Expert Commentary

Assessing Insurance Customer Relationships

Intangible assets, such as customer relationships, trademarks, technology, and employees, can be key value drivers for an organization. Within the insurance industry, customer relationships can be a particularly critical component for success, especially in recent years with the uncertainty of the economy, and particularly the low interest rate environment, making it more difficult for insurers to generate significant revenue growth or profit margin expansion. By understanding how the value of such assets is quantified, we can gain greater insight into some of the key drivers that influence the value of the business as a whole.

Valuation of Insurance Organizations
November 2013

In this article, I present an updated overview of the conceptual framework, as presented originally in my May 2010 article, "The Value of Insurance Customer Relationships or Policies," widely utilized by valuation professionals for valuing customer-related intangible assets. Additionally, I provide some insight into a few real-world applications of this framework in valuing customer-related intangible assets.

Valuation Methodology

For the valuation of any intangible asset, there are three general approaches: the cost approach, the market approach, and the income approach.1 The cost approach is generally applicable when it is possible to collect all the costs associated with the development and maintenance of the subject customer relationships. This method is not commonly used in practice because it is difficult to track all of the costs associated with developing and maintaining customer relationships.2

The market approach involves the use of transactions of similar customer intangible assets as a basis for determining the value of the subject asset. However, more often than not, it is very difficult to find sufficient information regarding the price paid and financial statistics of the asset purchased.3

Accordingly, the most commonly used method for valuing customer-related intangible assets is the income approach. This method determines value by measuring the "present value of expected economic income to be generated from the customer relationship over the expected remaining useful life of that relationship."4 All of these methods can be used depending on the facts and circumstances surrounding the particular situation; however, here we focus on the income approach, which explicitly accounts for many of the key value drivers.

A form of the income approach often used in valuing customer-related intangible assets is the multi-period excess earnings (MPEE) method.5 Essentially, the MPEE method estimates revenues and, in turn, cash flows derived from the intangible asset and then deducts portions of the cash flow that can be attributed to supporting assets, such as a brand name or fixed assets, which contributed to the generation of the cash flows. These deductions are sometimes referred to as "supporting asset charges." The resulting cash flow, which is attributable solely to the subject intangible asset, is then discounted at a rate of return commensurate with the risk of the asset to calculate a present value. This valuation model is summarized in the following table:


Valuation Drivers

By analyzing how the framework above might be applied to the valuation of insurance customer relationships or policies/expirations, one can gain a greater understanding of which factors represent key value drivers for the asset. As an aside, this methodology can also be applied to an individual customer relationship or policy rather than a bundle of customer relationships, which is the focus of this article.

When applying the framework outlined in the table above, the starting point for estimating cash flows would be the stream of revenue, which can be in the form of either premiums or commissions depending on whether your perspective is from an insurer's or an agency's viewpoint. In the insurance industry, absent offsetting factors, revenues generally have a tendency to decline over time due to customer turnover, which is an ever-increasing problem within the insurance industry. According to J.D. Power and Associates' 2013 U.S. Insurance Shopping Study, of the 23 percent of customers who shopped for auto insurance in the past year, 45 percent switched insurers, which is the highest rate since the study began in 2008.6 This increase in active shoppers is due in part to the heightened availability of insurance pricing information through Web and mobile services as these channels make it easier to compare policies than ever before.7

In addition to impacting revenues, lost customers can also indirectly increase costs as it can cost 5 to 10 times more to acquire a new customer than retain an existing one.8 Unfortunately, with current turnover rates in the industry, studies show companies must add 17 percent of their customer base in additional customers every year to maintain existing volume.9 Given this trend, it is not difficult to understand why one recent study concluded that reducing customer attrition by 5 to 10 percent can increase annual profits by as much as 75 percent.10 Nationwide Insurance, for example, found that a 1 percent increase in customer retention increased annual premiums by $1 million.11 As such, it is clear that by raising customer retention rates, managers can enhance the value of their customer relationships and, in turn, their overall business. This same concept applies to other insurance lines.

