Most insurance agencies don’t budget. They operate on the 'Money-in-the-Bank’ or the 'Sell-and-Hope-for-the-Best’ philosophies.
The Money-in-the-Bank philosophy goes like this: as long as there’s money in the bank, the agency owner feels that he’s doing OK. If agents aren’t intuitive about anything else, they seem to know how much they’ll need each month to satisfy their carriers. They try to have at least that much in the bank (plus their payroll costs) and sweat profusely if the level falls below that number in the critical times for cash flow each month (payroll day, and the week that most company payments are due). When one of the key dates looms, the agency senses a crisis during which the owner pushes hard for agency bill premium collection. In the worst-case scenario, the owner has to supply funding to the agency (hopefully for a few days) or accesses the agency’s line of credit. The only breathing room this agent has is when the contingency payments arrive. Instead of using them as a bonus, he immediately pumps cash into operating funds to bolster the next few months when cash will be needed.
Every owner operating in the Money-in-the-Bank scenario feels a high level of stress. Even when times are good, they look forward to whether the excess money in the bank will float them over the bad months. They tend to spend more than they can afford.
The Sell-and-Hope-for-the-Best agent is the proactive version of the Money-in-the-Bank agent. They feel that as long as new business is sold to bolster the agency funds, expenses and company payables will be met and the call for loans to support operations won’t be necessary. Still, the stress is there, even though it’s met by a desperate continuing push for new business.
Agents who finally mature into the budgeting process (usually at the same time that they begin Strategic and Tactical Planning) do so to slay the dragon (stress) and get control over their business lives.
A budget is a projection of the amount and timing of income and expenses to the agency during the course of a fiscal year. It’s not guesswork. Most expenses are easily budgeted. Review your telephone bills for the last year and you’ll find that, if there are no upward or downward trends, you can budget approximately the same amounts in the same months as were incurred in the prior year. Do this for two or more years and you’ll easily identify if your expense is trending up or down and can budget each month accordingly.
Do the same exercise for each Operating Expense and you’ll have the expense side of your budget fully defined — and you’ll learn more about your agency’s operation that will permit you to implement cost control measures, if necessary.
Revenue budgeting is basically the same process as operating expenses. Income outside of commissions is non-operating income (i.e. bank interest and contingency). If monthly income in this category has a relationship to operating income (i.e. interest can be defined as a percentage of total income in an annual view), it can be projected the same way as we recommend the projection of expenses. If historical non-operating income is unique or has no relationship to commissions, you must use your best guess regarding the repetition, growth, or diminution of those income lines monthly and annually in the next year.
Contingency, by the way, does have a relationship to commissions — but not in the same year. The contingency percentage to determine trending is the relationship between contingencies paid this year and P/C commissions in the prior year (since paid contingency depends on the loss ratio and the growth in the prior year). If you have a long (five years or more) history of contingent incomes, the percentage of those contingencies against prior year commissions defines how to budget contingencies in the next year. Yes, we know that anything can happen in any year, but if you’ve been using contingency money to operate every year and if your percentage contingencies over a five to ten-year period reflect a trend, then it’s appropriate to budget that income line.
Operating income (commissions) should be budgeted differently. Every agency has a retention percentage every year. It’s defined as 'Current YTD Total Less New Business, the sum of which is divided by Prior YTD Total.' If you write $1,000,000 of commissions in one year, the retention defines how much of those commissions will be booked to your agency in the following year. This is a net figure that eliminates new business and is net of lost business, and growth or shrinkage of accounts in the interim. It, of course, includes the effects of rate changes (especially important in today’s hard market).
It’s possible (and probable this year) that agency retention will be more than 100%. If you have $1,000,000 at the end of the year and you lose 10% to lost business, but the other 90% increases by an average of 20%, your agency retention will be 110%.
The other component to agency commission income in the budget is new business projection. Although many agents squirm like a worm on a fishing pole when asked to project their new business for the year, it’s often not a difficult exercise. First, look at the new business generated over the past three years. Rationalize unusual writings (i.e. the one ‘Home Run’ account written a few years ago). Look at the trends and project the new business to be written in the next year based on the trends and the human environment in the agency (do you have more or fewer producers this year? Are all the producers working for a living this year?) Spreading the retention income over the 12-month period is easy. Identify the total commission income generated for the same month last year and apply the retention percentage to that figure to estimate the retained commission income this year. Also look at your new business writings in each month of the year during the past few years. This will tell you empirically which months are your weak ones and strong ones for new business. Project the distribution of your new business for the next year in the same proportion as the new business has been written historically.
Budgeting in an agency relieves the stress of guessing about the agency’s performance. It also lets you manage income and costs more closely, and permits you to make rational decisions about timing cash outlays. Finally, it tells you whether your retention is coming in as planned and whether you’re writing enough new business much earlier in the year than you’d have otherwise known.