If income goes down by 20% the only way to maintain the same percent profit at the bottom line is to cut 20% of expenses. The only way to maintain the same dollars at the bottom line is to cut more. It’s simple math.
There are essential things to consider in cutting expenses in an agency: payroll and everything else.
Early in May, Aon, Gallagher, and other large national insurance brokers announced compensation cuts for many classes of employees of 20% to as much as 50%. Their announced intentions were to avoid layoffs. These very large organizations employ their own economists and sophisticated financial forecasters and managers. Already operating at a high level in terms of managing all the income items I’ve mentioned they turned immediately to expense reductions and their first target was payroll.
Payroll expenses are typically 40% to 60% of a typical agency’s costs. So, there is no practical way to avoid considering payroll cuts if expense reductions are necessary to balance the books. There are two basic approaches to payroll cost-cutting. The first is to reduce the number of employees and the second is to reduce some, or all, employee’s compensation. The huge agencies hope payroll cuts will be enough. Of course, they already manage employee productivity at world-class levels. I’d suggest that most agencies would benefit from looking at reductions in force as the best solution to their cost issues.
In reviewing hundreds of agencies’ operations, I have noted that many operate with more people than they need for the income they have. In my own agency management days, I remember saying many times, regardless of staffing levels, that I’d never met a service person who wasn’t overworked. I recall when we first began to benchmark our operations and to staff accordingly what an amazing difference it made in our bottom line with no reduction in service quality and no increase in overtime.
Are you appropriately staffed? The best way to make that determination is to compare your income to other agencies in similar lines of business, of similar size in your part of the country. Two sources of benchmarking data are available. The first I recommend primarily for agencies with $1 million dollars of revenue and less is the “Growth and Performance Study” published by the National Alliance for Insurance Education and Research. The second study, which is particularly useful for larger agencies is the “Best Practices Study” produced by the Independent Insurance Agents and Brokers of American and Reagan Consulting.
When you benchmark your agency, start with spread.
Spread is the difference between Average Compensation Per Person (include all agency employees and contractors if any) and Average Revenue Per Person. If your spread isn’t at the average or better, you are staffed for growth!
If that’s your situation, you can dig into other metrics like Average Commission per CSR, Average Commission Per Producer, and so on. If you’re not average or better, you likely have some management decisions to make.
After benchmarking spread and service staff look at producer compensation. What you’ll see is that personal lines producer compensation averages under 25% and commercial lines producer compensation averages under 35%. If your compensation is higher you’ll need to ask yourself if your producers can afford that much luxury in a time of COVID.
Another metric to look at closely is the average book size of producers compared to your own. One thing larger agencies do really well is follow Henry Ford’s wisdom about the separation of duties. Producers in larger agencies don’t do any service at all--the spend their time selling insurance. They also have larger books of business than in smaller agencies (and they typically produce more new business each year as well). This is one reason those agencies have a lower commission rate typically than smaller agencies. Producers cost more than service people. This is key to think about as you think about appropriate staffing, appropriate compensation, and how to maintain profitability (or survive) over the next couple of years.
After payroll, the expense controls that the typical agency can put in place are fairly minimal in their potential impact. But I recommend going through the exercise. Begin by looking at every item in your expense ledger and asking, “does it help make the boat go faster?”. In other words, does it contribute to new business growth or increased retention? If it doesn’t is it absolutely required to be in business (i.e. E&O insurance, agency management system, etc.)? If you can’t answer yes to one of those questions you have a management opportunity.
If you’ve stuck with me this far let me offer you a word of encouragement. I believe that the next few years offer huge opportunities to the agencies who are focused on operational excellence and aggressive marketing for new business. Many agencies won’t do the hard work that is going to be required. Those that are willing to focus on client retention, new business selling, and best in class expense management can grow both their top and bottom lines. Those that aren’t willing to do the work will languish or perhaps sell (but their rewards for selling are going to be dramatically less as I will detail in a future blog). Some will die.
Which kind of agency will you run?