Commission reductions have been in practice for a number of years and, given the current expense reduction needs of carriers, there are no reasons to expect this will change.
Carriers will continue to reduce commissions, and if you are ready for them, you will be in a position to survive, no matter what.
While there are specific actions to be taken in direct response to reductions, there are also a number of intangible actions you might consider in order to increase your income, which can positively impact reductions as well.
We will discuss some of the intangibles first. There are three that we would like to feature.
They are as follows:
1. Improve your renewal retention ratio.
2. Improve staff productivity.
3. Reduce your overall expenses.
Improving your renewal retention ratio can have a dramatic impact on your bottom line. Consider the following scenario:
A hypothetical agency produces $1,000,000 in gross commission revenue in 1997. The agency wants growth of 10% in gross commission for a total of $1,100,000 in 1998.
We need to make some assumptions:
- The agency pays its producers 40% of the gross commission for new business and 25% of the gross for renewal business.
- The agency has an expense ratio of 25% of gross commission for renewal business and 80% of gross commission for new business (the expense ratios do not include owners compensation or profit).
- The $1,100,000 gross commission level will remain constant regardless of renewal retention ratio.
- We will use three scenarios
- $1,000,000 1994 commissions at an 80% renewal retention ratio will require $300,000 in new business commission to offset the loss of $200,000, and still provide for 10% growth overall.
- $1,000,000 1994 commissions at an 85% renewal retention ratio will require $250,000 in new business commission to offset the loss of $150,000 and still provide for 10% growth overall.
- $1,000,000 1994 commissions at a 90% renewal retention ratio will require $200,000 in new business commission to offset the loss of $100,000 and still provide for 10% growth overall.
With a renewal retention of 80%, the agency on this basis will generate $300,000 in owners compensation and profit. A five percent increase in renewal retention will add $75,000 (total of $375,000) to owners compensation and profit and a 10% increase will add $150,000 (total of $450,000) to owners compensation and profit.
A small improvement in renewal retention can have a dramatic impact on an agency's bottom line. A loss of a renewal has an even bigger impact, because the agency loses a cross selling opportunity and is not going to get the benefit of a rate increase, increased sales, or payroll audit. They also lose the opportunity to turn the lost client into an advocate and generate referrals from that client.
Advocacy allows the agency to build a wall around the account, which will help keep out the competition. It is a lot easier and much less expensive to grow a relationship with an existing account than it is to create one with a new account. Actions you can take right now to assist in improving retention are as follows:
- Track lost accounts monthly. Know why you lost it. Once lost, add it to your prospect database and prospect it next year. Stay in touch with them after you lose them. Contact them and ask them what the agency might have done to keep the account.
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If the reason was something that you could have controlled, tell the ex-client that you will correct the problem and then do it. When you go back to them, highlight the changes made.
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Price is normally the reason given, but some of the reasons are harder to glean. Price may have given the client an excuse to move because they felt that they were being taken for granted, or because they felt they were having a claim or service problem.
- Look at trending as you track lost accounts. If a particular producer is losing business, but the others are stable, start calling on the clients of the producer with the problem and see if you can determine what the problem is. If you are losing accounts because you don't have a competitive Workers' Comp market, profile your Workers' Comp business and see what is needed. If you need a stand-alone market, identify a book of WC business that can be transferred to a new market and go to see the potential market with a plan. You also need to look at accounts before they are lost. Regular feedback and communication is essential. Customer surveys can be very useful tools. Get everyone in the agency involved in renewal retention. We will devote a future newsletter to renewal retention strategies. The important point to remember, is that you have to make renewal retention a major focus in your agency.
Improving staff productivity is the second intangible. If you are automated, (most agencies are today) this is a much simpler process.
There are two important areas that can impact productivity. The first is that of consistency in processing and the second is an effort to regularly measure activity in the agency.
Your system will provide a multitude of reports in many formats, so you should be able to measure activity.
According to agency management experts, there are many standards by which you should be able to measure performance. Where a person meets or exceeds the standard, reward them and where a person does not, you need to do some training and development, or replace the person.
