Tag Archives: market value

$1.2 Trillion Disruption in Personal Insurance

Most of us don't think much about insurance. That's by design, of course. Insurance is supposed to be a safety net that affords us the leisure of not thinking about it. Unless of course, we have to. That generally happens about once a year when we're reacquainted with our premium. Ouch. According to statisticians, most of us will also have to think about our insurance about once every seven to eight years when we'll encounter a loss of some sort. Another ouch.

My insurance is pretty confusing. I pay for coverage of my house – a fairly precise calculation based on its quality, size, age, materials, etc. I get a guarantee that, if I keep paying my premium, my home will be covered for its replacement costs. That's pretty reassuring. But then it gets a little weird. I get a “blanket” (insurance-speak is very comforting), which is really a formula that assumes that all the stuff I own is worth, um, somewhere around 50% to 70% of the value of my home. Huh? Maybe there's a bit of science to this, but surely there's a lot of guess…and, according to research, about 39% of the time the formula is just wrong. (As one insurance CEO recently confessed to me, most folks are probably 50% underinsured). The complications go on: If I own something really valuable, some bauble or collectible, well, that has to go on a list of things that are really valuable, and those things get their own coverage. Then, so my stuff continues to be well-protected, I have to re-estimate the value of those things from time to time, or employ an appraiser. What's more, if I buy something or donate something I own, or if any of my things goes down or up in value for whatever reason, my insurance doesn't change — because my provider doesn't know about these changes. And, if you've ever had a claim to file, the process starts with the assumption of fraud, with the burden of proof borne by the policyholder, because most people don't have an accurate accounting of their possessions and their value. Still another ouch.

So while I'm not supposed to be thinking about insurance, maybe I should be paying closer attention.  

Change is coming like a freight train, and its impact has the potential to shake one of the world's largest industries to its core. For a little perspective: The property and casualty insurance industry collected some $1.2 trillion (!) in premiums in 2012, (or about twice the annual GDP of Switzerland). 

At the core of the P/C insurance enterprise is (and I know I am simplifying here) the insurance-to-value ratio, which estimates whether there's enough capital reserved to insure the value of items insured —  if values go up, there'd better be enough money around in case of a loss. All good, right? Except that for as long as actuaries have been actuarying, the value side of that ratio has been a guess — especially for personal property (the stuff I own other than my home). So, if I forget to tell my insurer about something I bought, or if I no longer own that painting, watch, collectible, antique; or if the precious metal in my jewelry has increased…then what? Am I paying too much, or am I underinsured for the current value of the things I own? Of course, these massive companies make calculated allowances for the opacity…but these allowances also cost us policyholders indirectly in increased premiums, and the inefficiency costs the insurer in potential returns on capital. 

The coming changes can be summarized in terms of three trends. First is the expectation of the connected generations, now entering their most acquisitive years and set to inherit $30 trillion of personal wealth. Second is the connected availability of current data about the value of things. Third is the emergence of the personal digital locker for things.

Data, data! I want my data! — the expectation of the connected generations.

If they're anything, the connected generations are data-savvy and mobile. If you’ve shopped for just about anything with a Millennial recently, you’re familiar with their reliance on real-time data about products, local deals, on-line values and even local inventories. (I was with one of Google's brains, and he showed me how retailers are now sending Google local inventory data so now it can post availability and price of a searched-for item at a local store). Smartphone usage is nearly 90% for Gen Xers and Millennials, and data is mother's milk to the children of the connected generations who are being weaned on a diet rich with direct (disintermediated) access to comparisons, descriptions, opinions, crowd-sourced knowledge and even current values. The emerging generations rarely rely on the intermediation of experts (unless validated on a popular blog with a mass following) and are not likely to be satisfied with an indirect relationship with those affecting their financial health. Smartphones in hand, depending on data in the cloud, they will demand and receive visibility into the data shaping all their risk decisions.    

And here's where the insurance revolution will begin: A connected generation that is apt to disintermediate and has access to real-time info on just about any thing will demand that they insure only what they own (bye bye, blanket); that their insurance should track to real values, not formulaic guesses; and that they have the ability to reprice more frequently than once a year. 

