March 2014
Burand's Insurance Agency Adviser
Resources and Information for the P&C Insurance Industry
Volume 19, Number 1

~ For a printable PDF version, click here. ~

In This Issue...

Do you know what keeps your E&O underwriter awake at night?

Your website, not reviewing policies, not discussing coverages, and not using checklists. Read More...


Balance Sheet Myths that Can and Do
Derail Agencies

1) My state is not a Trust State.

ALL STATE ARE TRUST STATES!
The FEDERAL GOVERNMENT IS EFFECTIVELY A TRUST STATE!
Read More...


Do insurance company automated underwriting systems really work?

According to most, maybe all, insurance companies using such systems, this is a rhetorical question. Of course they do or they would not have spent so much money on them. Another agitated response might be, of course they do as evidenced by the companies' tremendous profitability. Read More...


Minimal Acceptable Production for a
True Producer

Having had hundreds of articles covering many subjects published in insurance trade publications over many years, I find there is only one subject that continually arouses the ire of agency owners. That subject is the need for producers to produce their own business. Read More...

Solutions!

Chris Burand,
Accredited Business Appraiser
Institute of Business Appraisers

Burand & Associates, LLC

215 S. Victoria Ave., Suite E
Pueblo, CO 81003
p: 719/485-3868
f: 719/485-3895
chris@burand-associates.com

Visit us at:
burand-associates.com

Training is expensive.
Books are expensive.
Going to seminars is expensive.
All learning is expensive.
Being stupid is still much more expensive.

-No Time for Tact from Business Digest, January 11, 2013

"A false balance is an abomination to the Lord: but a just weight is his delight."

-Proverbs 11:1 (King James Version)


Do you know what keeps your E&O underwriter
awake at night?

Your website, not reviewing policies, not discussing coverages, and not using checklists.

Websites
Agencies are growing careless regarding what their websites state the agency does and will do for their clients. Such carelessness is partially a result of not paying attention, partially a result of good intentions with bad consequences, and a growing result of outsourcing web development.

Outsourcing web development is a perfect breeding ground for grand promises without the wherewithal to uphold those promises. A website developer will certainly look much better in the eyes of the agency if they make the agency look great. Website developers often have a flair for thinking of all the services and qualities agencies can provide clients. Meanwhile, agency owners love to see how great they are, especially when a third party writes the script and publishes it on the internet for all to see. And yet when everyone gets done with the love fest, someone has to do the work. If an agency advertises they will find the best combination of price and coverage, they had better find the best combination of price and coverage for every single client or put a caveat on their site advising they will only really do this for some clients.

Advising you are an expert is great if you are and you provide expert attention to every single insured. Advising you can write any risk may mean finding a home for every risk. Advising that you will review insureds' exposures may mean reviewing every insured's exposures every year. Agents are likely mistaken in believing they can advertise how great they are without having to prove that greatness to every single account every single year.

Policy Review
Some agencies have cut back staff so much due to the tough times they are no longer reviewing all policies at renewal. Others, believe it or not, may have cut staff so their productivity numbers look better for the various best practice type competitions in which they compete. Big egos can lead to stupid decisions. Others are just greedy, but the savings today will be spent tomorrow in E&O claims and employee dissatisfaction. Penny wise and pound foolish. I am not going to change those agency owners' minds with this article, but hopefully by making other agencies aware of what is happening, you will see wedges you can use to separate some of those agencies' clients from those agencies. The customers deserve better.

Foregoing Coverage Discussions for Long-time Insureds
This is scary to E&O underwriters because over time, even simple homeowners' exposures tend to change materially. For example, a study some years ago showed that a majority of homeowners who renovate their home forget to tell their agent. The result is a severe under-insured homeowner and this is a problem that has plagued this industry for at least the last 25 years. To help your E&O underwriter sleep better at night, regularly contact your clients, especially the ones from whom you never hear.

Coverage Checklists
E&O underwriters know a coverage checklist is the best way to eliminate E&O exposures and yet, almost no agencies use them consistently. Maybe some E&O underwriters are just numb on this point and their sleep is no longer hindered but take pity on the new underwriters. They are not numb yet to the huge risks they see, which could be mitigated by a relatively simple tool but with an almost complete refusal by agencies to use the tool. They know it is not a matter of "if" but "when."

