For brokers looking to sell and active brokers looking to protect their commissions
By David Ethington
We are frequently asked about the value of commissions, so this topic is clearly a concern for brokers. Determining the value of a book of business requires outlining specific information unique to each situation, defined by each seller and buyer in a given scenario.
Here’s what we don’t do: We don’t follow the typical processes used in many industries because our industry is unique. We don’t use financial methods based on projections of future revenues, or look back three years to calculate trends. We don’t add significant value to any type of insurance line, nor do we place great value on the seller’s “type” of clients.
Here’s what we do: We use a valuation model that is based on how health commissions are paid to health brokers. The first question we want to know is: who receives the commissions?
- The solo health insurance professionals have commissions paid directly to them.
- A few brokers have assigned their commissions to a corporation like an LLC (Limited Liability Corporation) or S Corp.
- And with employed brokers, many must assign commissions to their employer.
The key is that the value of commissions is significant, no matter who handles receiving the commission payment. One reason is because persistent income is unique to the health insurance profession. CPAs, lawyers, and many professionals must seek new business to replace clients who have purchased services and moved on. These professionals are in many ways jealous of us.
Health brokers enjoy steady payments which depend on doing the work to retain their clients.
We agree with the thought that commissions are valued in different ways. The often-used concept we can apply here is “Value is determined by what a buyer is willing to pay to the seller.”
Scenario: two partners are looking to separate
The valuation process primarily focused on the commissions. It involved a formal and costly procedure amounting to $10,000. This process, commonly employed in the merger and acquisition industry, utilized various mathematical formulas. It was rigorous, expensive, and yielded 8 to 10 different results based on different financial models. Surprisingly, each model’s outcome closely aligned with the expected values established prior to the process. All the numerical values were derived from multiplying the annual revenues by a certain factor, with some consideration given to assumptions about future customer retention. Some models incorporated different discounting figures, while others factored in revenue losses based on projected client lifetimes or policy cancellations/changes.
Initially, the partners hoped for a multiple of three times as a favorable valuation. However, the models demonstrated that a value of three times exceeded the upper end of the spectrum. Ultimately, the partners had a valuation figure to use as a basis for negotiation.
The specific type of commissions played a crucial role in this agency’s case. As a unique agency, 75% of its revenue stemmed from Medicare overrides, with the remaining balance coming from retail health insurance across several lines. This revenue composition is uncommon among many brokers but is typical for agencies with downline producers.
Over these past seven years we have worked with hundreds of health insurance professionals to help them protect, grow, and sell commissions. In every case, commission value was centered on the annual total paid to the writing broker.
With commissions paid to health insurance professionals, it is best to base the value of a book of business on annual commissions.
Looking at annual commissions as the basis for valuation makes it understandable for both the seller and buyer. It is critical to have an understanding between two parties. When the buyer and seller can agree to use annual commissions as the basis for valuating a book of business, then the sales process can move forward.
Having ten models of valuation is not necessary for a retail health insurance book of business. This is because there are only a few variables involved in the sale of most broker’s commissions. Even with agencies, override income is commission based and this revenue can be included in the model we suggest based on an annual commission method.
With the annual commission total as the basis of the value, the focus moves to what the payment amounts will be and for how long.
Since in our model the payment of commissions is based on the valuation, payment over time is often a better method for several reasons. First, the tax impact is reduced. A one-time payment is taxed heavily and often results in a lower actual amount received after tax compared with payments made over time. For those looking to get the maximum payment, or “largest multiple” of revenue, payment over time is always the best option.
The payment amount is a point of negotiation. Buyers and sellers often settle on a percent, or “split,” of commissions paid overtime. So, the next step is to define the period of time payments will be made by the buyer to the seller. This is usually over several years. A split can be fixed over each year or vary annually. These points are determined and included in a final formal purchase agreement.
The valuation method takes into account both the split percentage and the payout period. For instance, if a 50% split is agreed upon, with payments made to the seller over a period of five years, the approximate value would be 2.5 times the annual revenue. Under this model, the buyer commits to paying the seller the agreed-upon split on the commissions that are transferred to the buyer. This payment is calculated and made to the seller on a monthly basis. Additionally, this valuation method also factors in any increases in commissions that occur during the payout period, resulting in additional payments to the seller. However, it’s important to note that if commissions are lost for any reason, the seller will not receive compensation for these losses. Only actual commissions received can be paid out to the seller.
After the buyout terms are agreed to and the payout period is set, the focus moves to retention of commissions. Commission retention now becomes the most critical part of the sales process. This is because when a sale of a book of business occurs, two important retention steps are required. First is the transfer of commissions to the buyer and the second is transfer of client relationships to the buyer. Both steps lead to the highest commission retention.
To complete the retention plan part of the sales agreement, it is ideal to find common ground between buyer and seller on the three key ingredients of a deal: commission retention, payout amount percentage and payout time period. As you can see, the actual value of a book of business is the combination of all three components
Commission retention is a critical part of the sales process. When a sale of a book of business occurs, two important retention steps are required. First is the transfer of commissions and the second is transfer of client relationships.
In the model outlined, it is clear that client retention is vital. Fortunately, it is to the mutual benefit of the seller and buyer to agree on a client retention plan. In our model, we include details on what is expected of the seller after the sale. Listed activities that lead to higher retention will benefit both parties. The list includes common marketing and service practices.
Valuation For Planning
Planning is important for all brokers. Knowing the value of your book of business is helpful. Documenting your succession plan in writing is required. Our Purchase Agreement and Commission Protection Agreement are fully customizable for our broker clients. Hopefully, you now understand the importance of determining the value of your book of business not only when you need to sell but also when you plan to stay active.
The valuation model we outlined above works for brokers looking to sell and active brokers looking to protect their commissions in all life events.
We enjoy helping active brokers learn how to apply these agreements.
Contact us for a 15-minute consultation to see which agreement fits your situation.
Based on the call, we can help outline your options.
David Ethington is VP of the Medicare Division and director of Broker Relations with Commission Solutions, Integrity Advisors. His work has excelled due to his commitment to provide the best service to both health clients and health brokers. David respects the hard work it takes to build a book of business and enjoys working with retiring brokers. He serves on the board of Directors for Orange County Association of Health Underwriters (OCAHU).
David has participated in the commission protection process for seven years He’s also involved in acquisitions, especially in the broker relationship transfer of commissions. David lives in Orange County with his wife and their cats. He is an avid runner and completes several long-distance events annually.