Although price remains the biggest decision point customers consider when purchasing insurance,12 there can be many factors that influence customer buying decisions and, in turn, customer retention. Customer communication, for example, can lead to higher customer satisfaction and loyalty. According to a survey conducted by Deloitte, the vast majority of respondents said that the ability to interact with their insurers over multiple channels such as in person, over the phone, online websites, or smart phone applications is a critical factor when making policy decisions. The study also showed a generation gap within the channels preferred.

For example, the younger generations (ages 18–34) were twice as likely as the older generations to say they would change insurers to secure online services. The use of smartphone applications was much more important to them as well. Features that customers most commonly look for online include checking the status of a claim, obtaining information about products and services, and securing price quotes.13 Furthermore, advances in analytic tools and data allow companies to determine the appropriate methods for communication for different customers, as well as the right customers to focus on based on risk and profitability. The factors mentioned above can lead to higher customer satisfaction, which, in turn, can lead to renewal rates nine points higher on average, according to a study by Quality Planning.14

While the amount of future premiums or commissions is often one of the most substantial drivers of value, as outlined in the framework above, one must also consider the costs incurred in generating those revenues and furthering those value drivers discussed above. Claims tend to be the largest expense that will come from customers. However, these losses can be partially mitigated through diversification of the customer base.

For instance, a property and casualty insurance company might provide policies to companies in several geographic regions so as to reduce the risk of incurring significant catastrophe-related losses all at once. In addition to claims, salaries and commissions for sales employees should also be considered, especially in association with improving customer retention. To maintain customer satisfaction and sales levels, having the right talent is key as studies show that even a modest improvement in customer experience can strengthen customer loyalty.15 As a result, many executives plan to increase their focus on key talent management areas, including performance management, succession planning, and development and training,16 which could lead to higher expenses related to the workforce. However, by making investments in employees and agents, companies may actually be able to expand revenues and increase cash flow.

Additionally, marketing represents a large portion of expenses attributable to customers. Marketing has historically been disproportionately focused on acquiring new customers. Of this, most messages have focused on price; however, research shows that price-sensitive marketing messages induce customers to view policies as a commodity, which results in more frequent shopping and switching. Higher acquisition costs and lower retention rates for frequent shoppers make it that much more important to shift focus to retaining existing policyholders.17

Once revenue and costs, including any applicable taxes, have been considered, the next step in applying the framework above would be to deduct supporting asset charges. As mentioned previously, businesses employ a variety of tangible and intangible assets in their operations that work together to generate cash flows. To determine the value solely relating to the customer relationships, companies may need to allocate portions of the cash flow to the other assets that support the customer relationships. For insurance customers, this might include brand name, proprietary technology such as customer analytics or databases, or the assembled and trained workforce that is crucial to maintaining customers.

In furthering the improvement of customer retention and communication, according to a KPMG insurance executive survey, 64 percent of respondents planned to increase spending on information technology (IT), up from 49 percent in 2011. In particular, most respondents foresee their IT investment dollars going toward improving IT infrastructure, followed by customer growth or service initiatives, and data warehouses.18 While such initiatives may provide value creation for the firm as a whole, these investments yield additional deductions that should generally be taken if one is attempting to isolate the value of the relationships or policies themselves. Ultimately, the exercise of deducting supporting asset charges is conducted to address which assets of the business are responsible for the cash flows being generated.

Real-World Application

Is it the strength of the firm's relationships that yields cash flow for the firm, or is it something else? Answering this question is often a focal point of analyses that practitioners perform in real-world situations requiring the quantification of customer-related intangible assets. For example, in certain complex commercial litigation matters, financial experts may be retained by the legal teams involved to quantify aspects of customer relationships or policies in order to calculate economic damages or lost profits.

