Trends 2004: Are You Prepared’

One of the basic fundamentals we stress to our clients is to be proactive, not reactive. In order to be proactive, one needs to understand and exploit current and future trends. Most trends can be predicated by understanding recurring cycles and applying that knowledge to the current situations.

So what will 2004 be like for insurance agents and brokers? The following is a list of major industry trends that need to be factored in to the business plans of agents and brokers.

Hard market to level off

The hard market was firmly in place for at least the past three years. Prior to this, almost a whole generation had lived under soft market conditions! During 2003, many insurance companies have posted losses from various perils and risks, including corporate scandals and the recent California fires.

Typically, the market cycle (hard or soft) is a function of insurance company profitability. In a hard market cycle, the companies have low profitability and react in a few different ways. First, they raise premium rates. Then they look at their least profitable lines of business and either tighten the underwriting or pull out of certain regions or the entire market for those lines or products.

Most insurance companies were profitable during 2003. This trend should continue for 2004, especially since the overall economy for 2004 is looking very good. This market cycle, however, might not be driven by current company profitability, but rather long-term risk analysis.

There is still a great deal of uncertainty regarding future terrorist attacks, the continuation of the U.S. involvement in Iraq and how asbestos, mold, latent defect and other such insurance issues are handled. Because of this turmoil, insurance companies and reinsurance companies are sending mixed signals. Underwriting will still be tight.

It appears that the overall hard market cycles will level off by the middle of 2004. Certain policy risks for certain classes of business in certain regions will continue to experience rate increases and tight underwriting conditions. Some premiums for certain risks might even “soften.” However, overall, it looks like both commercial and personal lines insurance will maintain the current rate and underwriting levels. We won’t see soft market conditions for at least a full year or two.

This trend means that there will be more of the same. Tight underwriting will mean difficulty in placing higher-level risks. With stabilized premiums rates, the customer will have more comfort and agents and brokers will have a better ability to predicate insurance costs.

Fewer companies/less lucrative agreements

Despite the fact that there are some insurance companies making a good profit, there are a fair number of companies in weak financial condition. This is leading to an increase in the rate of companies being downgraded from the rating services. Most likely this trend will continue through most of 2004.This will result in a smaller pool of “A”-rated companies and an increase in the threshold for contingents from the carriers.

The net result is that brokerages will be representing fewer insurance companies and they will be more loyal to the main companies they have the bulk of their volume with. The typical brokerage today continues to have more than 50 percent of total premium volume in their top three markets and the balance is in another five to seven markets.

The flip side will also be true—carriers will want to appoint fewer brokerages and will keep the ones they can depend on for growth. We also anticipate that for certain types of business, more company service centers will be in operation and the companies will try to insist on that route, especially in personal lines and small commercial.

Many insurance companies have changed or even eliminated their profit sharing arrangements. Some have also cut their commissions again. For example, the affect on California firms of the cut in commissions (and possibly contingents) paid by the California State Compensation Fund will devastate many agencies when scheduled rate reductions take effect.

Mergers/acquisitions for strategic reasons

The hard market has improved the financial strength of most firms. Most weak brokerages since the late 1990s have been acquired or died. The trend in the past has been that firms without perpetuation plans, enough carriers, or the volume to satisfy their existing carriers, had to merge or acquire to survive.

About 20 years ago, there were around 75,000 independent brokerages in the U.S. Today, there are estimated to be about 25,000. Most of the firms are still under $2 million in revenues, with only about 150 privately held firms over $10 million in revenues. The industry has already experienced the bulk of the necessary consolidation. Weak firms were bought up several years ago.

For the most part, the remaining force of brokerages is relatively healthy. The frenzy to merge or acquire has taken a sober turn and will slow down. Most of the good firms that wanted to sell or merge have already done so. The marketplace is left with many good firms that want to remain in business and are willing to do what it takes to survive and grow.

This means that everyone is a buyer and there are fewer and fewer good sellers left. In one respect, M&A activity could significantly drop off from its rapid pace. But once the price gets high enough, some sellers might start to appear again. Many firms still do not have good perpetuation plans in place. This means that a number of firms, which have been making money, and seem to be key players, have yet to surface as possible sellers.

The trend is that firms that are acquiring or merging today are much more strategic in their planning and execution. Firms merge today for the purpose of being a “better” firm, not just to be a “bigger” firm.

Banks and insurance

Yes… banks are definitely in the game and more are getting into the insurance business at an accelerated rate in many states.

