Carriers have made a huge mistake. Most do not yet get it. Some never will grasp the mistake they’ve made. Some will know but will forever deny they have made the mistake. However, it is a strategic mistake nonetheless. This mistake has created great opportunities for a few specific entities and for a few very intelligent companies — and significant opportunities exist, for a short time.
The proximate cause of the mistake was when companies quit appointing and developing new agents. The old Aetna (when Aetna was a large P/C carrier for those who do not know) had an innovative new agent program as did a few other companies. Somewhere along the way, someone calculated that these programs were too expensive and/or the return-on-investment (ROI) was too poor. Quite similarly, companies looked at the success rate, on a volume basis, of new agents and determined the results did not justify the hassles of dealing with new agents.
Given the costs and success rates I saw, their decisions were reasonable based on the time frame considered and the limitations that existed at that time. The decisions were not even short sighted because the negative effects were not realized for at least 10 to 20 years. Most companies’ analytical systems are inadequate to identify the cost today either, but a large cost is definitely being incurred.
Insurance companies are different from other companies. Insurance companies need to be around for decades and decades. This is a text book example of a bad financial analysis because the time frame used in the analysis was wrong. System limitations, text book “seven” year limitations, or CEO time to retirement was substituted for the decades-long consideration applicable to insurance companies.
Focus on Agency Perpetuation
When companies decided to not appoint new agencies, they began focusing on agency perpetuation. An emphasis on agency perpetuation, and it is now a top priority for many carriers, is also misplaced. The true concern of carriers is not agency perpetuation. That is nothing more than a diversion to make everyone “feel” more constructive. The real issue is their fear of large roll-ups of their agencies by private equity and the public brokers. Make no bones about it, they would not be nearly as concerned with agency perpetuation if the roll-ups were not occurring.
Agency perpetuation from a carrier perspective is a play to not lose strategy. They emphasize perpetuation because in a perpetual soft market, most companies are at a disadvantage to serial buyers of agencies. The carriers are trapped because they need that volume desperately. Small agencies have no negotiating power. The rollup firms and others have tremendous negotiating power. Additionally, they do not have to perform as well because in some cases, they are wagging the dog.
By not appointing new agents, the source of new agents dried up, as did the ability to offset the rollups and aggregators. Agencies were never ever going to be perpetuated 1:1 or one perpetuation for every two retirements. Most agencies were never run well enough to perpetuate in the more demanding conditions of today’s market.
The buyers buying these agencies don’t seem to be running them any better and sometimes they are worse. However, with the volume, today’s buyers don’t have to run the agencies as well relative to their carriers in a perpetual soft market. The dam hasn’t completely broken, but it is leaking profusely.
Failure to Understand
A long time passed between the initiation of this process and today. Many CEOs have come and gone between the decision to not appoint newly created agencies and today’s consequences. From some CEOs’ perspectives and wallets, it never will be a mistake because as the roll-ups get larger, more pressure will be applied to insurance companies to merge, which we are seeing.
Most selling CEOs make a fair bonus/send-off when they sell their companies. The industry does suffer though because the more concentrated it becomes, the new agencies and the new entrepreneurial blood still can’t find a home unless they promise to sell billions over the internet. When this occurs, it appears some companies appoint these new Silicon Valley agencies sometimes without even verifying all the parties have the appropriate licenses (that subject is for another article).
The key elemental, analytical mistake company analysts/consultants made was the failure to understand how insurance is truly sold in the insurance agency spectrum.
The vast majority of P/C insurance policies were sold by small, less than five-person offices. Insurance is sold on a personal basis (albeit, getting less personal daily). This means that as people retire, the personal relationship is lost. This means it has to be replaced by new blood building new personal relationships. A large proportion of all new blood that wants to build new relationships wants to run their own agency (as proven by all the small shops). This means that internal perpetuation on a wide scale is more a wish, a dream, than a reality. The human is the deciding factor.
Perpetuation is not about money/financing especially in today’s flooded, monetary-easing world. It is about new blood wanting their own agency and wanting to build their own agency from the ground up rather than buying into an existing agency and dealing with someone else’s relationships.
This is a key reason a few organizations that provide carrier relationships to start-up firms have been so incredibly successful. Per the advertisements of one such organization, they have assisted in 3,500 new agencies. They recognized the carriers’ strategic mistake and took full advantage of it.
New Blood Agencies
Once all the nonorganic income items that do not involve U.S. retail sales are eliminated, and especially after adjusting for premium inflation, publicly traded brokers have achieved collectively less than 0 percent organic growth the last five or so years, according to public SEC filings.
Yet the small agencies that companies would not appoint directly are writing the small commercial and personal lines and growing organically faster than any other market segment. They rake in the sales. Approximately 6,000 new independent agencies alone have been created in the last five to eight years, but almost all are writing through other organizations. The companies still do not understand the value of direct appointments. Even if these new agencies never write more than $1 million premium, that is $6 billion premium! That is the minimum and they had to write this from scratch so it is pure organic growth. That is likely what they have already written, with more to come.
The industry has only grown $74 billion in total over the last five years. According to A.M. Best, of that, State Farm accounts for $7 billion, Berkshire (including GEICO) accounts for $10 billion, Allstate accounts for $4 billion, USAA accounts for $4 billion, American Family accounts for $2 billion. These five carriers accounts for a total of $27 of the $74 billion in growth. If you add Progressive ($5 billion), Farmers ($1 billion), Nationwide ($4.5 billion), the total increases to $37.5 billion, roughly half of the entire industry’s increase.
Compare this to Travelers ($1.4 billion), Liberty Mutual ($3.3 billion), Ace/Chubb ($1.7 billion), Hartford ($0.7 billion), CNA ($-0.2 billion), Erie ($1.6 billion), Auto-Owners ($1 billion), Tokio Marine including Philadelphia ($1.7 billion), Fairfax ($0.9 billion), Cincinnati ($1.3 billion), Great American ($1.4 billion), Hanover ($0.5 billion), and MetLife ($0.5 billion). Combined, these are the top independent agency carriers by size, and they have increased by $15.8 billion with premium inflation. The new agencies have contributed a minimum of $6 billion of this!
During this time, rates and exposures overall have increased by approximately 3.5 percent annually for the entire industry (for a total of 16.8 percent). Therefore, a carrier writing $10 billion in 2011, should be writing approximately $11.7 billion in five years, a $1.7 billion increase. Obviously then, much of these carriers’ growth is due to nothing more than rate increases and some exposure growth. (For example, the top 30 carriers combined wrote $314.9 billion in 2011. With a 16.8 percent expected increase, they should have written $367.8 billion in 2015. They wrote $370.1 with Berkshire being the main difference because it grew 50 percent). That means the new blood agents likely generated ALL new business!
The opportunity still exists for a few, smart, insightful carriers to use some of their record surplus to bring new life blood into the industry. Recognize it is human nature to want to run your own business as the key to perpetuation, not perpetuating existing agencies. Share this article with a colleague.
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