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Winning small: insurers that pressure agencies to increase their books of business may be initiating their own demise.

Most insurance carriers work with agencies with books of vastly different sizes. How does book size affect the insurer? Does a carrier's profit margin vary for an agency with a $500,000 premium book vs. an agency with a $4 million premium book?

Experience working with insurance carriers and consulting for insurance agencies suggests that larger agencies get more compensation as a percentage of written premium. The reason for the discrepancy is larger agencies should qualify for more companies' contingencies because they can meet the ever-rising minimum-volume thresholds. Additionally, larger agencies receive bigger contingencies because they qualify for the better contingency contracts and sometimes simply because they have more volume. The result is that agencies with smaller books make less regardless of their book's profitability, raising the possibility some smaller books are actually more profitable than larger books. As a result, if a company does not gain cost savings from agencies with large books, its profit margin will decrease as average premium per agency increases.

Some agencies with larger books (not necessarily larger agencies, but large books with a particular company) use their size not only to get more compensation but also to push through risks that should not be written. Companies also give these agencies more time, sometimes decades, to improve their loss ratios. The result is companies pay more for worse results. Not exactly the best business strategy.

These are the effects of negotiating leverage. Agencies with larger books have the ability to force companies to reduce their profits through higher expenses and/or higher losses. Although forcing a company to reduce its profits is not usually the agency's goal--which would be self-defeating--it is often the result of an agency's demand for greater compensation and more liberal underwriting.

Get-Big-Quick Schemes

The larger the book, the more leverage flows to the agency. This situation is going to get worse and worse for companies. Private equity firms, investment bankers and huge consulting firms regularly seek help from agency consultants about how to build a large agency/brokerage quickly so they can negotiate better deals with companies. They rarely care about building stronger agencies, faster growth or better productivity. Their entire business model consists of building an agency/brokerage big enough to squeeze companies for more money.

One company is already so used to being pressured it has a written script for dealing with the negotiations. This might work when dealing with five to 10 large agencies/brokers, but how about 25 or 50 or more, especially with big agency/broker chief executives playing much harder ball than smaller agents of the past? The situation is exacerbated when a company has pushed for larger books and has very few small agents upon which to shift dependence. Some shops are getting big enough to start their own insurance companies if they desire. What then is the insurance company's role? What power does the company have?

Key agents of an insurer already in this situation have said that if the carrier raises rates, they will move all their business, leaving the company destitute. The carrier must raise rates to maintain its rating--it truly is stuck between a rock and a hard place.

The most interesting aspect of this situation is companies are pushing for their own demise. Companies are intensely, and even harshly, demanding bigger books of business from their agents. For some agents, the only recourse is to sell to a larger entity. Agencies can only get so big. This is a very mature market. Every time a sale occurs, the market consolidates and companies lose a little more leverage.

A Winning Strategy

By implementing an alternative distribution/growth strategy, companies do have a better solution. Thanks to technology, a company can service an agency with a $500,000 book almost as profitably as a $4 million book and they do not lose pricing power. While the company's base expense ratio might be slightly higher, the commission expense should more than offset it. If the smaller book is not due to adverse selection and the company is one of the agency's top three carriers, the company will be under less pressure to make underwriting exceptions and therefore achieve lower loss ratios. Regaining pricing power will more than make up any small increase in operational expense.

Health and life companies are using this strategy successfully already. Property/casualty companies have an opportunity to reverse this decades-long slide of giving up more and more negotiating leverage.

Analysis of insurance company results shows that those companies retaining the most negotiating leverage with their agents are most successful. The correlation is almost perfect. They are growing quickly, their profits are strong and they are stable companies. On the other hand, many of the companies that are recently pushing up daisies are those that lost the most negotiating leverage through the years. They simply needed the business too much to do business on their terms.

Negotiating leverage is a wonderful, powerful and very profitable characteristic that all companies should aspire to possess. Corporate America is discovering this today in the harsh world of not being able to raise prices. Insurance companies are going to great lengths to give away a valuable tool. Why are so many insurance companies planting the seeds of their own demise? Companies interested in harvesting a brighter future are following a strategy that keeps them in control.

Chris Burand is president of Burand & Associates LLC, an insurance agency consulting firm.
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Title Annotation:Industry Strategies
Comment:Winning small: insurers that pressure agencies to increase their books of business may be initiating their own demise.(Industry Strategies)
Author:Burand, Chris
Publication:Best's Review
Geographic Code:1USA
Date:Jun 1, 2004
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