The time is coming for variable-rate insurance that reflects changes in the values of items insured and is offered on a real-time basis for any item that the owner deems valuable. 

The price is wrong — the real-time valuation of everything.

Over the past few years, several data services have sprung up whose charters are similar: something like developing the world's largest collection of data about products — their descriptions, suggested retail price, current resale value, user manuals, photos and the like. No one has yet dominated, but it's early yet, and someone (or probably a few) will conquer the objective. Similarly, there are a few excellent companies that are collecting and indexing for speedy retrieval the information about every collectible that has been sold at auction for the past 15 years. I know something of these endeavors because our core product relies on the availability and accuracy of these data providers to collect the values (and other attributes) of the items people are putting into their Trovs (our moniker for the personal cloud for things). It is only a matter of time before we will be able to accurately assign a fair market value to most every thing — in real-time and without human intervention. This real-time value transparency will transform the way that insurance is priced, and how financial institutions view total wealth.

My stuff in the clouds — the automated collection and secure storage for the information about my things.

Within 12 to 24 months, connected consumers will embrace applications that will automatically (as much as possible) collect the information about all they own and store it in a secure, personal cloud-hosted locker. These “personal data lockers” will proliferate because of their convenience, because of real financial incentives from insurers and other service providers and because data-equipped consumers will have powerful new tools with which to drive bargains based on the data about everything they own. These new tools will pour fuel on the re-invention of insurance because all the information needed to provide new types of insurance products will be in the personal cloud-hosted data locker.

Progressively (pun noted, not intended) engineered insurance products that account for the connected generations' expectation of access to data, the abundance of data about products and collectibles and the active collection and accurate valuation of the things people own may turn the 300-year-old insurance industry on its head. Doubtless, the disruption will leave some carriers grappling for handholds and wondering how they could have insured against a different outcome.

This article first appeared in JetSet magazine.

Breakthroughs in Managing (and Insuring) Tangible Assets

In recent years, high-net-worth families have increasingly turned to tangible assets for more than their aesthetic values. A 2012 Barclays report found that high-net-worth individuals in the U.S. hold an average of 9% of their wealth in tangible assets. A 2011 ACE Private Risk Services study of high-net-worth households found that 74% of respondents, all with more than $5 million in investable assets, cited investment value as a reason to purchase rare art or wine, valuable jewelry, sports memorabilia or classic cars. Two-thirds said the potential for appreciation in value was important in their purchase decision.

As values of many categories of tangible assets have escalated, these assets increasingly serve to diversify investment portfolios during periods of volatile market gyrations. In the ACE study, more than half of the respondents reported that the investment diversification value of their tangible assets has become more important to them since 2008.

“Investors are increasingly looking to hard assets, such as valuable art, antiques or fine watches and wine collections, because of the perceived ability of these assets to hold value during market fluctuations,” says Tom Livergood, chief executive officer and founder of The Family Wealth Alliance, a Chicago-based family wealth research and consulting firm. “Across the industry, we’ve seen investors rush to safety and stay there.”

Blind spot

Even as tangible assets gain recognition as a new asset class, high-net-worth individuals rarely bring to their passions for art, wine or jewels the same rigor they have when making financial investments or business decisions. In ACE’s 2011 study, despite the growing number of households reporting greater importance of tangible assets to their investment portfolios, nearly 40% of those surveyed did not have all of their precious items insured against property loss with a valuables policy. Additionally, one in three reported that they were not updating the market value of these assets at least once every three years, and a full 15% of respondents had no formal documentation of their non-financial assets.

“It’s amazing how often some advisers, especially those with sophisticated knowledge of financial markets, suddenly turn unsophisticated when it comes to non-financial assets, notably art,” says Ronald Varney, owner and president of New York-based Ronald Varney Fine Art Advisors.

