Introduction

The Future of Independent Insurance Agencies after COVID-19

As I write this, the nation and world are beginning to “reopen”. And as all of us move into the future, we all realize that it won’t be the same as the past. Even if the pandemic ended tomorrow, which it won’t, the follow-on economic impacts to the insurance industry will be felt for at least the next two years even in the most optimistic analysis.

While insurance agencies have fared well through the first two months of the pandemic, there will be significant impacts on operations and income in the coming months. Commercially focused agents have already begun to see premium reductions for some renewals, but no agencies have yet begun to really feel the financial impacts to come. 

That is good news for agency owners and leadership teams because it gives them time to prepare. The real stroke of luck for many is that this crisis developed during a period when many agencies were receiving annual profit-sharing checks and PPP loans.

Tony Caldwell

Over the next few months, those kinds of positives will be gone, and we will be faced with significant income reductions. These reductions will be felt in different ways, and in various degrees of seriousness, depending on the type of business an individual agency writes.

Regardless of whether an agency focuses on personal insurance, business insurance, or a combination, this is where most reductions will come from:

  • Policy cancellations

  • Policy coverage reductions 

  • Lower premium renewals 

  • Return premium on audit

  • Lower or no profit-sharing next year

In addition to these certain results, agencies are likely to see other income challenges like lower commissions, contract terminations, and other reductions to agents, as insurance carriers deal with their own shrinking top and bottom lines.

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We will discuss each of these in detail later along with agency strategies to reduce their impact or use them as foils for operational improvement. First, let’s look briefly at why these things are unavoidable.

The Unavoidable

Unemployment

As of mid-May 2020 the “true” unemployment rate in the U.S. was approaching 25%. This comes from:

  • The 14.7% reported rate, plus 
  • Unemployed workers who had not yet filed for unemployment insurance, plus
  • Unemployed persons who had “given up” looking for work.

This is the highest rate of unemployment in 85 years.

But as awful as that rate of unemployment is it still doesn’t tell the whole story.

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Payroll Protection Plan

In March, Congress passed the Payroll Protection Plan, providing forgivable loans to businesses with under 500 employees - the typical business client of an independent agency.

These loan proceeds kept as many as 30 million people employed according to Stephen Moore, an advisor on the president’s task force to reopen the economy. Those loan payments will be used up in August, according to the latest news. How many of those “saved” jobs will disappear then?

Not all of them, surely, but many.

Of course, the economy may be in full scale “reopening” mode by then. Right?

Insurance agents know that many businesses don’t reopen after a serious property loss – even when insured for business income (which no one is in the current crisis). There will be businesses that don’t reopen. Jobs associated with those closed businesses won’t create liability or workers’ compensation premiums. Many will reopen and then fail, taking with them jobs, payroll, and premium.

Resuming "Normal" Operations

Of those that open many will not see normal operations and sales for many months. Restaurants, for example, can only seat one third to one half the number of diners that they did formally.

With scientists advising that the virus is likely to be with us a couple of years, or longer, how long will social distancing – and reduced restaurant capacities be with us?

In addition, it is very clear from consumer polling data that people will be slow to return to their normal patronage levels. Also, many people, with reduced incomes will be less able to afford restaurants. There will also be some who don’t go back to their previous habits because they’ve learned to enjoy home cooking. How many restaurants (with razor-thin margins in normal times) can survive with such reduced sales?

Practically every kind of business faces unique challenges to their survival.

At the bottom of all of this is the fact that unemployment is going to remain high for a lot longer than any of us would like. That means lower payrolls, lower premiums, and lower commission. Lower payrolls also mean lower sales activity for virtually all businesses, which in turn means lower premiums. 

Finally, in an economy where economic activity is about 70% consumer-driven, it is clear we will have a long road to recovery and to increasing insurance premiums.

The foregoing should give any insurance professional pause to think about the future of agency income from commercial lines. It should also give one a lot to think about in terms of personal insurance. It is true that homeowners must have insurance, but there are going to be fewer homeowners in the next couple of years. As people experience dragging unemployment, and the current foreclosure moratorium ends, people will, unfortunately, lose their homes. That will lower agency income.

While it isn’t clear yet to what degree virtual work will continue when the economy fully reopens, it is clear that some virtual work will continue. It also seems obvious that personal travel will be reduced both out of fear, but also out of economic necessity, for some time. This all represents an auto-exposure decrease which will result in lower premiums and commissions.

