Agency Growth And The Perpetuation Dilemma


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by Carol Hammes

Despite the incredible deepening of the commercial soft market, many independent agencies have continued to grow and have been quietly providing a very comfortable living for their owners. Although continually faced with market, organizational, and personnel challenges, these agency principals have found a way to deal with problems before they become crises. In the presence of such a calm and effective management style, enough new business is produced to more than offset attrition. The agency is on a steady growth curve and morale is good. Then, seemingly overnight, things start to unravel. The system that had been running so smoothly becomes a roller coaster of minor disasters. The team spirit grinds to a shaky halt, and what was once frequent laughter becomes almost constant bickering. Revenues level off or even begin to decrease, and the profit margin erodes.

When this happens, a lot of agency owners and managers blame the market conditions, temporarily forgetting that they had been doing just fine in the same competitive market until only recently. Seizing on this convenient excuse for all of their ills, they are tempted to try to ride out the storm 'until the market turns.' With so much capacity available, the hardening of the commercial market still lies in the distant future-if it will happen at all. An agency that was generating a 12% profit can withstand 10% revenue decreases for only two years before serious adjustments have to be made to keep from going under. Waiting is not a viable option. At the first sign that the well-oiled machine is rusting, you must actively search for the cause and get things turned around quickly. With premiums and commission rates going down at a steady pace, there's not a lot of room for procrastination.

In most cases, the organizational difficulties are rooted in the very success that the agency had been enjoying. It may simply have grown past the point where the existing organizational structure can operate effectively. The agency has failed to adapt to the changing requirements of a growing business. To get to the next level, a new type of management style and philosophy becomes necessary. Recognizing and accepting the need for radical change is difficult when the owners are still making money. But if they wait to act until the coffers are almost dry, it may be too late.

The first step, then, in solving the organizational problem is to accept that fact that you have one. Then all of the owners have to decide whether they're willing to make an all-out effort to get things back on track. It takes a strong commitment and a lot of hard work to break away from a growth plateau. And the strength of that commitment will largely depend on the personal goals of the principals: remaining years before retirement; chances of children coming into the agency; desire to perpetuate internally; need for large amounts of retirement income, etc. Principals who are not in agreement with what the others want to do or who have decided that they are ready to slow down should consider early retirement.

If enough of the owners feel that way they may opt to sell the agency to an outsider or to merge with a firm that has a more energetic and adventuresome group of owners. Most agency sales happen when the firms are at a growth or perpetuation crossroads. And it is certainly better for everyone concerned (including the employees) to enter into a business combination rather than to ride the revenues down into a lower agency value and possible bankruptcy.

For the many groups of owners that decide to pursue internal growth and perpetuation, the next step is to address the underlying cause of the drop in sales, productivity, and morale. In some cases, new organizational relationships have not been clearly defined or communicated. In others, job functions have not been allocated properly for an agency of this larger size. From the time a third person is added to the staff, a constant re-evaluation should be made of who should be doing what, and how. Since most agency owners wear a number of hats, it's difficult to anticipate the need for change if the firm is growing rapidly. As a result, many firms stagnate at what have come to be called agency growth plateaus. Although every insurance agency is unique, the solutions for breaking out of these levels often have common threads.

Common Growth Plateaus

The first critical level that an agency may hit is the sales plateau, when the book of business reaches the size where the one owner/producer is saturated and cannot handle the sales or servicing of additional accounts. For the agency to grow and to perpetuate, another salesperson must be brought in. But the money to fund that person must come directly from the owners' compensation or profit. The choice becomes one of expanding the agency or retaining the owners' current standard of living. Most owners willingly choose the expansion route at first, but after several false starts with young producers who do not work out, it's easy for them to become discouraged.

Unfortunately, without a new producer, internal perpetuation opportunities will be limited-if not nonexistent. The absolute No. 1 requirement of a successful perpetuation plan is willing participants, and most CSRs and managers do not have the entrepreneurial spirit to take on the risk of ownership the way many (although not all) sales-oriented people do. Also, without a new producer, there will be little growth, causing the insurance companies to become dissatisfied and possibly terminate the contracts that are necessary to keep the agency competitive. Eventually there may be nothing left to perpetuate.

