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47 Cards in this Set

  • Front
  • Back

What is profit maximization? Why do so many brokers profess to follow it but fail to do so?

The more profit the better! --> but practicalities of operating the brokerage on a day-to-day basis distract attention from a focus on pure


What are the 2 methods of valuing a brokerage?

1. Multiple of Commissions

2. Multiple of Earnings

How does the multiple of commissions approach work?

Relatively simple approach.

Does not consider profitability in the value

calculation so a highly profitable brokerage and an unprofitable brokerage with the same

commission income would be valued the same using this method.

What are three items used to establish the value of a brokerage?

1. Financial Information

2. Nature of business operation

3. Other factors

What kind of financial information is used when valuing a brokerage?

1. Balance Sheet Items

2. Income Statement Items

3. Other Financial Items

What balance sheet items are looked at?

Assets & Liabilities

Assets - Cash, Accounts Receivable, other assets (office facilities, software, etc.)

Liabilities - current & long-term liabilities

decrease value

What Income Statement items are looked at?

Revenue & Expenses

Revenue - Commissions, investment income, other income, sometimes contingent profit

sharing earned is considered

What other financial items are looked at?

1. Cash flow - large amounts of cash available are better; receivables over 60 days outstanding have reduced value due to increased costs & risk of bad dept

2. Billings - # of billings has an effect as the cost to bill a client is around the same regardless of size.

3. Tax impact

What aspects of the business operations are used to value a brokerage?

1. Location (if looking for a brokerage in that area, they'll pay more)

2. Companies represented (if they represent the type of insurers the buyer is seeking)

3. Type of billings (if looking for something with lots of direct bill

business will pay more for one with a higher percentage of direct billing)

4. Relationships with clients (high retention ratio more attractive)

5. Business Mix (if interested in personal lines, higher ratio of personal lines business is more valuable)

What other factors are used to value a


1. Quality of Employees

2. New Business Potential (single-policy clients more likely to move their business but they also give more opportunity to generate new

business. If brokerage is in a growing area also more potential)

3. Loss ratio (if loss ratio is high brokerage is less valuable)

4. Errors & Omissions Claims

5. Market Conditions

What is the biggest factor in valuing a


The profit potential as determined by the buyer

What are the three components to the financial management cycle?

1. Budgeting

2. Classifying Financial Information

3. Making Comparisons

Why is budgeting so important?

It forces the brokerage management to consider income and expenses in detail and to plan their financial results.

How are budget items classified

Revenue/Income and Expenses

What items are included under revenue/income?


Investment Income

Other income

What four production variables are used in calculating commission?

1. Retention

2. Changing insurance rates

3. Up-selling and cross-selling

4. New clients obtained

What does classifying financial information involve?

Segmenting income and expenses by type and source to enable the identification of patterns

Provides a consistent basis to compare financial results

Why is making comparisons important in financial management?

Helps determine the level of effectiveness.

Enables identification of problems so they can be corrected in a proactive rather than reactive manner.

What potential problems are there when a

brokerage doesn't have a separate trust fund?

If premiums are tied up in slow-paying accounts or used for other reasons a slowdown in sales could put the brokerage in the position of being unable to pay the insurance companies.

How does a trust & operating account set-up work?

All premiums collected are deposited in the trust account and then a cheque equal to the

commission is written on the trust account and deposited in the operating account. The only other cheques written on the trust account are for payments to the insurance companies and refunds to clients.

How big should a reserve account be?

Equal to the probable amount of commissions that may have to be

refunded to the insurance company.

Depends on:

1. The total of unearned premium = maximum exposure

2. Ratio of returned to total commissions over time = average experience

3. Commissions on large premiums should be considered since they are susceptible to competition and represent a greater exposure as far as unearned commission is concerned

Why are internal cash controls important?

Controls the handling of brokerage cash, cash equivalents, and negotiable securities to avoid employee dishonesty.

It's a vital risk management task

What is the dominant part of the brokerages

assets for most brokerages?

the Accounts Receivable

What factors contribute to the cost of accounts receivable?

