Are you one of the many agencies not receiving profit sharing due to the inflated loss ratios caused by the hard market? While this will have an impact on your value, the good news is the hard market is expected to be temporary and should not have a profound impact on your agency's value in the long term.

Here are three areas of agency valuation that are impacted by profit sharing and what you can do to protect the value of your agency:

1) Annual Revenue

Profit sharing, as it relates to agency values, is based on a three-to-five-year average. The agency is credited with the average annual revenue that profit sharing produces over those three to five years. While your agency is credited with the average revenue produced over a three-to-five-year period, you lose that same bottom-line revenue when you do not receive profit-sharing.

This graph shows an example of an agency that had a string of profitable years with strong profit-sharing revenues, followed by two consecutive years of losses. As a result of the losses in 2022 and 2023, the agency went from an average amount of $87,000 from 2019-2021 down to a $53,400 average over the past five years. When you experience two bad years out of three consecutively, it is important to advocate for considering a longer period of time in your valuation because your string of bad luck is likely attributable to the current hard market rather than your agency's performance.

If this agency were to consider only the three most recent years of profit-sharing, the average would be $34,333 instead of the five-year average of $53,400. By extending the consideration period to five years, the agency gets another $19,000 in annual revenue to be factored into the valuation analysis, which likely increases the value of the agency.

The impact on valuation also varies based on the percentage of the agency's annual revenue that is derived from profit sharing. For most agencies, profit-sharing represents between 6%-10% of annual operating revenue. Since most agencies do not budget for profit sharing, it does not affect annual operating revenue, but does have an impact on the profitability of the agency.

2) Profitability Margin

Independent agencies typically have a 25% EBITDA (earnings before interest, taxes, depreciation and amortization) profitability margin when profit-sharing is factored into the profit and loss statement.

In the case of the hypothetical agency in the graph, losing approximately $87,000 from the agency's annual revenue likely decreased its profit margin by 5%-7%. Profitability margin is another key metric in determining agency value. When profit sharing is good, it has a positive impact, but when profit sharing is negative, it likely will impact the overall value of the agency.

3) Carrier Relationships

The impact of not receiving profit sharing depends on how many years your agency does not receive it. If this is a one-year anomaly that can be attributed to the hard market, then it will likely not have a meaningful impact on agency value. However, if you have consistently high loss ratios with your key profit-sharing producing carriers over the past three to five years, then it will have a greater effect on your value.

A long string of high loss ratios will do more than just affect profit sharing; it will also risk the agency agreement with some of your key carriers. While you do not have control over when losses happen, ensuring the protection of your carrier relationships and maintaining profitable business is critically important to both agency value and the ongoing relationship.

While the lack of profit sharing will have some impact on your agency's value, it should be minimal as long as the trends do not continue.

Jeff Smith is chief executive officer of IA Valuations and the Ohio Insurance Agents Association. 

The information provided in these documents is general in nature and shall not be construed as personal legal, tax or financial advice for your situation. If your agency has experienced a loss of profit-sharing in the past couple of years and are interested in learning how it has affected your agency value, please contact Jeff Smith at jeff@iavaluations.com.

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