KEEP A CLEAR FOCUS ON FINANCIAL MANAGEMENT
by Carol Hammes
The hardening market, together with the start of new year give you the perfect opportunity to reflect on how to improve your business. This document by Carol Hammes offers an analysis — with hard data — that you can use to evaluate your situation relative to others nationwide. NOTE: Although the statistics are from 2000, the analytical principles are not time sensitive.
A cautious sense of optimism has begun to invade the independent agency ranks. Firms that have struggled with soft market conditions in Commercial lines over the past decade are now seeing premiums and commissions per account increasing, sometimes at more than 20% over last year’s levels. At last the end is near!
But savvy agency principals are recognizing that the 'end' of the soft market might not be as decisive or as lucrative as it was in 1986. The financial disciplines that have been developed and honed over the difficult times can’t be forgotten as renewal premiums go up.
For one thing, the new market might not last long. Many experts are looking at less than two years of hardening before the downward trend begins again. There’s simply too much capacity out there and alternative/specialty markets are much more willing to handle difficult risks than they were the last time. These choices, as well as the heightened sophistication of insurance buyers, will undoubtedly take the edge off of the hardening market and might cause it to fizzle out relatively soon.
Another thorny issue involves the much higher level of operating expenses for most agencies. Compensation is increasing faster than inflation and the need to commit a substantial amount of dollars to automation will be ongoing.
The third threat to increased profits is the changing requirements of insureds and prospects. To meet the needs of today’s and tomorrow’s customers agencies must revamp their traditional ways of approaching, servicing, and communicating with their clients. This means that you might have to sacrifice high productivity levels and some profits to support new marketing initiatives and servicing programs. In short, now’s not the time to rest on your laurels and prepare to reap the rewards of the hard market. Know where your revenues are going, budget carefully for the future, and keep writing more new accounts.
EVALUATING FINANCIAL STATEMENTS AND ESTABLISHING PRO FORMA AND BUDGET RELATIONSHIPS
There are two ways to approach the evaluation and budgeting process. One is to determine the level of expected revenues and set expenses from that. The other is to start with projected expenses and work back to the level of revenues you’ll need to support those expenses and produce the targeted pretax profit margin (usually 18% or more). With either method it’s essential to conduct a review of the prior year’s results and compare them with the average agency in your size range. If you haven’t done such a review in the past, I’d recommend that you evaluate the five previous years to see how the expense ratios have changed with fluctuating revenue levels and market conditions.
The chart below presents the 2000 average agency composite ratios for four different size groups. The sizes are based on total agency revenues — not premiums — so be sure to select the appropriate group based on these criteria. This year we’ve changed the last two groupings to reflect the increase in agency sizes around the country. The third peer group now ranges from $1,500,000 to $4,000,000 in revenues and the top grouping includes agencies with more than $4,000,000 in total revenues.
The first four composites represent the average results (not the median) of hundreds of agencies nationwide. Because these ratios are averages of all of the good and mediocre firms they’re not necessarily recommended levels, but they do provide a good starting point for comparing your agency’s results with your peers. Identify areas in which your experience varies from the norm and determine whether these variances are desirable or even acceptable. If they aren’t, take steps to improve your performance this year and beyond. Remember, every additional percentage point in an expense ratio translates into a reduction of 5% of total agency value.
| THE MIDDLETON GROUP |
| Average Agency Income & Expense Composite Ratios for 2000 |
| Suggested Pro Forma Ratios for 2001 Budget |
| | | | | | |
| | Actual 2000 Averages | Suggested |
| Agency Revenue Size Range | Under | $600,000 | $1,500,000 | Over | Pro Forma |
| $600,000 | $1,500,000 | $4,000,000 | $4,000,000 | 2001 Ratios |
| | | | | | |
| P-C Commissions & Fees | 84.7% | 81.8% | 81.4% | 78.2% | 65.0% |
| Life & Group Commissions | 8.1% | 9.7% | 10.7% | 11.7% | 25.0% |
| Contingents | 5.3% | 6.2% | 5.7% | 7.1% | 7.0% |
| Investments | 0.9% | 1.6% | 1.8% | 2.5% | 2.0% |
| Miscellaneous | 1.0% | 0.7% | 0.4% | 0.5% | 1.0% |
| TOTAL REVENUES | 100.0% | 100.0% | 100.0% | 100.0% | 100.0% |
| | | | | | |
| EXPENSES | | | | | |
| | | | | | |
| Brokers Commissions | 1.0% | 1.1% | 1.5% | 2.2% | 0.0% |
| Travel & Entertainment | 1.5% | 1.7% | 1.7% | 1.9% | 1.5% |
| Automobile | 2.0% | 1.8% | 1.2% | 0.9% | 1.0% |
| Advertising | 1.1% | 1.7% | 1.8% | 0.9% | 1.1% |
| TOTAL SELLING EXPENSE | 5.6% | &
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