Make sure that you’re getting all you can out of your contingencies.
According to the Academy of Producer Insurance Studies, the average independent insurance agency with annual revenues of $250,000 or more spends between $1 and $1.08 in operating costs for every dollar of earned commission. So, how can agencies afford to stay in business? The answer: Contingency bonuses. Contingency revenue is pure profit. However, most agents don’t use contingencies to their best advantage. By using contingency contracts strategically, agents can increase their bonuses by 10% to 500%.
In essence, contingency bonuses are profit-sharing dollars that a contracted insurance company pays to an agency if the agency achieves predetermined premium volumes, loss ratios, and other objectives. Insurance companies offer contingency bonuses because they feel that agencies have a certain degree of control over loss ratios. The bonuses serve as an incentive for agencies to perform in-house underwriting functions before submitting applications to a company.
Contingency contracts vary by company, and the best contract for one agency might not be the best for another. That’s why it’s important to analyze all contingency contracts and their possible outcomes thoroughly before selecting one.
I started analyzing contingency contracts while working for an insurance company. A competing company offered one of my clients a commission percentage that my company couldn’t match. However, I knew my company had a very good contingency program and that my client would probably qualify for a contingency bonus every year. I analyzed all the agency’s variables and realized that the client would make more money in the long run by placing business with my company than with our competitor, despite its higher commissions.
A number of years ago, I created my own consulting company to help independent agents analyze their contingency contracts. Analyzing contracts isn’t necessarily a difficult task, but it’s time-consuming and requires knowledge of the contracts available.
When agencies hire me to perform reviews, I ask for copies of their contingency contracts, and their contingency statements and production documents from the past three years. From these, I can determine the agency’s volume, mix of business, loss ratio, retention rate, and growth rate. Once I have all this information, I plug the figures into each of the available contingency contracts. I run 20 to 50 scenarios to identify the contract that will best suit the agency. I also analyze all the different aspects of each contract so the agency can maximize its earning potential with each company. For instance, I’ll analyze which stop loss limit is best for the agency (if more than one is available), or determine whether certain lines of business should be placed with certain carriers.
Of course, you shouldn’t place business with a company just because it has a great contingency contract. Other factors must also be considered. However, a lot of business, especially in Personal Lines, is interchangeable. With such business, it usually doesn’t make a difference which company writes it because the coverage, price, and commissions are all similar, if not identical. You should place this business with the company offering the best contingency contract.
THREE QUESTIONS TO ASK
To determine which contingency contracts to use, first ask yourselves three questions:
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Which contract pays the most?
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How does each contract fit the agency?
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How does each contract work?
Which contract pays the most?
The only way to know which contracts pay the largest bonuses is to compare them on an apples-to-apples basis. I’ve found that using computer models is the best way to make this comparison. By using the computer models I’ve developed, I can instantly calculate what each company will pay for a given set of results. These charts clearly show that a huge difference exists between the contingency bonuses offered by companies that otherwise have the same basic commission structure.
How does the contract fit the agency?
No contingency contract is best for all agencies. Because each agency is unique it will obtain a unique result from a given contract. Make sure that their contracts fit your agency’s business. Let’s say that ABC agency, having a 40% loss ratio, a 1.01% growth rate, and 84% retention, would benefit more by placing business with company E at up to $1.75 million in premium volume; but with $2 million or more in premium volume, it would be more beneficial to place business with company A. The XYZ agency has a 40% loss ratio, an 8.7% growth rate, and 86% retention. This agency would benefit more by placing business with company A at any premium volume. Company A rewards agencies with high growth rates, while company E does not. This is a great example of how different contracts fit different agencies.
How do contracts work?
Many factors go into a company’s calculation of a contingency bonus. Almost all bonuses are based on a percentage of the profits an agency generates for a company; given a certain loss ratio and volume, the agency will earn a specific bonus. However, several other factors might play a role in how a company structures its contingency bonuses:
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Expense loads. Some companies subtract from profits expense loads ranging from 5% to 45% of total profits. The loads are set by a company at its own discretion. Contracts that don’t include expense loads are usually better than contracts that do because they give an agency more control over its earning potential. Expense loads often include commissions, loss-limit charges, company expenses, and loss expenses.
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Loss reserves, adjustments, and expenses. Companies vary in how they treat losses for contingency purposes. Some do not credit agencies when the carriers make large reductions in claim reserves; others give only partial credit for such reductions; and a few give total credit. Some companies increase their loss reserves every December, which could eliminate any chance for an agency to earn a bonus.
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Additional bonuses. A few companies have other bonus plans in addition to their regular contingency bonuses. Sometimes, these bonuses can increase total payments by as much as 50% and can be earned easily. These additional bonus plans must be evaluated individually and often can be negotiated in favor of an agency.
