I am trying to value diversified insurance companies using market multiples. When you have the "amortization of deferred policy acquisition costs" for life insurers, should I treat it as a cash expense, not as a non-cash amortization charge it ostensibly is?
This issues arises becuz we're comparing health insurers vs. life insurers. Back in 1986, many health insurers also had life insurance exposure. So this supposedly noncash chrage (deferred policy acquisition cost amortization), which is predominantly broker commissions for the unearned premiums of acquired life insurance policies, gets added back and increases the EBITDA base. (I know that we should use equity multiples -- i.e., PTI or BV but we're forced to use EBITDA along with those).
My thinking here is that this item should be treated as an expense because this large non-cash item articially lowers the EBITDA trading multiples when treated as a noncash charge. Subtracing this amount from the EBITDA base makes the multiples to be much more reasonable. Also, doing so makes the EBITDA multiples (i.e., enterprise value to EBITDA) to be similar to the PTI multiples (i.e., MV to PTI). Have you ever normalized the EBITDA base for a mixed insurer with life insurance exposure this way?
EV = 80
EBITDA = 20
EBITDA multiple = 4x
Amortization of deferred policy acquisition costs = 10
EBITDA adjusted by treating this amortization as an expense = 20-10 = 10
Adjusted EBITDA multiple = 8x
Will normalizing this way eliminate the distortions caused by this noncash item? Thanks.