As an example, litigation disputes in the insurance industry can arise from circumstances in which sales personnel terminate their employment with the plaintiff's company and ultimately the plaintiff's clients become clients of a competing firm. In those situations, a plaintiff may claim, among other things, that the departing salespersons violated certain contractual obligations and/or fiduciary duties or misappropriated intellectual property. As a result, the legal team for the plaintiff may retain the services of a financial expert to apply generally accepted methodology, such as the framework discussed herein or variants thereof, to determine the economic damages incurred by the plaintiff as a result of the allegedly improper taking of customers. In such a situation, the financial expert may need to deduct economic charges (such as supporting asset charges) to apportion the component of the allegedly wrongfully taken cash flows attributable to the relationships or policies that were allegedly taken.

Another real-world example arises following a business combination, when it may be required by financial accounting standards that an acquirer recognize identifiable intangible assets resulting from the combination including, but not limited to, customer relationships, trademarks/trade names, and technology. In such a situation, customer relationships may need to be valued, using the framework discussed above, and recorded on the acquirer's balance sheet. Furthermore, there are instances in which companies engage in the sale of customer relationships/lists. A thorough understanding of the value of the assets being sold, as can be provided using the framework discussed herein, can provide critical information to both the buyer and the seller in negotiating such a transaction.


The valuation methodology discussed in this article provides managers with a tool for thinking about business issues from a valuation perspective. For instance, the MPEE model discussed above suggests that customer retention is a critical factor in the valuation equation. By thinking through the presented framework to discern the business's key value drivers, managers can develop strategies aimed at improving elements of their valuation equation to enhance the value of their company's customer-related intangible assets and the business as a whole.

1Robert F. Reilly and Robert P. Schweihs, Valuing Intangible Assets (New York: McGraw-Hill, 1999), 96.

2Robert F. Reilly and Robert P. Schweihs, Valuing Intangible Assets (New York: McGraw-Hill, 1999), 345.

3Robert F. Reilly and Robert P. Schweihs, Valuing Intangible Assets (New York: McGraw-Hill, 1999), 346.

4Robert F. Reilly and Robert P. Schweihs, Valuing Intangible Assets (New York: McGraw-Hill, 1999), 347.

5James R. Hitchner, Financial Valuation: Applications and Models, 2nd Ed. (New Jersey: John Wiley & Sons, Inc., 2006), 972–973.

6"2013 U.S. Insurance Shopping Study Results," J.D. Power and Associates.

7"Next Practices in Insurance: Driving Growth with Better Customer Engagement," Mainstay Salire, LLC (2012).

8Sam Friedman, "The Voice of the Personal Lines Consumer," Deloitte (2012).

9Raj Bhat and Mishra Sanjiv, "Advanced Analytics Can Improve Customer Retention," ISO Review (December 2009).

10"Next Practices in Insurance: Driving Growth with Better Customer Engagement," Mainstay Salire, LLC (2012).

11"Next Practices in Insurance: Driving Growth with Better Customer Engagement," Mainstay Salire, LLC (2012).

12Sam Friedman, "The Voice of the Personal Lines Consumer," Deloitte (2012).

13Sam Friedman, "The Voice of the Personal Lines Consumer," Deloitte (2012).

14Raj Bhat and Mishra Sanjiv, "Advanced Analytics Can Improve Customer Retention," ISO Review (December 2009).

15"Next Practices in Insurance: Driving Growth with Better Customer Engagement," Mainstay Salire, LLC (2012).

16"Insurance Industry Outlook Survey," KPMG (2012).

17"Beyond Price: The Rise of Customer-Centric Marketing in Insurance," McKinsey & Company (January 2013).

18"Insurance Industry Outlook Survey," KPMG (2012).

Opinions expressed in Expert Commentary articles are those of the author and are not necessarily held by the author's employer or IRMI. Expert Commentary articles and other IRMI Online content do not purport to provide legal, accounting, or other professional advice or opinion. If such advice is needed, consult with your attorney, accountant, or other qualified adviser.

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