Archive for October, 2010

Insurance claims administrators and risk managers make up a significant part of the independent insurance industry service provider sector.

Some industry statistics

Classified under the SIC code 6411 and NAICS 524282, there are some 215,300 establishments concerned with independent insurance services in the US alone. The industry as a whole employs around 1,125,000 staff generating a total of $188.8M in annual revenues.

The typical insurance services firm is quite small with a staff of just 5 and the annual sales of some $1,000,000. The vast majority of these companies are privately owned.

Insurance administrators provide a range of essential services which include, among others:

  • Design and administration of insurance plans for individual and business clients.
  • Insurance investigation and fraud prevention.
  • Claims administration services.
  • Insurance verification and recovery service.

Insurance claims administrators with successful track record of earnings and loyal client base are desirable acquisition targets. Recent business sales give you an excellent basis for determining the fair market value of such firms.

Insurance administrator valuation using multiples

You can create a highly defensible estimate of business value by using valuation multiples derived from such comparable business sales. There a number of multiples to consider:

  • Selling price to net annual sales
  • Price to gross profit
  • Price to net income
  • Price to EBIT and EBITDA
  • Price to total practice assets
  • Price to owners’ equity

Your business value estimate should be based on a number of valuation multiples. Depending on the company’s earnings prospects and risk, each multiple can shed additional light on how the business does compared to similar firms in the industry.

The result is usually expressed as a range of business values, from low to high, along with the median and average values. You can also calculate your company’s value as an average of the figures given by each valuation multiple.

Example: using valuation multiples for insurance administrator company valuation

To show how such market-based valuation works, let’s take a typical insurance administrator service company with these financial parameters:

  • Annual net sales: $1,000,000
  • Gross profit: $920,000
  • Net income: $225,000
  • EBIT: $273,000
  • EBITDA: $295,500
  • Discretionary earnings (SDE): $385,000
  • Total business assets valued at: $288,200

We next pick several valuation multiples and apply them to the financials above. Here are our business valuation results:

Multiple Multiple value Business value
Price to net sales 1.5 $1,500,000
Price to gross profit 2.0 $1,840,000
Price to net income 6.8 $1,530,000
Price to EBIT 7.1 $1,938,300
Price to EBITDA 6.9 $2,038,950
Price to discretionary earnings 4.0 $1,540,000
Price to total assets 5.5 $1,585,100
Average Business Value $1,710,336

Each result is different. Why? It depends on how the company in the example compares to its peers for each financial performance parameter, e.g. business net sales, profitability or asset base.

Additional business valuation methods to consider

As a rule, defensible appraisal of an insurance administrator firm should use a number of professionally recognized valuation methods. To supplement the market approach we have shown above, consider using income based valuation methods such as the Discounted Cash Flow. For owner-operator managed firms the Multiple of Discretionary Earnings method is a good choice.

Business goodwill valuation in divorce and partner buyout

Established firms in this industry often create considerable business goodwill. A common problem is how to handle this in cases of marital dissolution in the jurisdictions that treat business goodwill as part of the marital estate. Often the goodwill needs to be separated into its personal and institutional parts based on the statutory or case law in your jurisdiction regarding the distribution of goodwill assets.

Valuation of an Insurance Administrator Firm

Choosing industry specific valuation multiples is one of the biggest challenges in business valuation. When done right, such “apples to apples” comparison offers you a very defensible way to demonstrate what a business is worth.

Typical valuation multiples

You can calculate the estimate of business market value using a number of valuation multiples – each establishing business value in relation to some measure of its financial performance. Here is our short list of the valuation multiples most commonly used to value private businesses:

Do valuation multiples vary by industry?

A key question: just how much do the valuation multiples vary by industry sector? Let’s take a closer look at what such valuation multiples represent.

Business value is about risk and returns. Hence, to measure what a company is worth, you need to estimate both its earning ability and assess its risk. The standard way to evaluate business risk is to calculate the so-called discount and capitalization rates. There are a number of well-known income-based valuation methods that you can then use to appraise a business.

Market valuation multiples are related to this concept. This is especially clear when these multiples are applied to business earnings such as EBITDA or net income. In fact, these valuation multiples act pretty much as the inverse of the company’s capitalization rate – instead of dividing the business earnings by the cap rate, you multiply it by the valuation multiple. The result is the estimate of what your business is worth.

Industry risk premium and valuation multiples

If you take a close look at the Build-Up cost of capital model used to calculate the discount and cap rates for your business, you will see that one key component is the industry risk premium. This additional part of business risk depends, as the name implies, on the industry sector the company competes in.

Businesses in high risk industries are less valuable

The higher the industry risk premium, the lower the valuation multiple. This means that, for a given earnings forecast, the business value is lower. Put another way, the businesses in an industry with a high risk premium are more risky and, therefore, worth less.

Valuation multiples by industry – some examples

Just how much do valuation multiples vary by industry? We’ll use the typical Business value to EBITDA multiples for several industry sectors to demonstrate the difference:

Industry Sector SIC Code EBITDA Multiple
Architectural firm 8712 2.96
CPA / accounting practice 8721 4.38
Construction defect restoration 1522 4.62
Custom software development 7371 7.61
Engineering consulting firm 8711 8.19
Employment agency 7361 4.49
Environmental consultants 8748 6.47
Family medical practice 8011 2.71
Florist retail 5992 1.78
Gas station with C-store 5541 2.27
Heavy construction services 1611 4.37
Janitorial services 7349 4.92
Plastic products manufacturing 3089 6.16
Restaurant and sports bar 5812 2.22

Business appraisal using valuation multiples