An agency's retention ratio shows a potential buyer what they can expect to retain when purchasing a book of business (assuming the level of customer service does not change). A higher ratio will lead to a higher valuation, and vice versa.
An agency's retention ratio will also be an indication of the level of customer service the agency is providing to its insureds as well as how the agency is gaining new clients. A very high ratio, such as 95% or above will be an indication that the agency is developing relationships with its clients, providing excellent customer service, and looking out for the client's best interest. A growing agency with a low retention, such as below 80%, is an indication the agency is simply growing by "buying" their clients and not providing the proper level of service. These agencies will have a much lower valuation than an agency of equal size that has a high retention.
Two other factors that will influence retention are the economy and the current status of the market. It is not uncommon to experience a much lower retention rate during a recession and a softening market. Therefore, these two factors are also considered when valuing an agency.
Let’s compare two agencies, both with $5 million in earned premium and assuming straight commission rate of 10%.
Agency “A” has 90% retention. For the purchaser to maintain the agency at its current size the buyer of this agency must write $500,000 in new premium business during their first year of ownership.
Agency “B” has 80% retention. The buyer must write $1 million in new premium business during the first year of ownership just to maintain the agency at its current size!
The demonstration above clearly shows the importance of maintaining a strong retention ratio and why it plays a big factor in determining the value of any insurance agency.