The times they are a’changin’.” Bob Dylan’s 60’s refrain could be the theme song for a new spirit moving through the ranks of the insurance industry’s exclusive (captive) agents. The current hard market has accelerated a trend marked by a diminishing share of the personal lines market for exclusive agent companies, an increasing share for the independent agents and a burgeoning number of lawsuits.
“Independent agents are at a big advantage in a hard market,” said Bob Rusbuldt, CEO of the Independent Insurance Agents &Brokers of America (IIABA). “If you’re a captive, you’ve got one product at one price, and you can’t go to another market. An independent has price flexibility and offers [the consumer] a choice.” Contrary to the situation a few years ago, when captive agents and direct writers were seen as the wave of the future, now it’s the independent agents who are on a roll.
Many separate causes have been identified as contributing to the upheaval, but it has two principal origins—the increased economic pressure on the insurance companies and the explosive growth of technology in the last 10 years.
Companies with their own agents are either highly specialized or extremely large. The three biggest, State Farm, Allstate and Farmers, currently dominate the personal lines market. According to its Web site “State Farm has 71 million policies in force, 27 million households are insured with State Farm. One of every five automobiles in the United States is insured by State Farm, making it the nation’s No. 1 insurer of cars. State Farm is also the leading insurer of homes in the United States.”
Allstate says it insures “one of every eight autos and homes in the U.S.” and is “one of the leading U.S. life insurers as well.” When you include the various Auto Associations (AAA), Nationwide, American Family, Farm Bureau, UMAA and others, exclusive agent companies control over 56 percent of the market for personal auto, homeowners and other personal lines (See Captive Agent Companies chart).
Dealing with problems
Despite that impressive market share and the powerful position it gives them, the big three have problems. While some exclusive agency companies continue to grow, notably Nationwide, which also writes a lot of business with independent agents, the big three have lost market share in each of the last three years (See chart on pg. 30). All of them have recently withdrawn from selected markets, and the independents have been profiting at their agents’ expense. Rusbuldt foresees a not too distant day when independent agents will have at least a 50 percent share of the personal lines market to go with their 80 percent share of the commercial market.
The IIABA’s statistics show regional independent agents as profiting the most. But statistics show only results; they don’t explain why more policies are being written through independent agencies. Under the surface there’s a lot going on. “Allstate’s having the equivalent of a mid-life crisis,” Rod Guilmette said, who spent 30 years as an Allstate agent and now edits the National Association of Professional Allstate Agents (NAPAA) newsletter. “The company is neglecting its agents; it seems to see them only as a resource to be mined.”
This wasn’t always the case. “Allstate was built on the basis of employee/agents,” he indicated. However, starting in 1990, the company introduced changes, asking the agents to become independent contractors. The plan was originally voluntary, but then Allstate itself went through some major changes. In 1993-94, Sears spun it off as an independent company, in which Sears shareholders got proportional interests. An initial public offering followed. In 1996, Sears no longer controlled Allstate and its agents in California became independent contractors, whether they wanted to or not. By 1999, this policy was nationwide.
As a result the agents’ costs increased, but company control over them remained strict. They aren’t particularly happy with the situation. “It’s like the dark ages,” said Guilmette. “We believe Allstate is in violation of the terms of its own contract.” So did a number of agents in Michigan, who took the company to court in Florida over the matter. “Agents can be terminated at any time on 90 day notice,” Guilmette said. “There doesn’t have to be any reason given, but frequently they [termination notices] refer to ‘expected results’ or ‘business results,’ which essentially equals quotas.”
“Any reason can be used,” he continued. “When there’s any resistance [to a company directive] the agent’s terminated,” frequently the notice says only something like “failed to maintain a proper business profile.” Although he singled out Allstate, because it’s the company he’s most familiar with, Guilmette indicated that State Farm and Farmers do the same thing. As a result the majority of exclusive agents are living “in a climate of fear” and a growing mistrust of the companies they represent.
Why don’t they all just quit? “Well, there are definite benefits,” explained Guilmette. “The Allstate logo is instantly recognized, the company’s very sound financially, and its products are good products. Its claims services are among the best, and it supplies the computers and the office management programs.” Exclusive agents also gain another advantage over their independent brethren. “An agent becomes very knowledgeable about its [his company’s] products,” Guilmette said, and “it’s the agent who people call, who makes the sale and keeps the customer.”
Once you’ve been an exclusive agent severing the relationship can also be fraught with peril, as Rich Pyorre of Fort Bragg, Calif. found out when State Farm terminated his agency agreement. He first started with the company as a trainee in 1972, and had built up a successful business in his home area, as had his colleague John Wier in nearby Crescent City.
State Farm uses the independent contractor label
Unlike Allstate, State Farm has always maintained that its agents are independent contractors. In 1991, following a lengthy review of an SS-8 form filed with the IRS, it confirmed this. In a letter to its agents it said that only trainees, who are considered employees, must attend scheduled sessions. Once they become independent contractors they may be invited to such sessions, “but attend at their discretion.” The letter further specified that “State Farm does not impose consequences or penalize the independent contractor for not attending training sessions.”
