Forming A Strategic Alliance

FORMING A STRATEGIC ALLIANCE

by Carol Hammes

A major challenge facing the Independent Agency System today is to provide quality products and services in a more cost effective and user-friendly manner. Firms have been developing new marketing strategies that use a diversified approach to attract and retain customers, including mergers and strategic alliances. Carol Hammes gives you the details about partnering with others in this document. 

A number of strategic alliances have formed between independent agencies, between P/C agencies and Life/Health agencies, between insurance agencies and other financial entities such as banks, and between agencies and insurance companies in which the company might take an ownership interest in part of the joint venture.

To cut marketing and operating expenses, insurance companies are reducing the number of agency relationships and strengthening the commitment required from and given to the remaining agencies. This trend, which has increased dramatically in the past several years, is making it difficult for small to medium sized independent agencies (those with less than $1.5 million in total revenues) to retain company contracts. This situation is increasing interest in mergers, acquisitions, and strategic alliances (also known as joint ventures). Many agencies have joined others to deal with sales/marketing and insurance company challenges, to set up niche marketing programs, and even to make shared-employee arrangements. Some alliances provide all back office support for agencies, companies, and bank agency owners and create a new entity that, from an ownership point of view, appears to be jointly owned.

The key to these arrangements is that they allow the individual independent agent to maintain independence while giving them the economies of scale and marketing presence to access this new marketplace. A joint venture provides a good way to reduce the costs of distributing products and services through the agency system while allowing agency principals to maintain ownership in their books of business. This system can also be good for the bank or insurance company that wants to sell insurance products without taking an ownership interest at the outset.

An alliance can reduce the costs of doing business through the agency system and provide the opportunity to compete with direct writers and Internet sales effectively. But it isn’t something to be entered into lightly. As with any business decision, agency principals should do their homework.

• Will the joint venture enhance the agency’s overall plan and enhance personal and professional goals?
• How might it impact clients and employees?

The various forms of alliances can help agencies accomplish one, some, or all of these goals:

• Establish/maintain insurance company relationships;
• Enter niche marketing programs and/or obtain new qualified leads;
• Reduce expenses;
• Reduce management responsibilities and create more time for sales;
• Implement an ownership perpetuation plan.

Strategic alliances aren’t new in the insurance industry. P/C agencies have been sending business to Life agencies for more than 100 years and sharing markets through various brokerage arrangements. What’s different now is that the combinations are more formal, with separate joint venture agreements for a bank/agency marketing plan, a group of agencies joining together, dissimilar agencies sending referrals to each other, or joint participation in a niche marketing program. These written agreements are vital when the alliance falls apart, or if the parties disagree on how to divide the income.

If a group of agencies join to share markets, the insurance companies become more involved: recognizing and approving the partners, and recording business for purposes of volume commitments and profit-sharing qualifications as though it had been produced by one entity. Insurance company(ies) involvement is a key element, and you should contact the anticipated markets early in the negotiations. Some companies are receptive to alliances, others aren’t. Don’t waste time making irrelevant decisions among the other parties if you don’t have insurance companies to providing underwriting support.

If several agencies are joining, the goal should be to streamline and standardize dealings with a select group of carriers that can satisfy most of the marketing needs and provide some niche programs for the members. This consolidation will allow the carriers to deal with one entity instead of four or five and will enable them to realize productivity gains in servicing both the agents’ and insureds’ needs. The expense savings alone might convince the insurance carrier to join.

SELECTING PARTNERS

Agencies that wish to become involved in a strategic alliance must first identify the partners. These might be other agencies, individual producers, insurance companies, banks, or other financial institutions. Once you’ve identified potential partners it’s time for the 'chemistry test' to see if you have a good chance of success. This evaluation should include:

• Reputation and image in the community;
• Level of professionalism in dealing with customers;
• Personalities, skills, and experience of the people;
• Management style and focus;
• Growth objectives;
• Willingness to invest time and money commitments.

If your alliance will include other insurance agencies, you should also review all of these before signing any agreements:

• Insurance company contracts,

• Premium,
• Commissions and loss ratios for the last three years;
• Percentage of premiums derived from larger (target) accounts and the effects of losing one of these accounts on the joint company premium commitments;
• Fiscal responsibility history, especially with respect to payment of company accounts.

Also, you should make certain decisions during the preliminary negotiations with other agencies:

• Which companies will you share and will each agent be allowed to keep individual relationships;
• Who will have the authority to make which decisions regarding the shared companies;
• How will you divide contingents or other company bonuses/trips;
• When companies require a single account current, what will be the procedure to collect from each agency participant;
• How and when will direct bill commissions be distributed;
• How will interest on premium float be distributed;
• What happens when several participating agents compete on an account;
• Should there be one E&O policy;
• Should there be centralized underwriting and placement with the shared companies?

Some joint ventures might find it advantageous to share more than leads and marketing programs and insurance companies. Strategic alliances that include physical consolidation help reduce such expenses as occupancy, telephone, insurance, computers, advertising, receptionist, bookkeeper, office managers, and professional fees. If a small bank agency joins with a larger independent agency, they might even share technical employees to help service all of the business.

