 min read

When assessing the value of your MGA, don’t expect the same level of consistency as you would when assessing a bottle of wine: neither individual books of business, nor MGAs have aged very well.

“It’s important to be aware that you can’t assume that things will be the same as they have been,” said James Hilton, managing partner of Jacox-Hilton Producer Consulting, during an audio presentation sponsored by Advisor.ca.

James Hilton and Cameron Jacox have also joined forces with LSM Insurance for a series of articles on buying or selling a book of business.

“You have to factor in the unpredictable [regulatory] world we are now entering and its impact on margins, and you have to factor this risk into the valuation because the risk is now higher than ever before,” he continued.

Traditionally, businesses were valued purely based on revenue multiples such as three to five times service fees or three times segregated fund trailers.

“The problem here is it really assumes the MGA operates in a vacuum and it’s purely cash-flow based,” said Hilton. “It ignores the advisors and their books of business, and these are what generally comprise the MGA.” Jacox added, “A shoddy advisor base with low productivity that’s retirement age is far more important than historical service fees”.

Jacox-Hilton’s valuation model considers the advisor-centric business, so you can’t ignore their books of business and their skill in managing them when valuing the MGA.

Though it may be difficult to accurately pin a price on something since prices change on a daily basis, Hilton and Jacox firmly believe that you can go deeper than the traditional calculation being used in the financial industry today.

Advisor Level

“You can be more accurate by looking at the advisor level,” said Jacox. “So, we would look at a cross-section of advisor books in a very efficient way and look at the growth opportunities there and actually perform book valuations as well. Then, you can actually find out where this business is heading, so you’ll look at the age of the advisors, in-force monetization, process improvement using technology, and all the other critical factors.”

Book Valuation

Typically, Jacox-Hilton sees 2.5 to 3.5 times renewals and new business at about zero to two times. However, based on experience, they also see a high level of attrition (client loss) in the event of any succession by the advisor. These levels usually fall between five to ten percent, but can be much lower and much higher depending on a host of factors.

“We say five as a minimum because no matter how good the plan for succession is, there is really no way of getting rid of the feelings the clients might have of being pushed aside. So, you’re going to have some kind of attrition that has to be factored in to the renewal rate calculations,” continued Jacox.

He added that this number would be higher if the advisor lived by the 80-20 rule or if there were high differentiation in her practice, so the valuation would get more complex in those cases.

During this analysis of the cross-section of books, Jacox and Hilton would also go as deep as client and policy structure, asking questions such as, “What’s the age of clients?”

“For example, if most of the clients are over the age of 65, the reality is going to be seg fund business down the road and renewal attrition.”

Other elements during the book valuation process include looking at internal growth opportunities so that MGAs could better service policy holders and increase advisor-level production, normalizing revenues to route out excessive expenses or one-off cases, and evaluating the revenue capacity of the book itself.

Advisor Loyalty

Advisor loyalty is another factor used to evaluate the value of an MGA. “We define advisor loyalty as the amount of time an advisor has been with their primary MGA,” says Hilton. “When advisors are retiring, there’s no guarantee that the new advisor is going to stick with the same MGA, so there is a retention issue here.”

They both also believe that advisor age is the variance of where the advisor might be in the business cycle for the books. “Age is just as important as production, so you have to know whether they will be looking at retirement soon,” said Hilton.

“To minimize policy holder attrition when the book is transferred, we think that the brand and its relationship with the policyholders is what really drives attrition to be lower. So, if you can transfer books to a close colleague and maintain that relationship, in our experience, we’ve seen a lower degree of policyholder attrition after a transfer.”

Lapse Rates

Lapse rates are only good if they’re low, but at the same time, they’re enormously revealing in terms of what is in a book and the quality behind a book. “We have to ask, ‘How was the book approached by previous advisors?'” said Hilton. “Was the book used by an unscrupulous advisor that made big sales for big payoffs, though there wasn’t necessarily longevity to the policyholders, meaning the policies will lapse in a year or two?”

Obviously this is a concern because lapsed policies will negatively impact the value of the book to the point where there is actually little to no value left. “We want to look at the books and determine the stability behind them. At almost all times, if lapse rates are high, revenue is on a downward slope,” he continued.

Of course, both Hilton and Jacox thoroughly understand that most advisors are honest and hard-working people. However, in spite of this, lapse rates still need to be considered.

Regulation Valuation Impacts

From a valuation point of view, the increasingly regulated industry environment will reduce margins — plain and simple — but it has to be factored in just for the element of uncertainty that currently exists.

“If we’re going to be extremely objective about putting that into a valuation, what we would assume is that the mandates are going to be in place and therefore ask ourselves, ‘How you can adapt to those hypothetical mandates?'” explained Jacox.