This particular situation is actually a fascinating proof of how humans assess risk. When risk is not imminent, most people cannot assess risk correctly. The further someone is from the risk themselves, the clearer they can see it. Just like agents and underwriters. Exacerbating the problem is how humans perceive frequency and severity differently. The industry is pretty good at addressing frequency problems, but it is not so good at addressing severity problems because neither the people within the industry nor the public can articulate severity. For example, UM claims have a tendency to be few but severe. People can mentally assess why they need insurance if they have a 25% chance of incurring a claim, even if the claim is likely small. But they have a really difficult time assessing the importance of insurance when the chance is less than 1% but if it occurs, they are likely to incur a very large claim.

Humans as a whole have a large blind spot when it comes to severity which is why so many producers and agency owners cannot assess the value of a coverage checklist. But have one claim where a checklist would have saved them, and they will be an immediate convert.

Help your E&O underwriters sleep at night. Even if you do not see the risk and they do, they have your best interests at mind. Take pity on them and if you don't do it for yourself, take these steps for them.

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Balance Sheet Myths that Can and Do Derail Agencies

1) My state is not a Trust State.

ALL STATE ARE TRUST STATES!
The FEDERAL GOVERNMENT IS EFFECTIVELY A TRUST STATE!

Multiple laws exist in every state and definitely federally that simply put state, "You Shall Not Steal!" When an entity has a fiduciary duty to hold money in trust and then spends it, it has spent money that does not belong to it. Whether monies are comingled or the bookkeeper accounts for such monies in the correct general ledger account is absolutely secondary. DO NOT SPEND TRUST MONIES!

In general, and different states have different standards so check with your state's laws, if your trust ratio is less than 1.0, the agency is out of trust and by implication has spent money that is not its to spend.

2) If I don't comingle monies, I'm in trust.

See #1!

3) My accountant/CPA knows about agency trust requirements and would tell me if I had a problem.

High quality insurance agency accounting is not strict G.A.A.P. accounting for many reasons including trust requirements and the accounting requirements this necessitates. Most CPA's I have encountered or whose work I have seen do not know much except G.A.A.P. accounting. Knowing G.A.A.P. accounting is an achievement and one every accounting client should appreciate of high quality accountants. However, insurance agency accountants truly need to know trust requirements and extremely few do because trust accounting is not part of G.A.A.P. Since they do not know trust accounting, they cannot advise the agency owner properly.

Therefore, CPA's not only are not watching this key financial element for you, they are likely providing ignorant advice. It is ignorant because they advise on tax strategies, distributions and all other matters, even acquisitions, without considering the most important financial metric known to independent insurance agencies.

4) Only Net Aged Receivables matter.

Many agency owners only review their net receivables. The net is the result of subtracting credits from debits. The problem with only looking at the net is that many agency owners will conclude they do not have a receivables issue when in fact, they have a serious problem. The mistake is the agency has a legal requirement to return the credits and the insureds do not have a legal requirement to pay what they owe the agency.

For example, let's assume the agency has $30,000 in aged receivables and $20,000 in credits. The net is $10,000 which may not be a problem on the surface. Only $10,000 is at risk. However, the agency MUST return $20,000 and may not collect $30,000. At risk then is a total of $50,000, not $10,000. Pay attention to your gross aged receivables.

5) When buying an agency, I only need to price the Book of Business because all balance sheets are equal.

See myths #1-#4 for starters. Then consider that working capital is not free and a certain amount should come with the seller - for FREE! Next consider how old the aged receivables are and whether all are likely to be collected.

These five myths are only the major balance sheet myths. Many more myths exist. Balance sheets seem like such a nuisance to so many business owners but they tell the story of a firm's financial health (which is why surety underwriters rely on them so much). When I am evaluating an agency and I see the agency owner buying into any of these myths, their firm is almost always financially sick. On the other hand, the agency owners who truly understand balance sheets almost always have financially healthy firms. They may have other issues, but they are financially sound. Understand your balance sheet and manage it properly to build your opportunities and agency value.

