by Brian Deitz & Kevin Stipe, November 2007

National Underwriter

Does personal lines business have an important role in your agency's future? Most mid-size and large agencies we encounter don't have a clear picture for the strategic role that personal lines should play within their organization. Since it is an afterthought to their core commercial P&C and benefits business, we've watched agency owners vacillate year by year over what to do with it: Should personal lines be grown aggressively? Should it be divested? Should it simply be milked for profits?

In today's environment, growing personal lines business is difficult: agencies don't typically have dedicated personal lines producers and competing head-to-head with the direct writers is daunting. However, despite its typical low growth rate, personal lines is often steady, extremely profitable business.  A well-run personal lines department can generate margins that are 10% - 20% higher than margins on commercial business.

So what are the industry's top performers doing?  Many are reinvesting the excess profits from their personal lines department to fund growth in commercial P&C and benefits operations. In fact, for some agencies, their entire investment in future growth is being funded by that strategic stepchild - the personal lines department!

In today's soft P&C market, investing in organic growth is critical to the success of an independent agency. The most important investment an agency can make in growth is an investment in its production team: hiring and developing commercial P&C and benefits producers. Some agencies are wary of this investment because of its cost, as new producers don't typically cover their expenses, or "validate", until two to four years after being hired.

However, foregoing this investment can significantly limit an agency's capacity to grow organically. With current market conditions, agencies have to write new accounts to grow revenues, and increasing the number of accounts typically means adding more producers.  Over the long-run an agency's revenue growth rate will be dictated by the growth rate of its producer force.

Agencies that aspire to grow are increasingly asking "How much should we invest in new producers?" The industry needs a benchmark! For years, Reagan Consulting has looked for a way to measure this investment and to benchmark it across agencies.

A New Industry Benchmark

We've recently developed a statistic called the NUPP - Net-investment in Un-validated Producer Pay.  Expressed as a percentage of revenue, the NUPP provides a way to benchmark the amount of direct investment an agency is making in its future production force - which is typically made of one or several producers who are not yet "validated" (i.e. producers whose payroll expense is greater than what they would generate if paid according to the agency's normal producer commission schedule.)

The "Net-investment" of an agency should not be confused with the gross amount of pay and/or other expenses being invested in new producers.  The Net-investment in an un-validated producer is the difference between what the agency pays a producer and what he or she would earn under the normal commission schedule. For example, if an agency that pays a 35% commission rate has a new producer with a $100,000 book earning a $50,000 salary, the agency is making a $15,000 Net-Investment in that un-validated producer ($50,000 salary less $100,000 x 35% in producer commissions).

Agencies that are investing heavily in un-validated producers are spending a portion of current profits in an effort to drive future growth. As we've demonstrated in previous articles, the investment in new producers - assuming they validate in two to four years - provides enormous investment returns.  In our view, this investment represents a necessary trade-off that agencies have to make. Skimping on this investment now in search of immediate profitability can damage an agency's competitive position and value in the future.

The table below provides an illustration of an agency's NUPP. The NUPP is then expressed as a % of revenues to allow a comparison with other agencies. We've found successful agencies often have a NUPP of 1.5% of revenues or more. This means, for example, that an agency with $20 million in revenues should be investing - on a net basis - at least $300,000 in un-validated producers. In other words, the agency is paying those producers $300,000 more than they would earn under the agency's normal producer commission schedule.

In our view, a NUPP of 1.5% or higher is a healthy level of investment in an agency's growth. If an agency is investing below 1.5%, it may not be doing enough to ensure future revenue growth and value creation.

Keep in mind that the NUPP is only intended to measure the pure payroll investment in un-validated producers.  As a benchmark, to make it comparable against other firms, it is intended to be simplistic.  It is not designed to measure all of the other ancillary expenses that accompany new producers - such as overhead expenses, support costs, etc.  So when these other costs are accounted for, the actual investment being made in new producers at any given time might be more than twice the NUPP.

Conclusion

What does the NUPP - which is typically invested in commercial P&C and benefits producers - have to do with personal lines? Unfortunately, many agencies skimp on their NUPP because their commercial P&C and benefits divisions alone can't support the necessary investment. But, amazingly, a typical agency's entire NUPP can be funded by a well-managed personal lines department.

How? A personal lines department is, on average, 10% of a large agency's overall revenue (according to the 2007 Best Practices Study.) Assuming that the personal lines department creates margins that are, on average, 15% higher than the agency's other departments, the agency is generating 1.5% of total agency revenues in excess profits from its personal lines business. These excess profits can be re-invested to fund its entire investment in un-validated commercial and employee benefits producers.

The lesson here is that the strategic value of the personal lines department for many agencies is the investment fuel it provides for funding future growth in other departments. Personal lines divisions shouldn't be taken for granted, they should be run with a keen eye for profitability.

In today's competitive marketplace, investing in growth and developing producers is more important than ever before. Manage your personal lines business effectively, and you'll have the cash you need to make this investment and to drive agency value in the future.