John Jaques, an agency management expert, says that the average agency should be generating about $170,000 in gross commission per Commercial Lines staff person (Commercial Lines staff person is defined as all Commercial Lines staff, excluding producers).
He says that Personal Lines should generate $87,000 in gross commission per Personal Lines staff and that the agency should have about 680 accounts per Personal Lines staff person (defined as personal lines staff including personal lines sales staff or producers.)
Anyone on Personal or Commercial Lines staff should be counted, as long as their duties are in either area.
Administrative personnel are a separate category. If you can improve every Personal and Commercial Lines staff person's productivity by 10%, you will have increased your revenue with literally no expense investment in either the sales or administrative area.
A good agency system today can measure activity by staff person, and you should be able to look at monthly activity reports, which will tell you what each staff person is doing and whether or not they are doing it consistently and according to agency procedure.
Just think of the benefits of being able to see at a glance where the inconsistencies are and being able to do specific training to correct them. If everyone is doing tasks the same way, think of the positive impact on errors and omissions risk management. If you carry a $10,000 deductible on your E & O and avoid one claim, you have made an impact on profits.
The other productivity problem most automated agencies have is that they still operate with basically two systems. One is the automation system and the other is the continuance of a paper filing system.
The answer obviously is converting to "Transactional Filing" and the discontinuance of paper files. In fact, in E & O cases, if it is deter-mined that you maintain both automation and paper files, the courts will probably not allow the use of automation files and require the use of paper files. Many agencies use automation files as the major source of information and paper files as backup. As a result, the paper files are normally not very well maintained or organized. Once this is demonstrated in court, you have lost the case.
Of course, transactional filing is a major move and not one you should take without planning and training. (We will feature Transactional Filing in one of our future newsletters.)
With transactional filing you will only maintain computer files and they will generate activities as they are worked on. CSR's and producers should both be able to handle client requests as they come in by mail or on the telephone. If a change comes in by telephone, the customer file can be "pulled up" on the screen and the changes made right on the system as the CSR or producer is talking to the client. The letter to the company as well as the change request can be automatically generated and suspenses set with only a few key strokes.
Each activity is recorded in the system using an activity code and at the end of the month, activity reports can be produced for agency management which list all activity by code and the number. It is a foolproof way to track what is being done by each of them and they can be used to compare each of them.
They would also make exceptionally good training tools, as any inconsistency in processing and code use should show up.
Activities could be used as the basis for an internal audit, so that you can check and confirm that agency procedures are being followed consistently.
The result is that productivity improves. Just running one system will improve things and this further activity with respect to activity measurement, will improve things even more.
The last intangible is that of expense reduction.
There are many expense items to consider. One of the best ways to control expenses is to review them every month. That means to sit with your management and determine where expenses are not in line with budget. You can do this review very easily with a computer-produced variance report and look at any expense item that exceeds budget by a preestablished percentage and determine why.
Sometimes, it is useful to look at each budget item on an item by item basis and understand what makes up each one by reviewing general ledger entries, the sum of which makes up the budget item.
The point is that the budget process needs to be formalized and the review needs to be on a regular basis. When you are doing better than expected, (budgeted) determine why because you may be doing something in that area that you might want to carry over into some other expense areas.
On at least an annual basis, (preferably semiannual or quarterly) review all expense items in your budget and survey your staff about the use of things like:
- Memberships
- Subscriptions & publications
- Entertainment
- Travel
- Advertising
- Education & training
- Rent (if you are a tenant)
- Do you have more space than you need?
- Are you using the space efficiently?
- Supplies
- Equipment repair
- Etc., etc.
The biggest expense items you will have are payroll and benefits. Do shop your benefit program every year and try to negotiate the best price after you get a quote, especially with the carrier who is your current provider, assuming your experience has been good. (After all, your clients do it to you and this is a large expense to an agency.)
On payroll, always keep looking for areas where you can combine duties or absorb a position into two or three positions if someone leaves. Get out of the process of thinking that when someone leaves that their position needs to be filled by a replacement. By measuring activity, (discussed above) you should be able to determine the impact a lost person might have on your operation and take appropriate action.