So, for the owner of an agency of this size (generally $300,000 to $500,000 in revenues), hiring a new salesperson is important. Devoting a significant amount of time and energy along with the money to make sure that the next producer is successful is crucial. Many young people have a difficult time in a small-agency environment because there's rarely much sales management direction from the owner and usually no contemporaries with whom to share experiences. You have to create an environment of open communication, understanding, and discipline to keep them motivated and focused. And before even looking for that new salesperson, make sure that the office staff is as technically capable and as enthusiastic as possible. The owner/producer must have already started the delegation process and have developed a staff that can play a key role in placing the new accounts and servicing the business that the new producer writes. If the CSRs have become lazy over the years or if they have a poor attitude or a 'wrecker' mentality, they will guarantee failure for even the most brilliant of candidates.

Here are some key items to keep in mind when hiring and developing that new producer:

  • If the agency is located in a small town, find a self-starter who wants to stay in the community, and train him or her in insurance. Company field reps or underwriters from hundreds of miles away have no local connections are often uncomfortable in rural communities.
  • Give the person some accounts to handle to provide a basis for referrals and some meaningful initial work activity.
  • Treat a salary as a draw against future commissions produced (not a guarantee), make sure that the producer knows what he/she must do to validate, and put it in writing! Try to get a subsidy from an insurance company for the initial draw, but do not pledge more premium growth than you can attain.
  • Consider offering a deferred compensation plan so the producer can vest in the book of business in return for a lower upfront commission percentage. This will help with the cash flow now and provide a basis to trade that deferred income for agency stock if this person turns out to be a good long-term perpetuation candidate.
  • Set ambitious but reasonable objectives for the number of X-dates, appointments, and sales that will be expected for the first year of employment. And monitor the activity every week.
  • Be prepared to terminate the arrangement quickly if positive activity and results are not apparent after the first six months.

With the addition of a successful producer, the agency can grow relatively happily and steadily until there are 10 to 12 people. This is when the management plateau often strikes. At this stage, more individual and department specialization is necessary, and an increased amount of time must be spent on personnel management. The owners are usually the best producers, and it's not an effective use of their time to spend it managing the day-to-day operations. And most of time they would rather do almost anything but get involved in minor employee issues. The problem is that if the person in charge does not get involved, the small fires invariably become big. Someone must pay more attention to directing, controlling, and motivating the staff.

The obvious solution is to hire a person to handle personnel and systems management while the owners and producers spend their time selling. But an agency with less than $1 million in revenues is not large enough to afford the luxury of a full-time manager. As an interim measure, it is necessary to appoint working supervisors in several departments to help with the daily personnel-management chores. Because the owners are not accustomed to delegating management responsibility, however, this appointment often falls short of expectations. If the necessary authority does not go along with the assigned responsibility, the supervisors cannot provide effective relief and everyone gets frustrated.

The key to delegating is to pick the right person: one in whom the owner has enough confidence that he/she can be relatively comfortable turning over at least some of the reins. The most frequent mistake that agents make in appointing supervisors is that they pick either the best CSRs or the employees who have been with the agency the longest. People with good technical and customer service skills do not necessarily have the ability to effectively manage other employees who may have different levels of experience, training, and motivation. And those who have been with the agency since the beginning might not be as receptive to new procedures, automation, or the needs of the younger employees.

In theory, it's nice to promote from within, but the realities of a small business make this difficult. There are often serious adjustment problems when a person who was a peer one day is suddenly given management responsibility over co-workers. It may also be hard for agency owners to delegate the management authority to someone who has been a CSR. Whether you choose to hire from the outside or to bring one of the existing employees into the position, be sure to test the candidates carefully for management ability. For a working supervisor position, this is a much more important quality than insurance knowledge.

Agencies that are successful in establishing effective working supervisor positions can almost double in size again before they hit the next roadblock, the organizational plateau. This, the hardest plateau to break through, generally happens when there are between 15 and 25 people, although some agencies reach 30 or more in head count before life becomes unpleasant again. It's important to note that more than 90% of the insurance agencies in this country never grow beyond this size. Part of the problem at this point in an agency's development is the organizational turmoil that makes it necessary to change the fundamental management and operating philosophy. The firm can no longer be one big happy family, but must instead become a cohesive business organization with a definite chain of command. There must be written rules, policies, procedures, and regulations that are enforced by all the owners and followed by everyone. Exceptions to the rules cannot be tolerated. In short, for most agencies that have reached this size, having an office manager ceases to be a luxury and becomes a true necessity.

