by Shirley Lukens, February 1999

National Underwriter

Dickens could have been writing about the insurance industry when he penned the lines, It was the best of times.  It was the worst of times. Each year the industry is faced with new challenges and opportunities and 1998 was no exception.  Competition from both traditional and non-traditional sources was tougher than ever, margins continued to shrink, and technology became increasingly important, yet costly, as Y2K problems loomed.  At the same time, well-run agencies were bought and sold for premium prices and changes in the financial services arena created exciting possibilities. 

The annual Best Practices Study provides a glimpse of how effectively the best agencies in the country are responding to this emerging environment.  Each year the study looks at the financial and operational results of agencies in six revenue categories ranging from Under $250,000 to Over $5,000,000.  While the participants vary greatly in size and type of business written, this year's Study showed similarities in many areas.

When compared to the last two years, the overall retention rates did not change significantly in any of the Study groups.  The average retention rate of all six revenue categories was 90.6% for Personal lines, 91.6% for Small Commercial Lines, and 93.8% for Mid to Large Commercial lines. 

Although retention remained stable, the Study results suggest that even the best agencies are struggling to grow their revenues.  Net revenue growth fell or remained flat compared to the previous year in all but two of the Study groups.  Results in the Under $250,000 and the $500,000 to $1,250,000 categories revealed small increases while the net revenue growth rate for all Study groups averaged just 7.0%. 

Flat revenues, and easy access to capital, drove a tremendous increase in the number of mergers and acquisitions, especially in the larger revenue size agencies.  Nearly one in three of the larger agencies reported an acquisition with the average revenues acquired at $1,504,176.  Nevertheless, revenue growth remained flat for this group, the continuing effect of a soft market.

Banks were also a factor in the acquisition activities.  The 1998 ABI Study of Leading Banks in Insurance, a parallel study conducted by Reagan & Associates for the Association of Banks in Insurance, demonstrated a clear trend toward agency acquisitions for banks seeking to enter the insurance business or expand an existing insurance operation.  Jim Campbell, head of the banks-in-insurance practice at Reagan & Associates, noted that banks have been more aggressive than expected at moving into the property and casualty business.  "More than one-fourth of the banks included in the study are currently selling property and casualty insurance and many more have plans to do so," Campbell said.

He added that the trend toward acquisitions is a preference among banks.  Most banks want a greater level of strategic and operational control than is typically afforded through a joint venture or outsourcing approach.  Many banks discover that the bottom-line contribution of a joint venture is not compelling and that a de novo start would take years to build.  This lack of viable alternatives increases the appeal of an acquisition strategy.

This appeal had many banks willing to pay 5 to 6 times earning for cream of the crop agencies, even as these agencies profitability shrunk.  In all but the smallest revenue size group of the Best Practices participants, pro forma profits declined or stayed flat compared with the previous year's Study results. The Study groups averages ranged from a low of 14.3% to the high of 18%, excluding the smallest group that had an average pro forma of 28.3%. 

Agencies participating in the 1998 Study continued to do a good job of managing their finances.  On the operational side, however, gains were difficult to make.  Generally, employee productivity improved when compared with the previous year's results.  Revenues per employee averages ranged from $66,751 in the smallest agencies to $114,267 in the largest.  The range in the most profitable agencies in each revenue category was from $85,345 to $137,510.   Most gains, however, were lost in higher compensation per employee with the mid-size agencies losing the most ground.  These agencies in particular listed the inability to hire, train, and keep quality producers and support staff as one of their greatest weaknesses.

Identifying the most appropriate producer compensation package, one that is both motivational to the producer and affordable to the agency, continues to be an issue for most agencies.  In discussion with Best Practices agencies that are also clients of Reagan & Associates, many indicated a move to increase the commission percentage paid for new business while reducing the percentage paid for renewals.  In small commercial and personal lines, the agencies are often paying much higher commissions on new business and eliminating the commission paid on renewals altogether. 

The Study suggests that the participating agencies have made downward adjustments in their Commercial Lines producer compensation packages.  The percentage of the average Commercial Lines producer's annual pay (salary, commission, & bonus) averaged 32.6% of his book compared with 34% for the previous year.  The Study again revealed a notable production gap between the average Commercial Lines producer and the top Commercial Lines producer in an agency.  New commissions generated annually by the typical producer in the six Study groups averaged $47,135; new commissions generated by the top producers in all the Study groups averaged $77,886.  The top producer spent an average 30% of their time soliciting new business, 51% servicing existing accounts and the balance of their time on professional development and management activities.

During 1998 many agencies complained of pressure to reduce the number of national carriers represented in order to meet volume commitments.  Although this pressure was significant, especially on smaller agencies, the Study showed a slight increase, rather than a decrease in the number of national carriers represented.  Only the Over $5 Million study group had a reduction in the number represented, falling from 6.2 to 5.1 in personal lines and from 26.7 to 18.9 in commercial lines.  There was, however, a corresponding increase in the number of regional companies these agencies represented.

Although the percentages were close, AMS was the system used by most agencies in four of the six study groups.  Applied Systems was the system used most by the agencies in the $500,000 - $1.25 Million category and Delphi was the system of choice for the Over $5 Million agencies.  In all revenue categories agencies continued to improve in the utilization of their systems, especially in the commercial lines side. Even the number of producers with terminals on their desks increased, suggesting that automation can be a helpful tool in growing a book of business -- and that was a goal of major significance in 1998!

Shirley Lukens is a senior vice president with Reagan Consulting, Inc., and may be reached via e-mail at shirley@reaganconsulting.com.