To Evan Jehle, a New York-based principal at Rothstein Kass, a professional services firm with a significant family practice, wealthy families typically pay 
far less attention to their personal property than to their business affairs. “Our clients would never let something fall through the cracks in their professional lives, but many families have never thought of their tangible assets in this way before.”

Thomas Handler, partner and chairman of the Family Office Practice Group at Handler Thayer, a Chicago-based law firm recognized as a leader in serving family offices, private businesses and high-net-worth individuals, says his office often advises clients who don't have a business plan for their tangible assets. “It is incredibly important for wealthy households to understand how to hold, report, title and insure their non-financial assets in estate planning.”

Challenges of managing tangible assets

Today’s investors have the opportunity 
to reap significant benefits – financially
 and aesthetically – by investing in
tangible assets, but these investments 
pose risks and challenges different from investment
 in traditional assets. Wealthy households and their advisers may cheer the rebounding market for art and other valuables, take comfort that they have diversified their investments and look forward to potential price appreciation in the future. However, those cheers could be premature if owners of non-financial assets fail to understand and properly address the critical issues facing these assets. Those issues include: value and authenticity, documentation, estate and tax planning 
as well as insurance; additionally, owners of tangible assets should embrace the new technology tools that dramatically improve the management of tangible wealth.

Value and Authenticity

The market value of tangible assets can change, sometimes rapidly. In July 2013, a 1954 Mercedes-Benz sold for $30 million, the highest price ever paid for a car at an auction, shattering the previous record of $16.4 million set in 2011. Global sales of wine, diamonds and precious gems have also been increasing, often to record levels. In December 2012, Sotheby’s recorded its highest one-day jewelry sales in the Americas, selling $64.8 million of high-carat diamonds and precious gems. The Live-ex Fine Wine 50 Index reached 106 in April 2013, up 5.3% in the first half of 2013. Over a 10-year period, prices for gold more than quadrupled, only to retreat more recently.

The market for fine art is especially robust. In 2012, Christie’s auction sales totaled more than $6 billion, a 10% increase from 2011. In May 2013, Christie’s reported $640 million of sales in its Post War and Contemporary department in one week, setting an auction record for any individual category.

Dramatic shifts in the market present challenges as well 
as opportunities for investors in tangible assets. “Today’s market is both global and complex,” Varney says. “Modern and contemporary art have made all the headlines, for that is where the greatest demand is today; but by next year the market could be turned upside-down, as happened in the fall of 2008 amid the global financial crisis.

Alan Fausel, vice president and director of the Fine Art Department in the New York office of Bonhams, a London-based auction house, cites the rapidly changing market as a serious issue for investors. “There is a huge risk and reward in today’s market because so many investors are entering uncharted territory. Today’s contemporary market has seen so much volatility and so much uncertainty with newly famous artists, that investors are especially challenged to understand the true value of the works they own.”

Protecting investments in art, jewelry, antiques or wine begins with an appraisal. Smart investors should perform their due diligence to select appraisers with specific expertise in the genre of their assets. “An accurate appraisal is the foundation for every decision 
an investor will make regarding his or her tangible assets,” says Anita Heriot, Philadelphia-based president of Pall Mall Advisors, a U.S. and U.K. art appraisal firm. Before donating, selling, insuring or placing valuable items in a succession plan, investors must know how much everything is worth. “Wealthy individuals must understand that the values of their tangible assets have changed, and these values will continue to change over time,” Heriot says. “Without understanding the value of their property, people cannot even begin to make correct decisions.”

Heriot observes that wealthy individuals sometimes drastically undervalue their tangible assets. She recalls one family that was tracking assets based on appraisals from 1983, with nearly 30 years between consultations. The collection was originally valued at about $2 million, but, after an updated appraisal, the
 fair market value was nearly $100 million. “There were paintings of incredible value hanging on only one nail, including a Rothko with an insurance value of at least $70 million. Had this family known what their property was worth, they certainly would have taken better care
 of it.” An appraisal from a qualified professional can
 also minimize other risks, as well as provide guidance regarding potential fakes and forgeries. In addition, an appraisal can identify other issues that could affect the value of the item or the right to ownership. These include the sale of items made from protected species, protected antiquities or stolen works.