Management fees that each participant pays generally cover any joint expenses. Fees are based on the respective premium volumes, commissions, number of accounts, or whatever else makes sense for the structure of the arrangement. Sometimes it’s a one-time referral fee for providing a lead. Some alliances designate one entity to provide all of the support while the others provide financial support. Others create a separate legal entity with all participants as owners of the administrative corporation or partnership.

Whatever the reason for the strategic alliance, and whatever the form, agency principals must recognize that they’re giving up some of their independence in return for marketing and expense savings opportunities. Disagreements will arise inevitably. Try to anticipate everything that might come up and make decisions ahead of time — in writing — to ensure that everyone knows who has the authority to make what decisions. Obtain written concurrence from insurance companies, and set specific written provisions for fair and equitable termination of the agreement.

If you’re involved with several insurance agencies or in other situations where you’ll have access to each others’ account information, execute non-piracy agreements with all participants and their employees to restrict everyone from soliciting business from each other for the period of the agreement and two years thereafter. It’s also wise to include provisions for injunctive relief and to specify damages in the event of a breach. The contract should have provisions for dealing with changes in ownership of any of the entities, dishonesty, fraud, or the voluntary decision to pull out of the alliance. You should also cover financial arrangements for the demise of the alliance.

Once an insurance agency gets tied up in a joint venture, it might be difficult for that agency to be sold to an outside entity. Joint ventures can enhance the value of the agency by providing extra volume, commissions, and expense savings. But they can also detract from marketability. Implement a buy/sell agreement that provides for the sale of a book of business to another participant in the event of retirement, death, or disability.

In fact, one of the best reasons for entering into a strategic alliance is to facilitate a perpetuation plan. A bank might want to weigh its options in insurance without diving in headfirst. An insurance company might want a taste of retail sales without alienating other agents. An agency principal might not be ready to sell now, but would like to know that their agency had a future in the event of death or retirement. Having that fallback position can be very important for all parties.

An alliance can also give younger producers the opportunity to obtain equity through the production of business. Assume that two agency owners in their late fifties don’t want to sell for several years. Each has identified a younger person in their agency to whom they’d eventually like to sell ownership interest. But the young people are getting restless.

The younger producers can set up an alliance to accrue the value of their books in that entity, rather than in the individual agencies. The new organization will agree to purchase the books of the older agents at a designated time. The alliance can share insurance company contracts, employees, and other expenses, which increases the value of the books of business. This type of arrangement can work very well in rural areas or in family agencies. And if it turns out that the younger people don’t want to exercise their right of first refusal, the combined organizations can actually enhance the value of the agencies and of the newer books of business to any third party buyer. Sometimes bigger is better.

Depending on the type of strategic alliance, there are a number of questions you should ask. If you’re after a loose-knit marketing program, many of these questions won’t apply. But if your purpose is to develop a relationship that might end in a merger or acquisition, then most of them will be important. Remember, if there’s more than one principal, you need to make sure that everyone’s on the same page. Variances within one of the participating organizations can spell disaster for the entire joint venture.

Here’s a list of questions to pose to the ownership group:

1. Are you having trouble attracting and retaining company appointments because you don’t have enough premium volume and haven’t grown appreciably?
2. Are you having trouble getting competitive quotes in this new harder market?
3. Has a review of your profit-sharing agreements and agency contracts revealed that you can’t meet volume requirements for the more lucrative bonus levels unless you gear up the sales effort?
4. Has your contingent income averaged less than 6% of total revenues during the past three years?
5. Are you having trouble finding time to manage the office, maintain the necessary level of service to your clients, and also produce new sales?
6. Would you like to add a new producer, but feel that you can’t support one?
7. Do you lack an ownership perpetuation plan and/or potential candidates for ownership?
8. Are your revenues per employee less than $80,000 (divide total revenues by total number of employees including producers and owners)?
9. Is your payroll (before owners’ bonuses) higher than 50% of total revenues?
10. Are your total operating/administrative expenses more than 20% of total revenues (occupancy, DP, PC insurance, professional fees, dues, subscriptions, contributions, printing, postage, outside services, equipment)?
11. Do you have more office space than you need, or are you running out?
12. Do you honestly feel that after having run your agency for all these years that you could share decision-making on common issues with other agents, or more importantly, with people such as bankers who have a very different outlook on a number of issues?
13. Agents who answer 'yes' to more than half of these questions might be good candidates for a strategic alliance. The most important question is the final one. Agency principals who can’t share common decision-making and who are uncomfortable delegating should find another way to accomplish their goals. Although it’s a viable option for some, setting up a strategic alliance isn’t for every agency.

Reproduced from The Middleton Letter with permission from Carol A. Hammes, CPCU. Carol Hammes can be reached at The Middleton Letter, P.O. Box 459, Pine, CO 80470; (303) 838-7385; (303) 838-7387 Fax; e -mail: [email protected]; Web site: www.middletongroup.com.