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Disclosure and compliance will influence value of books of business

By Alain Thériault | April 21 2015 09:01AM

Disclosure requirements that come into effect on July 15, 2016 and the ever-increasing burden of compliance will influence the way advisors’ books of insurance and investment business are valued.bosch_tonyIn the succession program that HUB Financial is about to launch, vice president of broker development Tony Bosch says that the firm has put a great deal of emphasis on compliance. The succession program will include training components to deal with the subject.

According to Bosch, advisors must know how the new regulations governing commission disclosure and compliance will influence the value of their clientèle. “There could be a lot of liability in a block of business and there might be a lot of additional work to put into that block to make sure that you don’t have any liability risk when you decide to buy,” he warns. His advice to advisors is that if they have not taken this factor into consideration, they should not make the purchase.

Bosch believes a block of business that has been serviced regularly, with files that are well organized, fully compliant, and up to date is worth a lot more than one that has not had this kind of care for a long time.

But not all buyers seem inclined to check for risks that may be hidden inside a book of business. Alain Vézina is senior partner and business advisor at Nessa Capital, a firm that provides independent evaluations of books of business. He has found deficiencies in a number of transactions that directly concern compliance. In his opinion, the amount of due diligence that is done on assets leaves something to be desired, as does the disinterestedness of the evaluation itself.

In my opinion, the days when a transaction was based on some arbitrary multiple are over – one which was the result of some baseless standard, such as two or three times insurance renewal commissions.

– Alain Vézina



“Many buyers are negligent or they do not do any due diligence on what they buy,” comments Vézina. When they sign a contract to buy a block of business, he says many advisors merely check to see if the renewal commissions will be enough to service their debt payments.
Tipping point

He insists that reviewing files, the client management system, and how well compliance requirements have been met is crucial today. “We have been talking about it for several years. But it was only two years ago that qualitative criteria began to take precedence over quantitative criteria when evaluating books of business,” observes Vézina. “I feel that the tipping point is in progress, some valuation ratios are overvalued, especially with respect to mutual funds.”

Quality will also be the watchword in life insurance. “In my opinion, the days when a transaction was based on some arbitrary multiple are over – one which was the result of some baseless standard, such as two or three times insurance renewal commissions,” says Vézina.

Blind faith in renewal commissions is no longer appropriate either, he adds. In fact he believes it is impossible to limit oneself to renewals, given the costs and requirements of compliance, the higher expenses of running a business, the increasing demands of clients, as well as the competition from financial institutions and major national distribution networks.

“The expenses and the unprecedented amount of time required by compliance and the new disclosure rules (CRM2) which will come into force in July 2016 mean that the cost to service, maintain, and develop in-force business is more significant and above all more tangible than before,” underlines Vézina. In certain cases and in certain areas, he believes this could potentially cause the real values ​​of in-force business to drop.

He also thinks that the use of standard multiples is misleading and often does not stand up to a closer analysis of the clientele and its characteristics.

Lastly, he thinks that the amount of disability insurance on an advisor’s books can be an important criterion, one which may determine the likelihood of the purchaser generating an attractive level of future income. He believes disability insurance is a better indicator of potential revenue than the presence of segregated funds, for example, as well as living benefit products in general. The complexity of the field means that someone who has the expertise to communicate with these customers using a specific vocabulary, and the ability to discuss the ins and outs of the products, will very often be successful.

The Retention trap

Presented as the holy grail in transactions involving books of business, committing to remain on board for a certain period of time is not always ideal for the seller. Everything depends on the terms of this engagement. “With respect to the presence of the seller during the transition period that follows an acquisition, I am skeptical,” comments Vézina.

“Many mutual fund transactions fail because the buyer tries to impose the risk of retaining clients on the seller. For example: ‘I pay you a price of X and in 12 months or 24 months I will pay a final amount of Y, depending on how many clients I have kept.’ I drive it home to sellers that they should not fall into this trap because any responsibility for retention rests with them,” warns Vézina.

Instead, he advises that buyers do their homework before imposing such arbitrary clauses. “The buyer has to analyze the seller’s practice, style, in-force business and must make his own calculation about the clients he could lose in a transaction and negotiate the acquisition price. In some cases it may be appropriate to demand a scaled sale price for reasons other than just customer retention.”

Future income

Moreover, it strikes him as risky to rely solely on renewals, and not to have a way of calculating the amount of new sales a book of insurance customers might generate in both good and bad years. “In investment transactions, the buyer and seller often do not have the same rate of commission pay-outs, and the most common mistake is to ignore this gap in the calculation of future income,” he adds.

Alain Vézina also believes that, compared to life insurance, there is a certain amount of overbidding for in-force investment business. “I know a firm that does not buy blocks of investments, or it buys as little as possible. It prefers to buy blocks of undervalued insurance business. This is because its members have expertise and offer a range of services that allow them to pick up investment clients from their competitors. Their return on investment is much higher with this strategy,” he notes.

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