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Do insurance company automated underwriting systems really work?

According to most, maybe all, insurance companies using such systems, this is a rhetorical question. Of course Automated Underwriting Systems (AUS) work or they would not have spent so much money on them. Another agitated response might be, of course they do as evidenced by the companies' tremendous profitability.

An issue exists here where even if the companies are right, they are right for the wrong reason. Insurance company profitability is always and--barring some wild and currently unimaginable change in business models--will always be highly correlated with loss ratios. Losses have regularly consumed more revenues than any other line item for the last 200 years and I do not see this changing. In fact, losses have generally consumed between 55 percent and 65 percent of premiums on a rather consistent basis.

So if an Automated Underwriting System works well, causing a reduction in losses relative to premiums, then what will the company do with the extra money? Historically in this industry, companies always lower rates. When rates decrease, loss ratios will again increase unless some way, somehow, the AUS causes losses relative to premiums to always decline.

Some might have been lulled into believing this is how AUS's work given how loss frequency has fallen off the cliff. But to come to this conclusion would be to believe that AUS's are actually causing people to incur fewer claims rather than shifting claims to less sophisticated companies and/or getting more rate.

An AUS then is likely a temporary advantage, at best, from a profit perspective. This is why some companies are right for the wrong reason. If these systems truly work, they effectively provide a cost advantage enabling the company to write business for less money, thereby giving the company the ability to increase market share profitably. The smartest companies are indeed taking advantage of this opportunity.

Other carriers are less competent but want agents to think otherwise. For example, if these systems work as well as advertised, then the following results are incongruous. The following is from an A.M. Best report. "... [the company has] focused underwriting discipline... [and] predictive modeling initiative..." The report continues on, stating, "...despite reporting a combined ratio which slightly exceeds the commercial casualty composite." Its combined ratios have not decreased over the last five years even with underwriting discipline and predictive modeling. At best it looks to me as though these efforts have only mitigated poor results but this company can't use AUS's to increase sales. They are still playing defense, not offense.

Another reason claiming victory so early may be misguided is that so much of the industry's profits lately have been generated by reserve releases. One might argue that these releases are justified by new reserving models, but that means the old models were wrong and I haven't seen a press release on this subject. Furthermore, it just seems odd to me that claims could be so fully developed that releases of such magnitude are completely justified only 12 to 24 four months out. It might be worth exploring the extent to which the reserve releases match Wall Street earnings expectations.

Another possibility exists. Underwriting success is fairly basic. One must write risks profitably, but not so profitably that other companies (since the barriers to entry are almost nonexistent) might offer the same product for a lesser but still profitable rate. This "sweet spot" is obviously hard to identify, making underwriting as much art as science. Trying to make it too much a science seems an awfully dangerous endeavor. I strongly recommend anyone with even a slight curiosity on this matter to read The Quants, by Scott Patterson. This book is about how really smart people built extremely fast and complicated software to make security trades. In essence, the goal was to take human decision making out of the equation.

As the book brilliantly describes, the Quants did not address the people factor. The systems they built changed the way all other systems and the people interacting with those systems traded. Likewise, the AUS models rely only on data and assumptions. Numbers simply do not tell the whole story. And, what if the data and/or assumptions are simply wrong?

If an AUS truly works and the initial results are not luck and are not due to reserve releases, then when other companies build their own AUS's, all companies theoretically will offer insurance for a lower but still profitable price. The losers will be the companies that have not been able to lower their cost structure.

However, if the AUS's only intensify competition or give a false sense of success or if the people (i.e. agents) working within the system learn how to gimmick the system, an AUS may actually make future loss ratios worse. Clear examples would be that the AUS chooses risks or prices risks poorly.

Potentially I can envision a different problem arising. A smart insurance company with good leadership could employ good underwriters. I have had the fortune of knowing some good underwriters and they are artists. They can underwrite risks faster, better and less expensively than machines. Of course finding enough of these people is difficult, which is one reason AUS's are so attractive. Even if the underwriters are not perfect, agents truly appreciate a company that has good underwriters. All else being equal, or even if the rate is slightly higher but competitive, an agent will give such a company first shot at quality business. A good agent is the best upfront underwriter imaginable. So if a company can charge slightly more, it can afford slightly more expense, remain competitive, and likely get first shot at the best business that will more than offset its higher expenses.