Smaller Personal Budgets

As consumers face continued economic stress, and uncertainty reigns universally, they will naturally seek to reduce their personal expenses. I think it's reasonable to assume they will cut insurance coverage and premium where they can. 

This means lower commissions for agents. There will also likely be a slowdown in the making of major life decisions for some period of time. This means fewer trade-up home and auto buyers and perhaps a delay in things like marriage and having children. These all have negative implications for premium and commission.

Questionable Profit Sharing

So, as you see, there are a lot of things that will drive cancellations and reduction of insurance. The last item of income reduction I see coming is profit-sharing. Profit-sharing is typically paid to agents who have a large enough book to qualify, based on a loss ratio under 55 to 56%. Many profit-sharing agreements also require either positive premium growth or at least no negative growth to qualify. All three of these things are problematic for profit-sharing income in 2021 and 2022 at least. 

As premiums decrease, liability exposure will also decrease, so I expect that loss ratios on casualty business may be relatively unimpacted by COVID. However, property losses due to weather should not change. Yet, profit sharing is based on loss ratio on the whole book of business. With agencies in many parts of the country usually experiencing loss ratios in the high 40% to mid-50% range in typical years, it is very likely that the reduced premium will result in non-qualification for profit sharing based on loss ratio.

It is hard to see where most agencies will be able to avoid negative premium growth in some or all of their books of business. Even if loss ratios are in the money, the negative premium retention will disqualify them. 

For smaller agencies, in particular, maintaining the required minimum volumes to receive profit sharing is clearly going to get more difficult over the next couple of years.

Even if an agency manages to avoid the negative growth of premium risk, maintain an acceptable loss ratio, and keeps premium above the required thresholds to actually receive profit-sharing, it will undoubtedly be less than in prior years. This is because virtually all profit-sharing systems have a gridded payment scheme where the percent payment goes up when volume goes up and the loss ratio goes down. 

It is going to be very hard for most agencies to make as much money in the next couple of years on profit sharing as in the past. Since this income item represents most or all of a typical agency’s profit (according to the Growth & Performance Standards and the Best Agency Study,) this alone is a serious issue.

So, What Next?

To summarize, virtually all agencies face significant challenges in maintaining income over the next few quarters. In turn, this presents profound problems for maintaining profitability and agency value. This brings us to the questions:

  • Is it hopeless?

  • What can we do about it?

In answer to the first question, I would have to say it may be hopeless for some agencies. If agencies don’t take the right actions to minimize the damage, they face very uncertain futures. If an agency is unlucky enough to have most of its business in the oil and gas, restaurant, hospitality, or travel-related business segments, survival may be a tough proposition. 

Assuming your agency is either focused on personal lines or commercial lines, with a fairly broad book of business, the situation is far from hopeless. But it does demand action and you cannot hope to operate as you have in the recent past.

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Communicate with Customers

The first thing every agent should do to minimize their downside (and maybe create some new opportunities!) is to communicate with every client. By communicate, I mean talk to them. You need to clearly understand each client’s needs, fears, and prospects. This is the only way to accurately gauge your own risk. More importantly, it is the beginning of the most serious attracting and retaining effort you have ever made.

Focus on Retention

Retention is more important now than it has ever been. Simply put, you cannot afford to lose any clients and still stay in business. Customer relationships have never been more important: they need to know that you’re looking out for them and that you care about them. This isn’t the time to try to do that with an email or newsletter you hope they read. You must talk to them. Ask them questions. Encourage them. Serve them.

Graphic - Retention

The very best agencies in America have a 95% retention rate. The average agency’s retention rate is 85%, according to the Best Practices Study. If you’re typically losing 15% of your business, and then lose 5% to 10% in profit sharing, and then lose premiums of 10-20% due to cancellations and lower renewals, and then lose some to audit refunds... can you stand that?

That’s the challenge. Start with retention. Make it your goal to not lose a single client. You won’t be perfect, but you’ll be better. And that may be enough. 

As you think about retention, remember the economic stress every business and every individual is under. They will all want to reduce expenses. If you want to keep your business during this time you must remarket every policy. As an agent, channel how your customers feel right now, and cater to that: you must do all you can to assure your clients that their premiums are as low as they can be.

Increased Rates

One other thing that is going to aggravate the situation (for you and your clients) is that insurance companies will continue to raise rates. In the last several years, personal and commercial auto rates have risen dramatically, but not fast enough to outpace losses. Even though people are currently driving less, which is reducing frequency, severity is rising even faster. Auto rates are going to continue to rise.