You might find that you can pass off some duties and then hire a part time person for the rest. Normally, you do not have to provide benefits to a part-time person, so that would have a double impact on expenses. The last item is to pay for performance and not just time on the job. Activity based performance can be measured and reward an improvement in productivity. The other equation in this process is to reward the person who not only improves their productivity, but also consistently operates within agency guidelines; ie, follows workflow, provides feedback so that you can continue to improve, and constantly demonstrates a positive client relationship.
For those who do not perform to expectations, they are your candidates for "up or out" handling. (They either progress positively or they will be replaced.)
We have discussed intangible strategies to deal with commission reduction and now we to focus on the tangibles.
First, we have addressed this issue from the standpoint that carriers would employ commission reduction as an expense lowering tactic.
There is another commission reduction situation that may impact an agency as well. We have to also consider the fact that in a soft market, because renewals are being written at lower prices, commission is reduced in proportion to the premium reduction.
The tangible strategies we will discuss here apply to that situation as well as the company commission reduction.
There are five tangible strategies that might be employed and they are as follows:
- Use company relationships as a vehicle to either get concessions or improvements in profit sharing, expense allowances, advertising, or association reimbursement.
- Roll a book of business over to a carrier who will give you enhanced commissions or who will give you a first year increase and/or who will assist with the rollover, so that you don't have to spend a lot of your own office staff time to do it.
- If you pay producers for Personal Lines production, new and renewal, eliminate renewal commissions first and turn all servicing over to your Personal Lines CSR staff. If you do not now pay Personal Lines renewal commission to producers, consider reducing the new business commission for producers and turning more of the new business production activity over to your CSR staff. Have the producer do less for the reduced commission.
- Take specific actions to improve your cash flow and to reduce agency debt service.
- Reduce your agency receivables and bad debt write-offs.
The list is not limited to only five, but that is what we will focus on in this letter.
The first tangible strategy: "Use company relationships as a vehicle to either get concessions or improvements in profit sharing, expense allowances, advertising, or association reimbursement." This is self explanatory.
If a carrier announces a commission reduction, you may be able to negotiate an extension of time before the reduction takes over. If you have a "Preferred Agency" contract with your carrier, they may have guarantees built into the contract which automatically will lock in com- mission levels and require a one-year advance notice of a commission reduction. The point is that if you have a good loss ratio with a carrier and you have made an underwriting profit over a three to five-year period, you may be in a position to dictate or at least negotiate terms.
Of course, the message is that you need to be in a preferred contract mode with your carriers. Planning efforts should be focused in this direction. You need to have sufficient profitable volume with a carrier, so that you have a degree of control.
If you cannot get concessions on a reduction, try to negotiate better terms on your profit-sharing agreement, including a growth bonus if you meet some pre-agreed commitment.
If that does not work, see if you can get money from them for some marketing help, advertising, or association or industry support organization. Even a direct mail campaign, where the carrier picks up postage costs, may help.
Your agency may be able to get an expense allowance for some services you perform for the carriers. For example, if you have draft authority for claims, you may be able to talk them into an allowance for handling claims for them. If you have a preferred agency contract, you may be able to talk them into some concessions.
The second strategy that might be employed is to roll a book of business over to a carrier who will give you enhanced commissions, or who will give you a first year increase and/or assist you with the rollover.
If a carrier is willing to take a good book of business and has a higher commission level than the carrier which is reducing commission, you can maintain your income level and put yourself in a position with the new carrier to grow. If you don't have a preferred agency contract, this may be the missing ingredient to obtain one. You may even be able to talk them into a one-time rollover bonus commission and you may be able to get a time-bounded commitment to guarantee that they will not reduce your commission for an agreed upon time frame.
The key is to think ahead and get commitments and concessions up front. For example, your profit sharing agreement may not have a built in growth bonus and if your loss ratio is acceptable when profit sharing time comes around, you may be able to get them to commit to a growth bonus as well.
There are a number of carriers who want to grow their Personal Lines book of business and you may be able to do some consolidating and benefit your agency in the process. The timing may be right to attract a new carrier which is interested in some new and profitable growth and is willing to pay for it.