1. Surrendered Opportunity Cost of Funds

2. Increased Cost of Collections Activity

3. Cost of Borrowing

4. Reduced Bad Debt Expense

5. Commission Losses from Failure to Extend Credit

What topics should an accounts receivable policy include?

1. Payment arrangements (what is expected of the client and the broker)

2. Credit checks

3. Payment methods

4. Responsibility for Follow-Up

What are six ways to finance premiums?

1. Brokerage Financing

2. Financial Institution Financing

3. Insurance Company Financing

4. Premium Finance Companies

4. Captive Finacne Companies

6. Cash Only Financing

What is brokerage financing?

The brokerage has its own system of financing premium. They may divide the payments and allow payment in instalments without a service charge.

This method ignores the time value of money to the brokerage

The broker may also levy a service charge on the unpaid balance.

Some brokerages may see the service charge as a source of substantial income and encourage the customer to use this type of payment.

Also ignores the time value of money, additional work created, and trains the client to pay slowly

What is the advantages of financial institution financing?

Easy payments to the financial institution

Brokerages receive premium in advance

What are the advantages of a premium financing company?

Prompt commission payments to brokerage

Reduced billing expense

Reduced collection expenses

Lower accounts receivable

Allows use of money until it is due to the insurance company

What are the pros and cons of cash only financing?

+ less work

+ more income for the brokerage early in the policy term

-- decrease in sales

Why is managing expenses so important?

Saving a dollar in expenses is identical to making a dollar of pre-tax net income

What are some methods of controlling expenses?

1. Communicating

2. Identifying Areas for Cost Control

3. Classifying Costs

4. Analyzing Expenses

What are some changes to the brokerage that can result in substantial savings?

1. Employing modern technology

2. Converting to insurance company computer issuance of private

passenger auto and homeowners policies

3. Converting to direct billing for personal auto and homeowners policy

improvement in work organization results in increased productivity since there are specific work standards and the employees know what is

expected of them

What does cost accounting do?

Focuses strictly on costs to match expenses with products and departments

What does expense analysis consist of?

Developing expense standards and making


How can a brokerage indirectly maximize

employee income?

1. Employee incentive plans

2. Bonus plans

3. Stock Option plans

4. Performance plans (i.e. profit sharing or stock purchase)

5. Deferred compensation

6. Pension plans

What are the advantages of leasing equipment besides decreasing income tax liabilities?

1. Leasing companies may not need a down payment and finance 100% of the value. This conserves the brokerage's cash and working value.

2. Permits rapid changes in equipment, reducing the risk of obsolescence

3. Permits deduction of the full value of lease payments of equipment

4. Provides tax advantages through acceleration of the lease payments

5. Adds to borrowing capacity of brokerage as leasing does not add debt

6. May be more flexible because lease agreements may contain less restrictive provisions

What is the acid test? What does it measure?

Measures the brokerage's liquidity position and the safety margin of cash required in order to allow for the fluctuations that occur in cash flow

A brokerage with a high % of current assets in cash has higher liquidity than one with a large % of assets in accounts receivable

Acid test = [cash + accounts receivable (<30 days) ] / current liabilities

What is the equity-to-debt test? Who is it

important to?

Indicates how much we owe compared to how much we own.

Is of special interest to long-term creditors because shareholders equity is total assets minus total liabilities.

The higher the ratio the stronger the brokerages financial position

Equity test = shareholder's equity / total assets

What are some methods to measure efficiency?

1. Cost per account ratio

2. Revenue per employee ratio

4. Lapse ratio

5. Commission lapse ratio

5. Policy count ratio

6. Expense ratio

7. Close ratio

How is the cost per account ratio determined?

Divide the total number of accounts handled by the brokerage into total office and general


How is revenue per employee ratio determined?

net revenue / total # of personnel

Why is it important to look at the lapse ratios?

Helps to visualize effectiveness of the brokerage in creating & maintaining client relationships

How is commission lapse ratio calculated?

commission volume lapsed /

commission volume of renewals

How is policy count ratio determined?

# of accounts lapsed /

# of accounts subject to renewal

What is the most meaningful efficiency measure? How is it calculated

The expense ratio

= total brokerage expense / commission income

How is close ratio determined?

# of policies sold / # of quotes provided