Once you determine which contingency contracts are most beneficial, the next step is to determine whether you’re eligible for the best contracts and to measure your bargaining power. To qualify for better contracts, agencies should have adequate premium volume. With higher volumes, agencies can qualify for companies’ best contracts and have more bargaining power to negotiate better deals. Most national companies require an agency to have a minimum premium volume of $250,000 to $1 million to qualify for contingency bonuses. However, an agency usually needs at least $1 million in premiums to have any bargaining power. Smaller agencies with lower premium volume might choose to work with regional companies. Some regional companies offer significantly lower contingency thresholds than the major national companies — sometimes as low as $50,000. Small agencies can also consolidate their business with fewer companies to generate an adequate amount of business per company. Compare all available contracts. Then, when attempting to negotiate a better contract with a carrier, you can prove that the insurer pays substantially less than what other companies would pay for the same book of business.
Most companies are fairly receptive to negotiation, and will consider changes at any point during a contract period if the negotiating agency has a good loss ratio and adequate premium volume. However, autumn is usually the best time of year to negotiate. Most contingency contracts are renewed annually, so company marketing representatives are under pressure to get new contracts signed by January 1.
Some companies will even negotiate items other than contingency bonuses. Negotiable addenda might include higher commission percentages or enhanced contingency contracts. Many companies have a basic contingency contract but offer additional bonuses under an addendum. Some companies offer as many as five or six of these additional bonuses. But to return to the contingency contracts themselves, agents often negotiate how loss reserves, “take-downs” (reductions in loss reserves), and IBNRs affect contingency bonuses.
- Loss Reserves. Assume that you have a one-year contingency contract without any kind of averaging or carry-forward provisions. If one of your clients has incurred a large loss for which the principals believe the insurance company has significantly under-reserved, and the agency’s loss ratio is already too high to receive a contingency bonus for the year, you should negotiate with the insurance company to set its loss reserve as high as possible for that year. Because you’re not going to make a bonus for the year, you have nothing to lose. If, on the other hand, the company waits until the following year or beyond to increase the loss reserve to an appropriate level, your loss ratios — and contingencies —will suffer for an extended period.
- Take-downs. Many companies have contract provisions stipulating that agencies won’t t be given credit for negative loss ratios. For contingency-calculation purposes, the best loss ratio you can achieve is zero — even if the loss ratio in a given year is really less than that. Normally, the only way a loss ratio can become less than zero is if the company makes a large reduction in a prior year’s reserve. When a company does this, the agency often loses twice: first, because the initial loss reserve is probably set too high, thus reducing the agency’s contingency; second, because the agency probably won’t receive full credit for the reserve being taken down if it reduces the agency’s loss ratio below zero. Sometimes, agents can negotiate at least partial credit for negative loss ratios. Take-downs can be confusing and are often a source of agitation for agents.
- IBNRs. If a company counts IBNRs (incurred but not reported losses) against contingency bonuses, it’s in your best interest to find out how much in IBNRs is being charged. I’ve seen cases in which IBNRs have been set so high that it was virtually impossible for an agency to earn a contingency. Agents very rarely have any control over IBNR charges — but if they feel that a company’s IBNR limit is set too high, they have two choices. They either can try to negotiate lower charges or they can just move their business to another carrier. It’s important to find out what IBNRs have been set within the past few years. They seldom vary by more than one or two points.
- Mistakes. Finally, be on the lookout for mistakes in contingency contracts. We find a fair number of mistakes in contingency calculation — often to agents’ disadvantage. Discrepancies can occur if agencies and companies record sales differently. For example, if an agency’s cutoff date is one day off from a company’s cutoff date, the agency’s numbers can come out quite a bit different from the company’s.
CONCLUSION
While it can be time-consuming, contingency contract analysis should be a part of every agency’s agenda. If you’re not using contingencies to their utmost advantage, you’re leaving a lot of money on the table. The only catch to making more contingency money is that you have to ask for it! I recently spoke with about a dozen insurance company marketing reps, all of whom agreed that they would increase an agency’s contingency compensation if the agency made a solid case for such action. When I asked if they would pull out of an agency if it tried to negotiate for more money, they all laughed!! As one rep recently told me, “We’ll always pay a good agency more than the standard amount if they ask for it — but they have to ask.”
A contingency bonus of $25,000 equals the average profit (not commission or revenue) an agent would earn by selling $357,143 in additional volume. Which is easier: generating $357,143 in business or analyzing your contingency contracts? If you want to make more money without selling any additional policies, making more cold calls, or cutting expenses, analyze your contingency contracts and use them to your advantage!