AUS's are clearly the way insurance companies are going, some only because they are following the herd. The danger is in not understanding the negative competitive advantage created rather than the permanent competitive advantage discussed publicly. This mistake will only result in inadequate pricing because AUS's are about gaining market share not profit. Another danger is not recognizing how a system can change other systems' and peoples' behaviors. It will be interesting to watch as time passes whether different underwriting models and philosophies will develop. If so, which will be more successful? Understanding the true advantages of AUS's will give executives and even agencies a better understanding of how to develop their strategies.

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Minimum Acceptable Production for a True Producer

Having had hundreds of articles covering many subjects published in insurance trade publications over many years, I find there is only one subject that continually arouses the ire of agency owners. That subject is the need for producers to produce their own business.

When I write how it makes no sense for producers to get credit for walk-ins and call-ins, I always upset some agency owners and I usually hear from a few. They cannot fathom how their producers can succeed, or even survive in many cases, if call-ins and walk-ins are not given business.

I cannot fathom why anyone would pay someone 30 percent to 50 percent for sitting behind a desk waiting for the phone to ring.

I cannot fathom why agencies pay producers for renewals when they do not work the account through the year or even look at the renewal. The customer service representatives (CSRs) do all the work, including the renewal. It would be cheaper and easier to just buy the producer an annuity. For example, if the commission is $500 and he/she is paid 30 percent on renewals, get the employee an annuity that pays $150 annually for 10 years and tell the producer not to touch the account. At least then the producer would not get in the way of the CSR when trying to do something on the account.

I understand that $150 annuities are not available, so package them. I understand the agency carries a risk the accounts will not renew, but that is beside the point. If the agency were really concerned about renewing the accounts, the producer would have to actually work the renewal.

Agency owners also continually give me grief and write angry emails and tell me I am making them mad when I speak out that real producers should produce at least $300,000 of their own commissions. I have been accused of demoralizing producers, creating revolts, and causing dissension. These are literal accusations. Readers thinking I am making up all of this and who understand that my position is quite reasonable, even liberal, should know that I am not creative enough to make up this stuff.

The first line of denial is that the economy is too poor. Then it goes to the soft market. Then it goes to how many small accounts exist and how few large accounts exist. Then it gets creative. So let's think this through together. I have surveyed hundreds of agency owners, producers and commercial CSRs as to what the minimum commission is on a properly written small commercial account. By properly written, I mean the insured buys all the necessary coverages. Readers who are thinking about the minimum size account that the insured requests have already identified a key problem: in that case, the producer is an order taker, not a producer. Order takers do not need to be paid half as much as producers.

The answer as to the minimum size has ranged from $500 to $750 commission. So if a producer does not write any account less than $500 and writes a fair number of $1,000 commission accounts, he or she should average at least $750 per account. According to the latest Growth and Performance Standards (GPS) study by the National Alliance Research Academy, the average commercial account generates $1,075 commission. So giving a 25 percent benefit of the doubt to the agency and producer, using $750, this is 400 accounts. That's a lot of accounts.

If a book of 400 accounts at an average of $750 each is not doable, then the agency does not need a producer. It needs an order taker.

However, while by normal standards 400 accounts is a lot, it is not always that much if a producer has a small book. First, most producers do not work their smaller accounts. Second, over five years, this is 80 accounts annually. That is only 1.5 accounts per week. Producers who cannot write 1.5 small accounts per week are not really producing. Let's figure that 1.5 sales per week at even a 20 percent hit ratio requires 7.5 calls/proposals. That is doable because if a producer has less than $300,000, what else does the producer have to do?