Documentation

All too often, high-net-worth individuals and families find the process of documenting, tracking and managing
the contents of their home, including fine furniture and other valuable items, to be onerous. Proper documentation of personal property typically involves photo or video records, storage of purchase receipts and, in the case of highly valuable items, expert appraisals, proofs of title and provenance and records of any restoration work. Moreover, values need to be regularly updated, sometimes on both a depreciated-value and replacement-cost basis.

“Families rarely keep accurate records of their tangible assets because, quite frankly, it can be a lot of work,” says Jarrett Bostwick, wealth transfer and estate planning specialist at Handler Thayer, the Chicago law firm.

“If someone buys two pieces of art, a piece of jewelry, two watches and a diamond pendant for his wife, then they have to sit down and put a schedule together, contact the insurance company and have them come in and have them ask you a whole bunch of questions, which is kind of a pain. Rarely do our clients partake in this kind of rigor.”

If documentation is done at all, it tends to be completed inadequately and infrequently. ACE Private Risk Services and Trōv have been collaborating on a program in which specialists have examined the contents of more than 3,000 homes of high-net-worth families. In this Home Contents Valuation program, ACE risk consultants used Trōv technology to provide the industry’s first customized estimates of the value of a home’s contents at policy inception. Nearly 50% of the homes evaluated did not have enough insurance to cover their contents, and the average amount of underinsurance exceeded $415,000 per home. Condominium homes were particularly at risk. Nearly 80% had inadequate contents coverage. Among homes warranting an increase in contents coverage, those with a structural value of $2 million to $3 million had an average shortfall of $417,000 in contents coverage; those with a structural value of $5 million to $7.5 million had an average shortfall of $852,000. Furthermore, many valuable items were only protected by general contents coverage in the homeowner policy, when they should have been listed as scheduled items in a valuables policy.

The lack of proper documentation of a family’s tangible assets can lead to wide-ranging problems. “You have to know what you have in order to be worried about it, and to take steps to avoid losing it,” says Joy Berus, attorney at Berus Law Group in Newport Beach, Calif., a specialist in tangible asset protection. “If a family doesn’t have an updated inventory of their valuable possessions, they leave themselves vulnerable to taxes that could have been planned for and reduced, discrepancies, risk of serious financial loss and the inability to pass down their assets to the next generation with a step up in basis. Proper documentation of a household’s tangible assets is the first step in identifying a family’s tangible wealth, and can make the difference between security and paralysis.”

The magnitude of the potential issue is evident in one statistic: Over the next
 30 years, as much as $27 trillion of 
family wealth will be transferred from 
Baby Boomers to their children and grandchildren. That inheritance will include a great deal of tangible assets that will need to be documented, appraised, accounted for and protected.

Wealth managers often encounter situations in which a client dies and the family or trustee does not know where all of the valuables are. “These issues don’t usually come up until a client passes and you have to collect all of the assets and figure out what’s there,” says one wealth manager who works with high-net-worth clients. “Tangible assets aren’t addressed enough in the typical conversations between wealth managers and their clients.”

Handler, the attorney, points to a noted photographer who was living in a retirement home. 
He kept with him a large collection of negatives of images of leaders, celebrities and historical events.
The photographer suffered from dementia, and over
 the years most of the collection slowly disappeared. “Unfortunately, the family did not have a record of everything and didn’t know who took the photographs,” Handler recalls. “We found some of the items on the black market on websites. But the vast majority is never going to see the light of day.”

Berus recalls working with professional athletes and asking if their wealth advisers asked them if they possessed sports memorabilia. “Every one of them said the same thing, ‘Nobody has ever asked before.’ One retired football player talked about how he lost the majority of his lifetime collection because it had been in a fire, and it wasn’t insured. He couldn’t prove what he had and had a major loss because of it.”

Berus adds, “When people don’t know what they have, they can lose money and be taken advantage of by people who do know what they have. You don’t want to lose the value of what you own or be taken advantage of. You also don’t want to cause tax problems for yourself or pay unnecessary taxes. When you know what you have and know what it is really worth, you can make better decisions.”

