Valuation Metrics Used In Pricing Life Insurance Managing General Agencies

1. Valuation Metrics Used In Pricing Life Insurance Managing General Agencies Daryn S. Hobal, CBV, CFP

2. MGA Transactions Announced in 2011-12 • An MGA with 2,500 brokers and 11 regional offices in Ontario, Quebec and Atlantic Canada acquired by a subsidiary of a U.S. Private Equity Firm. • Subsequent to the transaction above the MGA acquired a Quebec-based MGA with approximately 1,800 new advisors. Post transaction the MGA will have in excess of $220 million in in-force life insurance premiums and $2.5 billion in segregated fund assets under management to become one of the largest MGAs in Canada. • A privately held MGA announced the acquisition of an Ontario-based MGA. The acquisition strengthens the acquirer’s position in Ontario and allows for expansion into Atlantic Canada. • A Canadian public company announces the acquisition of a 67% interest in an entity created from the amalgamation of an MGA with an Eastern Canadian operation and a Western Canadian based MGA.

3. More to Follow… “Yes our plan is to continue to grow and there are others that we’re in deep discussions with and…did say that he has $$ to make these kind of purchases” “The deal, expected to close…this new entity will also be looking to acquire other MGAs.”

4. Changing Ownership of MGAs Owner/Manager Institutional Private Equity Public Company

5. To • With the profile of MGA ownership changing so will the metrics used to price transactions. • In valuing a business it is important to consider who the likely buyer will be. • Vendors should be mindful of the goals of consolidators and their requirements. Public Companies • Goal is to make acquisitions that are accretive to their earnings per share. Private Equity Investors • In the business of investing in private companies to generate a return. • Looking to be passive investors and partner with management. • Looking to create value by growing operation and eventually divesting their interests through an IPO or divestiture. • Will often finance a significant portion of the purchase price and will want to use future cash flows to amortize the debt.

6. Past Pricing Metrics • Owner/Manager knowledgeable of the value of their in-force book of business to them. • Transactions negotiated around industry rules of thumb or established metrics. • Typically, rules of thumb would be based on a multiple of service fee revenue and/or assets under management.

8. EBITDA vs. Maintainable EBITDA • Acquirers not concerned with reported EBITDA but will want to get to a normalized EBITDA. • Typically Normalized for: • Owner/Manager compensation • Non-recurring revenue and expenses (transfer fees) • Non-arms length transactions (rent levels in owner occupied office, staff related to owner) • Normalized EBITDA is analyzed over multiple periods (averages, weighted averages, forecast) and a judgement is made as to what can be expected going forward.

9. EBITDA vs. Maintainable EBITDA • Maintainable EBITDA is an indicator of how much cash will be available to: • Amortize debt • Reinvest in itself • Pay a return to the investor • Transactions values are often expressed as multiples of EBITDA. • A multiple of EBITDA provides an indication of enterprise value (value of working capital, capital assets, goodwill and other identifiable intangible assets on a pre-debt basis).

10. Private Company Transaction Terms/Prices Cannot really be known unless: • You are party to a transaction. • A public company acquires a private company and metrics are implied from information disclosed to public in financial statements or press releases. What information is available with respect to transactions involving interests in MGAs?

11. Notes: Goodwill Impairment Test

12. What are the buyers acquiring?

13. What are the buyers acquiring? • Intangible Assets – Rights to future revenue. • Goodwill – Represents the excess cost of the acquisition over the entity’s tangible and intangible assets. “represents the expectation that XYZ Co. will be able to maximize the value of the contracts with major insurance carriers, and that synergies will be able to be achieved, to maximize the profitability of the combined entity.”

14. Identifiable Intangible Assets Standalone Goodwill Tangible Assets Synergies ????? Total Goodwill Paid Business Standalone Value Price The degree to which an acquirer will pay for synergies depends on the number of special interest purchasers in the market for the business and the quantum of anticipated cost savings or increased revenue post transaction.

15. Example – Company A • Expected Normalized Income - $100,000 • Investors Required Rate of Return – 20% • Value of Tangible/Intangible Assets - $300,000 $100,000 Capitalized at 20% (Inverse 5x): $500,000 – Value of Business ($300,000) – Tangible/Intangible Assets $200,000 – Residual to Goodwill Value of Business = Goodwill + Tangibles/Intangibles

16. Example – Company B • Expected Normalized Income - $50,000 • Investors Required Rate of Return – 20% • Value of Tangible/Intangible Assets - $300,000 $50,000 Capitalized at 20% (Inverse 5x): $250,000 – Value of Business ($300,000) – Tangible/Intangible ($50,000) – Residual to Goodwill Value of Business lies in the value of its identifiable tangible/intangible assets = $300,000 (No Goodwill)

17. Recent Transactions Involving MGAs

18. Company A purchases an MGA for a price estimated at $1,873,000. • $1,250,000 of the purchase price was paid on closing. 75% of the balance was payable 3 years after close with the remainder payable 2 years later. • $882,000 of the purchase price was allocated to identifiable intangible assets and $1,022,000 allocated to goodwill. • The Company indicated in its MD&A that the MGA had provided an additional $1.2 million in net revenue post close (extrapolated for full year - $1.31 million). • Implied Purchase Price as a multiple of net revenue: $1,873,000/$1,310,000 = 1.43X

19. Two MGAs amalgamated through an exchange of shares. • The shares of one of the MGAs were used as consideration. • The fair value of the share consideration was estimated at $3.308 million. • Management estimated that had the acquisition been made at the beginning of its fiscal year the acquired company would have earned $6.366 million in net revenue and $0.446 million net earnings. • The implied multiples of the transaction: • Price to post acquisition net revenue = $3.308/$6.366 = 0.52X • Price to post acquisition net earnings = $3.308/$0.446 = 7.4X

20. Valuation Principles To Consider • Value is greater of going concern value or liquidation value. • Rules of thumb should be used with caution. • Revenue may not necessarily equate to cash flow or earnings to an acquirer. • The amount of goodwill that is paid is partially a function of the strategic value to the purchaser and the quantum of the cost savings or revenue increases that are expected post transaction. • Negotiating other terms of transaction (vendor financing, retention agreements) can help a vendor realize a higher price and bridge differences in pricing expectations.