For example, he would get you to ask questions like, “What’s your client to product suitability?” “Are you currently doing any oversight in that regard?” “Are you doing any advisor oversight?” or “Any advisor screening?” He explains, “If not then you’re going to have a difficult time financially and operationally absorbing any type of hypothetical mandates that may come in.”

Enhanced technology that improves your ability to move paper around and communicate with your advisors will also greatly improve your ability to respond to new regulation mandates.

“Also, there will be some MGAs that will benefit greatly from a new mandate transition period because they have multiple carrier contracts,” said Jacox. “So, if we saw a mandate of one MGA at a time then some people would see huge attrition, while other people would see huge growth. Those folks who are more differentiated and have a more loyal base are going to really grow through this period, while others might just fade away or be bought up.”

Maximizing the Value of Your MGA

Most people only go through valuation when their looking to buy or sell a book of business, but Hilton says it’s also helpful as a barometer of your MGA.

“A valuation is very revealing in terms of an MGAs strengths and weaknesses and areas of opportunity,” says Hilton. “So we find a periodic valuation can actually help with business development and improving profit margins just through having a thorough understanding from a third party of what the book actually looks like and what the business looks like.”

Organic Revenue Growth

Similar to what public companies do when they want to increase share value, this is about short-term growth. “The way to really drive profit is through organic revenue growth. If you look at driving profit, there are really only two options, cut costs or increase revenue,” said Hilton. “However, if you start cutting costs, to a certain degree, you will be sacrificing client services.”

Organic revenue growth is basically the practice of increasing advisor production while bringing a new level of service to policyholders. “As advisors become more successful, the MGAs become more successful,” confirmed Hilton.

Advisors are traditionally focused on making new sales, and their books are generally very large by the end of their careers, but Hilton revealed that they often lose sight of the type of value their policyholders are receiving in the face of current alternatives.

“Essentially, they are sitting on alternatives that could benefit everybody — not only the policyholders and the advisors, but also the MGA and all the way up the supply chain to the insurance carriers. So, in a sense, servicing policyholders is no longer an obligation; it’s a tremendous opportunity,” said Hilton.

“We believe the way to really take advantage of these opportunities and find the client value is to identify them systematically and equip the advisor with everything she needs to make the new sales and bring value to the client.”

A Real-World Example

For example, one value opportunity could be in a heavy policy loan against a cash value. The loan has a premium that’s being paid on it, but the premium doesn’t even cover the total cost.

“The total cost has to take into account loan interest. It has to take into account the risk involved and maybe even opportunity costs because the net cash is sitting on the sidelines of the market and is being eaten away by a loan. The policy then costs 10 or 20 to 30 per cent higher than the premium being paid,” said Jacox.

From there, the question becomes, “Is this policy the best for that client?”

“We find that roughly 5 per cent of the policies in an advisor’s book have loans against them, and there are two types of loans: the Christmas loan, where the client borrows $25,000 against their policy in time for Christmas, and then there’s the one’s where the client is in real financial trouble,” said Jacox. “What this does is reduce lapse rates because these policies are all in danger of lapsing in the near future.”

Interestingly, 32 per cent of clients with loans against their policies are over the age of 50 and their policies were sold prior to 1999. “This really tells us that advisors don’t look closely at the older clients, who are supposed to be all set because their older, they’ve been with them a long time, and they’re supposed to be all set with the policy they’ll probably die with.

“Using this example is an opportunity to look at the very micro level to better service clients, boost that valuation, and provide a differentiating factor,” he continued.

Going Shopping

Another huge opportunity for increasing the value of your MGA is buying other MGAs or books of business.

“This is a huge opportunity,” said Jacox. “The primary reason we think so is because valuation multiples are low.

“We think that if we really aggressively face the challenges that are in our industry today in an entrepreneurial manner, multiples can be driven much higher and book acquisition or MGA acquisition can allow you to take advantage of some of that growth. It also mitigates the risks of your current revenue model by providing a steadier stream of renewal premiums.”

Multiples can be Boosted

The margins in insurance business are considerably higher than they are in other industries. Even still, Jacox and Hilton believe that they can go even higher. “We believe multiples can be boosted to five or seven times if we see these changes: high technology adoption, strong differentiating factors among MGAs, succession strategies not just being talked about but being implemented as advisors reach these critical ages, advisor sales assistance, and of course, regulatory certainty,” said Jacox, while Hilton ended with the following:

“We also believe that if we can continue to do our jobs by servicing policyholders, then we can bring a new level of stability and security to them, and we can do so in a much more profitable way more than ever before.”

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LSM Insurance
LSM Insurance

Thanks for the kinds words. I’m glad you found it helpful.

MB-Malik
MB-Malik

Amazing post and very interesting stuff you got here! I definitely learned a lot from reading through some of your earlier posts as well and decided to drop a comment on this one!