Loss Prevention

By definition, tangible assets are subject to risks of physical damage, theft and the ravages of time. Yet experts say that high-net-worth families often neglect
 to take steps to protect their art, jewelry, wine and other valuables from these threats. One ACE study, for example, found that 40% of wealthy individuals surveyed failed to take advantage of the services of a risk consultant who could help them reduce the risk of damage and theft.

Collectors do not always realize the risk-prevention measures available to them to help guard against, 
and minimize, exposures, says Heather Becker,
 chief executive officer of the Conservation Center, a Chicago-based provider of conservation services for fine art, textiles, photography and sculptures. “No one wants to think a significant loss will happen to them.”

Many families display or store their precious possessions in ways that increase the risk of loss. For instance, they hang artwork above an active fireplace, where the hot, dry air and soot accelerates deterioration. They neglect to place a historical artifact, such as a letter written by a famous figure, in an archival box protected by anti-ultraviolet protective glass, exposing the artifact to dangerous rays and fumes.
 Or they store a valuable stamp collection in a closet beneath a bathroom. If the tub overflows or the toilet develops a leak, the stamps could be ruined. “So many people forget that these assets – art, wine, gems – are very fragile,” Varney says. “Valuable assets can go from $1 million in value to $0 in the blink of an eye.” Investors who fail to properly address these threats remain vulnerable to severe financial loss.

Even items made of strong, durable materials can be
ar risk. Becker recalls the story of an ancient metal sculpture, which its owner stored in a warehouse for several years while not on display. While the owner made sure the sculpture was stored in a protective crate, the crate was stored on its side, instead of standing up. “The sculpture was severely warped and sustained considerable damage,” Becker says. “There is a cumulative effect to these risks that individuals must account for.”

Insurance

Given the increasing value of rare art, precious gems and fine wine, and the array of physical threats and other financial exposures confronting these pieces, proper insurance represents a critical part of a complete wealth-protection plan. Often the best place for families and their wealth advisers to start addressing this need is with an insurance broker or independent agent who specializes in serving families with emerging or established wealth. These insurance advisers, who can be recognized by their access to specialty insurance carriers, can usually suggest and coordinate services from a variety of experts.

While investors of tangible assets may go to great lengths to acquire the items they desire, they frequently fail to adequately protect them. In a 2012 ACE survey, fully 86% of insurance agents said the families who insure their homes and possessions with mass-market insurance companies likely carry too little insurance for their treasured items. One in three wealthy families was updating the market value of their collections every three years.

“Waiting three years or more mean their valuations will be wildly out of date,” says Fausel of Bonhams.

ACE Private Risk Services and Trōv analyzed 94 valuables schedules to compare stated replacement values with current market values. For the 48 schedules of fine art assets, comprising 1,722 objects, 665 objects were potentially underinsured. For the 46 jewelry schedules, one in four objects was potentially underinsured. Moreover, 32% of all the analyzed items had descriptions that were too vague or incomplete to allow for an accurate valuation. If a loss were to occur, this could lead to a dispute.

Emerging technology

For individuals and families with substantial tangible assets, new technology tools exist to make tracking, analyzing and sharing information about their assets significantly easier and more efficient. Pall Mall’s Heriot sees high demand for these tools: “As tangible assets become more valuable and wealthy families become more invested in their personal property, we see clients begging for a better understanding of what they own and greater knowledge of what it’s all worth.” The goal for wealth advisers and their clients should be to make tracking and analyzing information about personal property regular, everyday actions rather than infrequent behaviors.