We were already entering a hardening commercial property market as the pandemic began. The fundamentals here haven’t changed. Property rates are going up. In addition, the economic climate will also drive an increase in the moral hazard, which will have an impact on casualty rates. When rates go up while personal and business income are under stress, consumers have a hard time understanding. Agents need to respond by educating, but mostly by remarketing. 

If you don’t remarket voluntarily, your clients will demand that you do; or what is more likely, they will have someone else do it. Every policy is going to be on the street, and you must play aggressive defense or you will lose.

The corollary to the need to focus on retention is the opportunity for new business. Remembering that every policy is going to be on the street, there has never been a better time to go after new business than the next two years.

Aggressive New Business Programs

Most agencies aren’t focused on growth: they sell enough to cover retention losses and perhaps grow a few percentage points per year. Agencies like these must adapt or they will find their business picked over like carrion. 

If you don’t have an aggressive new business program, now is the time to build one; the biggest advantage for the aggressive agent is that many of their competitors will be at home with the sheets pulled over their heads (at least figuratively).

Leverage Technology to Expand Your Geographic Market

One massive shift in opportunities that COVID-19 has created for the aggressive agent is that now, geography no longer matters. Up until now, it has been difficult for many agents to build significant books of business outside their home communities or state. With the virtually universal adoption of Zoom™ and similar communications technologies, along with people flooding onto social media in unprecedented numbers, it is now possible to build significant books of business at any distance from your physical location. You now have virtually unlimited access to meet with people anywhere in the world - use it to your best advantage.

Management tools like Slack™ and Microsoft Teams™ make it a simple matter to manage remote employees, especially producers. In the next few years, aggressive agents will be building new books of business, focused on niche marketing across far broader geographies, than ever before. Their success will be enabled by the massive behavior shifts of businesses and consumers as a result of COVID-19.

Generate New Business from Existing Customers

Another opportunity for new business (which will also improve retention) is to sell more business to existing customers. While it is only a personal insurance comparison it is still pitiful: the average independent agent sells 1.6 policies per customer to the average captive agent’s 3 policies per customer. Whether you’re in personal or commercial lines be sure to sell every client every policy they buy (it will be easier to do than ever before).

Life Insurance Window

One last new business opportunity to consider focusing on is life insurance. Every human being old enough to contract has a better understanding of the value of life insurance than they did three months ago. Life insurance sales results are up as a result of this. Every agent can benefit, and the additional money has never been more important.

Maximize Commissions with Carrier and Book Management

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The final strategic pivot (with respect to income) that agency owners and managers need to focus on is carrier and book management. It is typical to see average agencies representing twice as many carriers as the Best Practices’ most profitable cohort of agencies, for any given size of agency. The measurable difference between average and “best” is seen in bottom-line profit. When the top line is as challenged as agencies’ top lines are going to be this merits attention.

The Best Practices agencies focus on putting their eggs in fewer baskets. This maximizes commission income because these agencies avoid placing business with carriers who don’t pay top commissions. Where a typical agency allows hundreds of thousands, or millions, of dollars to go to carriers whose employees all dress in white, the most profitable agencies don’t. The difference between a 15% commission and 10% commission has never been as important as it’s going to be now. To come through the next year, agency owners need to pay very close attention to where their business goes.

I look at lots of agency books of business every year in my work, and I’m always surprised to see standard business lines placed with E&S carriers. This represents a commission cut of 35%: you’re receiving a 10% commission where you should be getting 15%. With all the other COVID-created income problems, this must be stopped. 

Having an agency’s book of business spread among too many carriers also threatens profit sharing, as I’ve already mentioned. It also guarantees that the agency isn’t receiving as large a percent payment as they would, due to the gridded nature of profit-sharing agreements. Focusing on fewer carriers now will improve the profit-sharing potential of any agency. Moving books of business from one carrier to another right now should also mean increased income, as carriers are paying unprecedented amounts of money for book transfers. Now is the time to reduce your carrier count. 

As you can see there are several things an alert, aggressive agency owner can do to minimize the negative income impacts that the COVID crisis is bringing to our industry. But if agency income goes down by 20%, 30% or more, income action will not be enough. After you have done all you can to preserve and increase income, what else is there to do?

Cut Expenses

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, from 20% up to as much as 50%. Their announced intentions were to avoid layoffs. These very large organizations that 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, employees’ 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: 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 is at the average or better, you are staffed for growth!

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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 the time of COVID.

Book Size and Customer Service

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 - they 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.

Expense Controls

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, ask yourself: 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.

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 reduced). Some will die. 

Which kind of agency will you run?

 

 

 

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