Small Business Units Deliver Bread n’ Butter for Peak Performing Agencies

In the movie “City Slickers,” Billy Crystal’s character is taught he must understand “one thing” that will make his life complete. Along the way he meets a grey-haired cowboy who appears to have all the answers with respect to life. When Billy finally asks the cowboy how he can be so at peace, the cowboy holds up one finger and tells him that he needs to determine his priority in life.

The mantra of “one-thing” holds true with respect to agency operations. Many have recently come to the conclusion that they want to focus only on accounts over a certain minimum commission. For these agencies, their mantra has become that they want to maximize revenue per client relationship. While good in theory, most did not conduct any financial analysis to support their decisions or change the way they conduct business.

Such agencies have seen minimum thresholds, coupled with the hard market, positively impact the financial results of the organization. However, carrier appetites change and fierce competition rages for large accounts.

As agencies search for growth in a softening marketplace, more agencies are now looking to small business as a way to complement their current books of business and meet carrier requirements for additional premium. Unfortunately, small business does not fit within the mantra of maximizing commissions per client relationships.

Peak performing agencies, by contrast, not only maintain small business units, but also realize high profit margin dollars which they use to facilitate capital growth, agency reinvestment and ultimately perpetuation. They have conducted the analysis and changed the way they sell and service small accounts. They have made it work.

Assessing the profitability

Profitability on accounts is generally thought of in profit dollars and is based upon the amount of service that is dedicated to an account. In reality, the profit translates into profitability per hour spent on an account. By taking this viewpoint, agencies can determine the profitability per hour per client relationship. This viewpoint does not eliminate small business, but helps an agency understand the amount of service that can be provided to a small account.

To perform this assessment, an agency must establish a baseline of profitability per hour that is expected within the agency. The profit per hour must be based upon the expected results of the agency on an annual basis.

The average agency expects marginal employee profitability of approximately $53,000. The agency must determine the average hours worked by the employee to get profit per hour. For example, assume 2,080 hours less three weeks vacation, or 1,960 hours. By dividing 1,960 hours into $53,000, it can be determined that the average agency expects hourly profit of $27.04. This is the baseline for determining if the agency will work on an account.

Once a baseline is determined, the agency must then review the structure of its current operation at various account sizes to determine if it can generate the desired profitability.

Chart 1 – Cost to Market

In “Chart 1 – Cost to Market,” it is assumed that the operation had centralized marketing and that the agency had operating costs of $34,830 per service person. Both the salary and operating costs are translated into expenses per hour. As the chart illustrates, the hourly cost of this agency is $50.95 to market an account. Additionally, we assumed that it would take between four and six hours to market these various accounts. Therefore, the cost to market a single account ranges from $204 to $306.

The hidden cost of marketing is the fact that not all accounts are written by the agency. Hit ratio or closing ratio is important in this calculation as we need to “gross up” the cost to market the account for the accounts that were not written. At a 50 percent hit ratio, the cost to market is between $408 and $611.

Once the account is written, there is a cost to the producer who sold the account. We have assumed that producers in this agency are paid 40 percent new and 25 percent renewal. In the example shown in Chart 2, the cost to produce ranges from $261 to $1,044.

Chart 2 – Cost to Produce

After the account is written, the agency must then provide service to the account such as reviewing policies, issuing certificates and other account management services. The “Chart 2 – Cost to Produce” example shows the cost of administering those services upon the sale of the account.

Chart 3 – Cost to Service

For our purposes, we assumed that the services would require an additional three hours of the customer service representative’s time following the sale. In each instance, the cost would be $121 to service.

The marginal profit on an account in pure dollars increases based upon the size of the account as the amount of time to market, sell and service the account does not vary greatly at the various premium amounts analyzed.

Taking our analysis further, we can determine that the profit per hour under each scenario does not meet our baseline. Therefore, this agency should not write accounts under $2,000 in commission given the current operating structure of the entity. Remember, the target profit per hour is $27.04 and none of the account levels achieve that number.