Progress is promising. ACE Private Risk Services offers clients access to its Home Contents Valuation service, providing guidance regarding general contents coverage at policy inception–at the moment, coverage for personal property, a home’s contents, is typically assigned based on a percentage of the home’s structural value or it is a guess. Trōv has developed technology, partnerships and applications to tame the unruly mass of data about every tangible asset in its members’ lives. The core of the
 Trōv platform is a private, online digital locker where the information about property and possessions is collected and securely managed (called a Trōv, like treasure trove). Because most of Trōv users’ important personal property is located in their private spaces, Trōv is training appraisers and insurance risk managers to use its Trōv Collect application when they are in their clients’ homes. With the acquired information, a Trōv is activated – and with it a complete knowledge of what each family owns, where it’s located and what it’s worth. Acquisitions can be automatically added to a personal Trōv at retail point-of-sale, via electronic receipts and through a mobile application. The Trōv Mobile app enables members to snap a picture of any acquired item, add any support information, such as a receipt, package art, bar-code or QR-code, and send it to their Trōv in real time. As purchases are added, and as values change within the Trōv, the member can choose to have his or her advisers automatically notified to ensure the items are always accounted for and adequately protected.

Vision of the future

The future of wealth management encompasses an understanding of a client’s tangible assets as well as financial assets, completing the picture of total 
net worth. By using a continually updated inventory
 of personal property, families can manage risk on a real-time basis, applying effective loss-prevention techniques, securing the proper amounts of high-quality insurance coverage and anticipating tax and estate-planning issues. Insurance companies such as ACE will be able to recommend safety measures and introduce coverage rates that are increasingly fair, accurate and economical. Private bankers, estate planning attorneys and family offices will develop deeper relationships with their clients and referral networks. Wealth advisers will be able to expand the perspective they offer to clients and engage other appropriate professionals, such as insurance brokers, on a more timely and routine basis. Advisers who provide clients with a full-circle view of their assets will be well-positioned to gain a competitive advantage.

Cloud services, such as those provided by Trōv, will even enhance enjoyment of prized possessions. With a few simple strokes on a mobile device, an owner will be able to find like-minded collectors. Buying, selling and sharing will become a dynamic experience, and, because it will be easy to track the history of an object, every possession with have a story built into it. 

Conclusion

Demand for tangible assets of art, wine, jewelry and other collectibles is on the upswing, and auction sales across the globe continue to skyrocket. As these tangible assets are increasingly recognized as means of investment diversification, wealth advisers are challenged to provide a full-circle, comprehensive view of a client’s entire portfolio. Fortunately, new technology tools are meeting these ever-expanding demands. Mobile and cloud technology services improve the tracking, management and valuation of tangible assets, providing families and their advisers with greater awareness. Furthermore, these tools enable families to secure comprehensive insurance coverage and loss-prevention services, assess investment risk across both financial and tangible assets and more effectively anticipate tax and estate-planning issues. In today’s digital age, an analysis of any high-net-worth individual’s assets must include these tangible assets to complete the picture of total wealth management.

For the white paper on which this article was based, click here

What Is The Difference Between Intrinsic Value And Market Value Of Insurance Agencies?

I have been valuing insurance agencies for a long time. I have been valuing them using both the Intrinsic Value and Market Value methods most of the time. For anyone interested in reading a brilliant description of these two methods, I suggest reading the article, “Musings on Markets” (September 7, 2011), by Professor Aswath Damodaran of the NYU Stern School of Business.

Intrinsic value is usually determined using one of several versions of the discounted cash flows method (the exact definition of cash flow varies, but all are intrinsic). This method states a firm's value is determined by the firm's future expected cash flow, discounted for time and risk.

In theory, market value also emphasizes cash flow. However, my experience is that most practitioners, especially when applied by agency owners but also some consultants, so inadequately account for cash flow and the risk that something will go wrong so that for all practical purposes, cash flows are disregarded. This makes market value agency appraisals purely speculative. Sometimes the result is an under valuation. More often the result is a value exceeding reasonability. Sometimes market value and intrinsic value are materially the same. After all, a broken clock is correct twice a day and 730 times a year. Most people would say being right 730 times a year is an awesome record.

A good example is the real estate boom and bust. The intrinsic value of the real estate never supported the market value. Many analysts and promoters became quite innovative in their development of “intrinsic” metrics that supported the market values, but the basic cash flow never supported the market value. The real estate investment only made sense if one could flip the investment at an adequately higher price before the market crashed.