Although there have been some notable high priced transactions, some agents and brokers are still not comfortable with the thought of selling out to a bank. There still is some resistance, especially when the owner still wants to remain active. This is because the “cultures” and “philosophies” of banks and insurance agencies do not blend well.

However, it is clear that the first one that is sold to a bank gets the best deal. Banks that are acquiring more than one brokerage quickly become much more astute or selective about brokerage values. In the past few years, there have been some notable sales of large premier brokerages being the first purchase for a bank. The sales prices certainly did appear to push the brokerage value envelope. However, in reality most of the bank deals had growth and profit margin requirements, with some earn-out features. Some sellers have not been able to make those increases to receive the additional money they could have had with these requirements.

Soon the above market prices will become a thing of the past. Eventually the market price, a 15 percent to 25 percent premium, is the most a seller should expect from a buying bank. The best banks will buy good brokerages and let them continue running it without much interference. At some point, banks may bypass the brokerage system and set up internal operations to sell insurance direct.

Dot gone

The Internet has been and will remain a minor competitor mainly in personal lines and life/health lines. “Dot com” businesses will drain off a small percentage of consumers in the next year, mostly Internet junkies and price shoppers. The long-term trend, however, clearly continues to show that the independent agents and brokerages are very vulnerable in personal lines and life/health. There is not any significant competition with commercial lines via the Internet, now or for the foreseeable future, since most astute clients still like to talk to an agent rather than use the Internet for their insurance needs.

Agencies—diversify or niche

Brokerages will need to get into financial services to level the playing field. For example, State Farm has set up their own bank for its clients. Some customers will want to do one stop shopping with their insurance and financial needs. Besides selling all lines of businesses, brokerages will need to offer risk management, payroll services, retirement plans and human resource management counseling for their clients.

The paradox will also be true. Some brokerages will be successful by becoming highly niched, such as selling just program business. These brokerages may thrive on low margins and high volume, or with some programs high margins.

Many brokerages today find it is difficult to grow without some sort of program or niche, where they can present an advantage over the competition. These brokerages are the ones that command the higher price, as most often they have higher profit margins. The trend is that if one wants to sell at a higher price that firm must create specialties.

Few good producers

Most agency owners will agree that it is very hard to find good, loyal, hard-working insurance producers. They have given up long ago. Often, the producers looking are the ones that should not be hired. These are the ones that often leave one agency for a little bit more in pay or perks from another agency. The lack of good producers is a perennial problem and will remain so for a long time. Perpetuation plans are held in abeyance when it is hard to find these good producer players, especially with any management talent. Many firms today are growing their producers from within and adopting the account executive role to ease the burden of the workloads of the owners and non-owner producers with large books. The account manager approach costs the agency less money and provides the service staff more room for advancement.

Paperless environments

Technology is close to the point where it is really making sense. Until now, the computer was used as an expensive pencil and piece of paper. Paperless brokerages are appearing everywhere. Automation usage has also improved. Agents and brokers are no longer able to wait for their companies to get their “automation act” together and may choose to leave those companies behind that cannot keep pace with technology today. Talking directly to the companies via download and upload, as well as electronic mail, etc., is now the norm.

Firms that become “paperless” will eventually have a major competitive advantage. Becoming paperless certainly has a learning curve and it is not for the “old school” type. Being “paperless” is the way business will be done for 2004 and beyond. Unfortunately, any savings due to an increase in productivity will be offset with an increase in automation and technology costs. More and more firms have their own IT (Information Technology) person or department. How the business is run will revolve around the computer and those that maintain it.

Company mergers will continue

The year 2003 saw major divestiture of lines of business and the major merger of Travelers with St. Paul. There are predictions of still more notable companies that will need to sell or merge in the future due to financial weakness or the strategic desire to be bigger.

Who will be next and what will the affect be on insurance agents and brokers? There is not much that an agency can do except to keep all options open since this trend will continue. This is one more indication that the traditional loyalty between a carrier and an agent is long gone.

A final thought

These are some of the key trends that Oak & Associates predicts as being important for brokerage owners to pay attention to. The trend is that 2004 will be similar to 2003. There may not be much an owner can do about the external threats to their brokerage. It is far easier to be proactive and try to manage these areas by understanding how they will affect the firm internally and set up ways to accommodate the changes.

Bill Schoeffler and Catherine Oak are partners in the international consulting firm Oak & Associates based in California. For more information, call (707) 935-6565, or e-mail catoak@sonic.net.