Chart 4 – Total Cost (Year One)

For many agency owners, the conclusion above is obvious. Many agencies have stated that they expect to earn the profit on the renewal and that the first year is the cost of bringing in the account. In looking at an account on an individual basis, this conclusion may be true. However, the hidden cost the agency incurs is the remarketing of an account that does not renew.

Much like the hit ratio or closing ratio, the accounts that do not renew take resources away from the service staff and represent a cost to the agency. Therefore, to get an accurate view of the second year, we must expand our analysis beyond a single account.

For our purposes, we have assumed an 80 percent retention rate on five accounts written in the first year. The agency incurs the cost of renewing four of those accounts and the “hidden” cost of the time spent in the renewal process of the account that was lost.

Additionally, the analysis layers in the cost to market, sell and service five new accounts in year two. In essence, the analysis looks at the entire small business unit.

Chart 5 – Small Commercial Analysis

The “Chart 5 – Small Commercial Analysis” example shows that this agency should set the threshold for minimum account size between $1,500 and $2,000 in order to reach the desired result of $27.04 of profit per hour as previously defined. Accounts below this threshold will result in the agency not meeting the goal of profit per hour per client relationship.

Changing the way business is done

The obvious result of the exercise above is that a threshold makes sense for commercial accounts. However, any implementation also dictates that the agency critically review the way it does business.

Some agencies realize high profit margins on jumbo accounts because they can sell and service them well. Under the same accord, others realize high margins on small accounts for the same reasons.

In addition to the financial analysis described above, peak performing agencies have taken great care in considering and changing how they run their small business units. Some things to consider are: marketing, production, hit ration, service/retention, and technology.

Marketing. A small business unit must be an efficient marketer of new business, understanding how much time it can spend per account and the most efficient methods of marketing. Maintain a limited number of markets that the agency knows well. Take advantage of online rating and policy issuance. If potential accounts do not fit into the box from a pricing and service perspective, do not market them.

Production. Eliminate producer compensation on renewed accounts. Producers should have little to no involvement with servicing or renewing such accounts. Additionally, the producer commissions the agency is saving may be used to reinvest in agency automation and perpetuation needs.

Hit Ratio. The marketing department or producer must pre-qualify accounts in an effort to maximize hit ratios. They must also take into consideration the rates of current agency markets relative to those of other underwriters. If the agency and markets will not be able to compete on price in certain lines of business, the agency may not even want to quote such requests. Reducing the amount of time spent quoting the account reduces the “hidden cost” of marketing.

Service/Retention. In the eyes of insureds, good customer service boils down to a feeling of importance, frequent communication and predictable touches. Do not treat small relationships as commodity accounts to insureds. Treat them like kings, but with efficient and automated stewardship programs.

Think about renaming the small business unit (i.e., “Emerging Business Unit” or “Entrepreneurial Business Unit”). Have CSRs (not producers) call each account twice a year simply to make contact. Consider providing accounts with monthly e-newsletters that may contain industry premium information, health awareness tips, trends, etc.

Technology. Key to this whole analysis is the efficient use of technology by the agency to market and service the accounts. The unit must be able to reduce the amount of time and touches on a particular account.

Summary

Peak performing agencies maintain minimum commission thresholds and have realized increases in agency growth, profitability and capital, but they have also analyzed their accounts and implemented changes in the way they conduct business.

A word to those quick to set minimum account thresholds: Until such analysis is conducted, the agency may be leaving profitable business on the table. Understand agency goals. Understand accounts. Understand the profitability by size. Only then can the agency properly determine which accounts are driving the bottom line, which are hindering earnings, and how to best allocate agency resources.

Paul Vredenburg is a senior vice president at Marsh, Berry & Company. Inc. He can be reached at Paul@MarshBerry.com.

Topics Agencies Profit Loss Commercial Lines Business Insurance