There are also carriers who want small Commercial business and you may be able to make a deal with them to move a block of business to a service center. We are not enamored of service centers under the best of circumstances, but there are some agencies with which they may be compatible. The key is to stay in touch with your clients so to offset the negative impact we feel service centers have on "your" client relationship.
The key is to bargain hard before the commitment is made. Get the best commission deal you can and don't feel you have to roll over on renewal commissions and take whatever they are willing to give you.
If your book is profitable and growing, don't give it away for a short term gain. If you roll a book and the carrier assumes the expense of rollover, have your staff devote some real time to prospecting the business for other P-C lines and also Life insurance, so you can even generate some additional revenue in the process.
Strategy number three is to eliminate P-L renewal commissions to producers and turn all servicing over to your personal lines CSR staff. If you do not pay producers renewal commissions on personal lines, consider reducing producer new business personal lines commission.
An easy way to do that is to take them out of the process and let them refer clients to the personal lines unit. Pay the producer a one-time reduced commission for referring the business and let the P-L staff write and service it. Most agencies today do not pay Personal Lines commissions to producers anyway. Make it a part of each producer's planning to refer a certain number of Personal Lines accounts each month and then compensate them one time for those referred. If you have them focus on Commercial Lines clients and the employees of the clients, you put yourself in a much better position to keep the client on the books anyway.
Strategy number four is another step that can be taken. You need to take specific actions to improve your cash flow and to reduce agency debt service.
There are a number of actions that may be taken to improve cash flow. One step is to generate a return on the cash you are able to collect and use for a time. Another one is to binder bill renewals prior to renewal time. Even if you don't collect the renewal premium until the actual renewal date, you should be able to generate revenue from the collected premium for 30 to 45 days. Every day you collect prior to actual renewal date adds to revenue.
Never pay a bill early unless there is an offsetting interest savings. Try to get extended terms on any obligations you have as long as there are no penalties for doing so. Time credit card purchases so that you have the maximum time in the billing cycle to pay it off. Normally, you can pay off the entire credit card balance without any interest if you pay it within the allowable billing time. That can normally give you a 30 day float on your money, so long as you don't have to pay any interest.
Negotiate any purchases, especially major equipment or services. It is commonplace in business today to negotiate. Don't just take the first price quoted and take the time to shop any major expenditures. You should do it as a matter of course. Your clients do and if you are naive enough to think that they don't, go to one of your renewals with a renewal quote 10% higher and see if the client gives you a renewal order automatically.
Agency debt service is another cash flow problem. Most agencies have debt service. Your planning should always address debt service reduction. If you buy an agency or a book of business, try to buy it using its own cash flow to pay for it. Try not to get yourself in the position of having to pay for business which has been or will be lost. Pay only for renewed business. While some debt service is tax deductible, make it your policy to take windfall profits like profit sharing and use them to pay off or reduce debt.
With the exception of premiums collected early, it is very difficult to generate any revenue on money owed to someone else, so keep it at a minimum and as an emergency measure only. Sometimes it is better to lease a piece of equipment rather than buy it, if you can get the right terms.
Whether you purchase or lease and you still have to pay something to someone. Go into it to with the right attitude, and you'll have the advantage!
The last strategy is to reduce your agency receivables and bad debt write-offs. This one is obvious. Agents are not selling when they are collecting and by establishing an agency credit policy and sticking to it, you can spend more time on sales and less on collections.
Get sufficient deposits and don't bind anything without either full premium or a proper deposit. Have your producers tie down payment terms before the account is bound and written. Monitor and enforce uncollectable audit payment provisions so they are turned back to the carrier when they are delinquent.
Monitor producers who have consistently large additional premium audits or who have a higher than average ratio of over 30-day receivables.
We have discussed receivables in past newsletters, so we won't spend a lot of time on this topic other than to say that this is an ongoing process and needs constant attention.
Always remember that uncollected receivables are premiums offset with commissions, and if you are placed in the position where you have to offset them, you lose!
Control them and make your producers and staff responsible and accountable. They should have a minor impact on outcomes and more important, if you don't have the problem, you are able to spend more quality sales time.
This should assist you in dealing in a practical way with commission reductions. Taking action and incorporating some of these strategies into your planning should place you in a positive position to deal with this eventuality.