by Angi Bemiss, February 2006

National Underwriter

There is good news for insurance agencies:  Interest rates are gradually increasing.  As a result, there is once again "real" interest income on your bank statement!  Unlike commission income, interest income has no corresponding expense (payroll, benefits, selling), so 100% of the income goes directly to the bottom line.  At a conservative EBITDA multiple of 6, that means that $1 of interest income equates to $6 of agency value . . . or $1,000 of monthly interest income equates to $72,000 of agency value.

Question:  What does it take to earn $1,000 of monthly interest?  Answer:  $300,000 of average daily float.

Looking at it from an agency's perspective, that means that every $300,000 of monthly past-due receivables means a $72,000 decrease to agency value.  That is, if you give up 30 days' float because you don't collect premiums on the effective date (and forfeit the month's float before paying the carrier), it's a double whammy - You're losing interest income (today's value) and negatively impacting your agency's value (future value).

Imperial A. I. Credit Companies is the newest sponsor of the Best Practices Study, and they asked us to conduct some research on the collection practices of some "good collector" agencies.  Much of what we found won't surprise industry veterans.  But, the true dollar value of good collections did surprise even us.  It's something that we all talk about, but the actual numbers were surprising.  We'll address that first.  Then, we'll review the collection practices that make a difference.  Those practices are common sense, but it serves us well to be reminded of them from time to time.

First, let's look at float and interest income.  We have to begin with the appraiser's clarification of investment income as it relates to agency value.  The only interest that counts toward agency value is the operating interest that you earn on your "float," which is the excess of your carrier payables over your accounts receivable.  (The other cash in the bank is related to tangible net worth.  You get paid for that cash in the event of a sale, so that interest income goes away . . . because you're now keeping it!)

Float is the cash in the bank from premiums that are collected prior to paying the carriers.  As a conservative estimate, premium that is collected by the effective date is held for an average of 30 days.  (If the transaction is effective on the first of the month, you get 45 days' float if you pay the carrier on the 15th of the next month.  If it's effective at the end of the month, you get 15 days' float.) 

Let's look at a hypothetical situation:  $1.2 million agency commission, 2/3 of which is direct bill (some commercial, all personal, all benefits), and an average commission rate of 10%.  That leaves $4 million of agency-billed premium.  If you collect that premium by the effective dates, you have an average of about $300,000 premium in your bank account each month.  At 4% annual interest (.333% monthly) your monthly interest income is $1,000 or $12,000 per year.  Voilà!  Now, multiply that by your agency's actual agency-billed premium and you'll see the value of good collections.  In fact, I suspect that some of you are reaching for your Aged AR report right now!
 
Now, let's review those "common sense" best practices of collections:

• Producer guarantees encourage collections.  As a wise agency principal once said, "I ask my producers a simple question: ?Let me be sure I understand this - You want me to pay your client's premium for them?'"
   

• An enforced collection policy reduces bad debts.  Think about it . . . just as $1 of interest income equates to $6 of agency value, so does $1 of historical bad debt expense.  Bad debts means a decrease to agency income and agency value.
   

• Producer charge-backs reduce bad debt write-offs.  First, the producer "makes the agency whole" for some or all of the bad debt.  And, they'll chase after a past-due premium if they know they'll have to pay it otherwise.  (Keep in mind that we're talking premium here, not just the loss of their commission compensation.)
   

• Holding a producer's commission until the AR is collected encourages collections.  A deferred paycheck works effectively as an incentive to collect premiums.
   

• When senior management monitors the AR, items get collected.  As the old adage says, "What gets watched, gets done."
   

• Late fees lead to better collections.  We were a bit surprised to see that many agencies still charge and collect late fees.

As we interviewed our project participants, we heard them say something that we all know but that bears repeating:  It is important to have effective collection policies, but it's meaningless if you don't enforce those policies.  In most agencies, the producers are responsible for collecting premiums.  We feel that it is wise for an agency to provide support for the producers' efforts, such as in the form of a formal or informal credit manager (to call the insured's accounts payable department).  A producer's focus should be sales (in the form of collected premiums), so providing collection support is money well spent - especially if it improves the agency's float and ultimately the agency's value.

Angi Bemiss is a principal and senior vice president of Reagan Consulting, Inc.  She may be reached at 404.233.5545 or at angi@reaganconsulting.com.  Reagan Consulting is an Atlanta-based financial and management consulting firm serving the insurance distribution system.