If the argument is that they have lots of other things to do, then either they are not really producers or they are doing work that staff people should be doing. More often than not, they are doing these other things because they do not want to sell. In David McCullough's great biography of Harry Truman, he shows how in 1925 Truman sold AAA memberships. He made $5 commission on each sale. He sold 1,000 memberships that year. That equals one sale every 30 minutes. That means that at a 50 percent hit ratio, he made a sales pitch every 15 minutes for an entire year. In a time when many people still did not have phones and many did not have cars and an AAA membership was discretionary (versus the advantage property/casualty producers have whereby the insured will buy insurance and it is just a matter of from whom they purchase it), he had to make at least 2,000 calls. How many did your producers make last year?

If the argument is that there are not 400 accounts worth $750 in your area, then you do not need a producer because there are not enough accounts to justify the position. Or you can realize that no insurance commissioner in the country has banned an agency from working the next county over or even several counties over. If you are concerned they cannot make enough money traveling that far, then the accounts sold must be larger.

Which brings me to the last point for now. I know that a good producer in virtually any location in America can generate at least $500,000 to $700,000 in commissions. I cannot tell you the number of times someone has said, "Well, you know, in a big city those numbers might be feasible, but not in my little town." In every single instance, I have wanted to tell them that I know a producer within 30 miles of their office who has a book in excess of $500,000. I have seen agents get so red in the face they had to leave the room when I have stated this in seminars and, yet, I know of producers generating more than $1,000,000 commission less than 30 miles from their office. How is it that the demographics of the area are such that it is impossible for a producer to generate $300,000, much less $500,000 and yet a nearby producer is generating $1,000,000?

Here's the opportunity. Get your head out of the sand and get busy. There is more opportunity than you realize. You have saddled yourself with emotional baggage and possibly lazy or poor producers. Trash the baggage and start making your calls. You are absolutely not alone and the competitors that get their heads out of the sand first are going to win.

For those readers that are long past these rationalizations of poor performance, Lord knows this article is not going to change much in the industry. Identify these kinds of agencies and their top 10 accounts. Then go to work yourselves. It is likely going to be easier to get these accounts than to compete against your more sophisticated agents and brokers on their accounts.

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Chris Burand is president and owner of Burand & Associates, LLC, a management consulting firm that has been specializing in the property/casualty insurance industry since 1992. Burand is recognized as a leading consultant for agency valuations, helping agents increase profits and reduce the cost of sales. His services include: agency valuations/due diligence, producer compensation plans, expert witness services, E&O carrier approved E&O procedure reviews, and agency operation enhancement reviews. He also provides the acclaimed Contingency Contract Analysis® Service and has the largest database and knowledge of contingency contracts in the insurance industry.

Burand has more than 20 years' experience. He is a featured speaker across the continent at more than 180 conventions and educational programs. He has written for numerous industry publications including Insurance Journal, American Agent & Broker, and National Underwriter. He also publishes Burand's Insurance Agency Adviser for independent insurance agents.

Burand is a member of the Institute of Business Appraisers, a department head for the Independent Insurance Agents and Brokers of America's Virtual University, an instructor for Insurance Journal's Academy of Insurance, and a volunteer counselor for the Small Business Administration's SCORE program.


NOTE: The information provided in this newsletter is intended for educational and informational purposes only and it represents only the views of the authors. It is not a recommendation that a particular course of action be followed. Burand & Associates, LLC and Chris Burand assume, and will have, no responsibility for liability or damage which may result from the use of any of this information.

Burand & Associates, LLC is an advocate of agencies which constructively manage and improve their contingency contracts by learning how to negotiate and use their contingency contracts more effectively. We maintain that agents can achieve considerably better results without ever taking actions that are detrimental or disadvantageous to the insureds. We have never and would not ever recommend an agent or agency implement a policy or otherwise advocate increasing its contingency income ahead of the insureds' interests.

A complete understanding of the subjects covered in this newsletter may require broader and additional knowledge beyond the information presented. None of the materials in this newsletter should be construed as offering legal advice, and the specific advice of legal counsel is recommended before acting on any matter discussed in this newsletter. Regulated individuals/entities should also ensure that they comply with all applicable laws, rules, and regulations.


If you wish to be removed from this mailing, please e-mail AgencyAdviser@burand-associates.com. Copyright 1995 - 2014, Chris Burand