The same force occurred in the market for insurance agencies. Very few agencies have an intrinsic value exceeding two times today or five years ago or ten years ago. If a business appraiser or a business broker sees someone who wants to believe an agency is worth more, the list of rationalizations, justifications, fictitious economies of scale, insightful product diversification strategies, and capital plays (interesting since capital is arguably free in some forms today) are infinite. If someone shoots holes in all these arguments, then ultimately the business broker will play their ultimate card: “We're so much smarter that we can make this work.”

The fact is the intrinsic value did not justify the price paid by many agency buyers five years ago. The strategies that caused the buyers to believe the values were justified were mirages of wishful thinking. The market was overheated and for whatever reasons, if buyers wanted to be in it, they had to pay a high price. There is and was nothing else to it.

The fascinating difference between intrinsic and market value for insurance agencies is that the intrinsic value should remain in a rather narrow band because:

1. Profitability in a well-managed agency is stable. By well-managed, I am excluding firms that are 100% or more dependent upon contingencies for their profits. In these agencies, profitability will vary wildly depending on their contingencies. Otherwise, expenses do not vary much year-to-year in well-managed agencies and therefore, profitability is stable.

2. Sustainable growth is humble. When you read about an agency growing 10% to 25% annually, ask, “How many annuals?” In other words, how long have they truly achieved such significant growth? Also, what risks are they taking? The Property & Casualty industry grows at approximately the same rate as the U.S. economy because the Property & Casualty industry insures America's economy. That rate is approximately 3% annually.

The Property & Casualty industry is not a growth industry and it has not been one for decades. To pretend otherwise is like an older model choosing the right makeup, the right lighting, and the optimum angle to look ten years younger. In fact, the evidence is strong that firms who grow multiple times faster than average have a higher than normal probability of cheating. Often the cheating is not malevolent, but it is still cheating.

3. Risk is comparatively moderate. The insurance agency business is one of the least risky businesses. It may feel risky, but compared to most other businesses, it is quite safe.

These three factors combine to create periodic value fluctuations, but within a rather narrow band on an intrinsic basis. This is why owning an agency is a great business in tough times while maybe less appealing in great times. So why is the fluctuation so much more on a market value basis? Speculators. The speculators may be banks, brokers, private equity, other agencies, but they are speculating. This creates some issues because speculators use market value plus twenty percent or so for their values. They have a tendency to build price without adequate regard for supporting cash flow or risk. This is why a boom takes years to build and the resulting bust can take just a few weeks.

The fact that speculators pay too little attention to cash flow and risk has two significant consequences. The first is that speculators value good agencies and bad agencies too similarly. The result is they pay too much for bad agencies and sometimes fail to purchase the best agencies because they're not willing to pay an adequate premium for quality. Now, some really smart speculators have learned that certain kinds of supposedly bad agencies do not actually have post acquisition bad results. One should not confuse these two situations.

The second consequence is when inadequate attention is paid to cash flow and risk upon acquisition, speculators eventually cannot or do not pay enough attention to building the people and systems necessary for organic growth. This is readily apparent in some brokers' results today.

Whether you should or should not emphasize market value over intrinsic value depends on your position and the market cycle. As a seller in good times, the market value will usually be your best deal because this industry has blessed sellers with an infinite supply of irrational buyers. Their numbers grow and constrict with the seasons, but rarely are they in short supply for long. The only exception to this is the really good agency. A market value may rarely adequately capture the true value of these agencies' cash flows and risk. Internal perpetuation is almost always the best course for maximizing their value.

If you are a buyer, a brutally honest intrinsic valuation is the best way to manage your risk. Market value should be entirely secondary. Always remember that no acquisition is better than a bad acquisition and since roughly every study ever done shows that 75% of acquisitions are failures when truly tested, this rule is worth cementing in your brain. The exception is that if the buyer has such a bad situation that a bad acquisition can hide their current dilemma, then maybe make the bad acquisition.