In addition to tightening up the organizational structure and personnel management, an agency at this plateau must also set up and communicate long-term goals for sales, marketing, company relations, staffing, automation, and perpetuation. It is no longer sufficient to work hard; every person in the agency also has to work smart and in concert with one another. There are often several owners in an agency of this size and their own personal styles, objectives, and motivation levels might not be compatible with the overall agency goals or with the operating style of the other owners.

For example, one of the owners may be willing to give up most of his or her sales activities to become the manager. In that case, an appropriate compensation package must be developed to overcome the financial temptation to spend time on sales at the expense of handling management functions. The decisions regarding this compensation issue or other organizational concerns often bring to the surface serious disagreements between owners that had heretofore been swept under the carpet. These differences in philosophy must be identified and dealt with, no matter how difficult the resolution may be. Ignored too long, the disagreements between owners can literally blow the agency apart. If the organizational problems don't get you, the personality conflicts might!

Even in firms where the owners agree on the course of action and a good manager can be found, one more troubling issue becomes critical at this size. With $2 million or so in revenues (and an agency value hopefully somewhat in excess of that amount), getting new people into ownership becomes a real challenge. The second most important requirement of a successful perpetuation plan is an affordable value. In an agency of this size, the remaining three owners may be able to buy out the 50% older owner at the Buy-Sell formula value of 1.5 times the average of the last three years' commissions, plus or minus balance sheet. But can they then find younger people who are able to pay in excess of $1,250,000 to take over that 50% interest and stand in line to buy out the interest of the next three guys at the same formula? Certainly there are ways to mitigate tax consequences by trading deferred commissions for ownership. But there is a finite amount of money available through the agency and if you give the new owners a big discount to 'buy in,' there won't be enough cash available to retire the next group.

As I've written in another article, a stand-alone agency can bring less money to the bottom line than a fold-in operation. And an internal perpetuation plan is a stand-alone situation with few pro forma adjustments available to help get more profit (and value) to the bottom line. In a smaller agency, perpetuation transfers can often be accomplished by using the money that had been paid to the retiring owner in compensation to fund the buyout. In a larger agency, the retiring owner has often not been making as much money as his retirement payments would be under the current Buy-Sell Agreement. This is a very real problem that only becomes worse if the perpetuation issue is not dealt with in conjunction with the organizational issues at this plateau. Growing further without deciding how to bring in more players to help buy out the current owners only compounds the problem.

Our best guess is that there are from 3,000 to 5,000 independent agencies in this country that have broken through the organizational plateau and have addressed and perhaps solved the perpetuation issue, either by getting enough new people into ownership, setting up an ESOP, or consciously deciding that they are building the agency to sell it to a third party. They are continuing to grow beyond $3 million in total revenues with a number of owners and are operating like a true business enterprise. The next major challenge that these agencies face is the market plateau, the real or perceived saturation of their traditional marketing area.

The first thing to do when sales start to slow down and excuses increase from producers about 'no more accounts to write' is to gather the statistics to figure out if there is indeed any more desirable business to target. It may be that a more direct approach to sales will be necessary with sales centers, target marketing, and cold calling. If a concerted sales effort has not been launched in the past, the 'saturation argument' might only be an excuse. But saturation may indeed be reality. In that situation, the owners must decide: whether to expand into a new marketing area through acquisitions or opening sales offices; whether to concentrate on other lines of business such as Life and Health insurance; or whether to go into niche marketing with statewide or nationwide programs.

As is the case with other plateaus, making these expansion decisions involves taking on more financial risk and making significant organizational changes. Owners have to weigh the operational changes against their perpetuation plan and decide how much desire and energy they have to move forward. Major change requires a significant level of commitment. It's better not to enter into it if the effort will be half-hearted.

The late Carol Hammes, principal of The Middleton Group, was one of the Independent Agency System’s most widely respected management consultants. She will be sorely missed.

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