Pyorre relied on that statement, and learned that sometimes things aren’t what they seem. Summoned to attend an “LUTC Business Ethics Course” in 1998, he demurred for well-founded personal reasons. He also noted that the course was largely “self-study,” and could be done at home, and pointed to the “non-mandatory” language in State Farm’s filings and letters. “Finally,” Pyorre said, “the class wasn’t about business ethics at all. It was a class in banking and how to sell mutual funds.”
His refusal to attend the class led State Farm to terminate his agency contract “effective midnight Feb. 28, 1999.” On March 1, company employees marched into his agency offices and removed all of his records and documents, which were largely contained on computer files. It also refused to offer any termination payment as it said he had breached his contract.
His clients were his neighbors and people he’s known virtually his entire life. He re-launched his agency and signed a contract with Mercury Automobile Insurance, but State Farm was having none of it. According to Pyorre, the company urged the FBI to start a criminal investigation. Testimony given in his highly publicized lawsuit revealed that his FBI file contained 98 pages of documents, almost all of them from State Farm. Both he and Wier were named in a civil action by the company for allegedly stealing its “trade secrets,” i.e. their own client lists, and both agents counter-sued for the damages the company had caused them.
Although the jury awarded Pyorre $3.35 million and Wier $3.25 million, the judge in the case recently overruled the verdict and ordered a new trial. He indicated that the jury might have been confused over the definition of “trade secret,” or may have been unduly influenced by the many details brought forth in support of Pyorre’s and Wier’s contentions that they had been wrongfully terminated. After allowing the jury to hear the evidence the judge ruled that State Farm’s actions in terminating their contracts had been proper. The two men are presently considering their options.
A Farmers perspective
Farmers appears to be somewhat of an exception. Ralph Buchanan, who heads the United Farmers Agents Association (UFAA), meets with his opposite numbers—the heads of the other exclusive agents’ associations—twice a year. “After hearing what’s going on with management/agent problems at some of the others, Farmers isn’t doing that bad,” he said. “We still get picked on, but a lot less than the other guys.”
Farmers structure might have something to do with this. While the management group is owned by Zurich Financial Services (ZFS), the actual divisions operate as independent insurance exchanges, more along the lines of mutual companies, as the policyholders are considered as the “owners.” ZFS receives a management fee, however, from all the policies sold or renewed by the exchanges, and “lately they’ve been cutting back on employees and expecting the agents to do more of the work,” Buchanan said. Farmers agents have always been independent contractors.
As usually happens along emerging fault lines, earthquakes and volcanoes have erupted, not the nat cat kind, the legal kind. Pyorre’s and Weir’s problems with State Farm are only one example. The most serious challenge to the big three, however, may come from their own agent associations. Each company is being sued for declaratory relief, i.e. for a court interpretation of what those “independent agency contracts” really mean, and how much power the companies can exert over their agents.
The National Association of State Farm Agents (NASFA) is suing the company in Federal Court in the District of Columbia over its attempts to force agents to sell financial products, and is seeking a declaration to prevent the company from modifying, terminating, interfering with or otherwise changing agents’ contracts unilaterally.
The NAPAA’s Florida lawsuit is still pending and the UFAA has an ongoing action in California. “We don’t have any decision yet, as they’re [Farmers] pulling all sorts of legal maneuvers,” Buchanan said. “Right now the case is on appeal [over procedural matters].”
In spite of their heavy-handed approach, State Farm, Allstate and Farmers aren’t an “axis of evil.” They’re not lowering commissions and pressuring their agents because they like to terrorize people, but because they’re being squeezed economically. “Captive agencies no longer give the big companies the advantage they once had,” said Tom Calgaro, who heads the Safe Harbor Alliance in San Diego, which helps ex-captive agents get restarted, as well as Insurance Technology Consultants and Insurance Data Technologies, companies that provide agents with office management software and interface capabilities.
The sheer size of these companies means that even though they receive a greater volume of personal lines premiums, they also end up paying out a greater percentage of personal lines claims. More disasters, higher jury verdicts, and things like mold have increased both the numbers of claims and the amounts paid.
In search of
As a result the big three are seeking rate increases, a greater share of policy revenues by cutting commissions, or they’re leaving markets altogether, which ends up making them less competitive. State Farm, for example, announced a moratorium last June on new homeowners policies in California and 16 other states, after it posted a $5 billion net loss in the sector in 2001. Although it has lifted the ban in some places, it leaves State Farm agents in the states still affected with only renewal business. Farmers recently agreed to stay in the Texas homeowners market, but for renewals only. As Rusbuldt observed, “Can you imagine a Chevy dealer who can only sell used cars?”
The underlying problem goes beyond the increase in costs, however. Calgaro explained that up until the advent of the revolution in computer technology the big companies with exclusive agents enjoyed a solid advantage over their independent competitors. They could afford the huge mainframe computers necessary to manage their policyholders, and the salaries of thousands of employees. “They enjoyed around a 12 to 14 percent advantage in operating expenses.”
Today the situation is reversed. Independent agents are the ones leading the changeover from inefficient to efficient operating systems. “The big companies were too inflexible,” Calgaro said. “They ignored it [the new technology], or they couldn’t justify [the costs of] installing it.” Smaller companies and agents were much quicker to recognize the advantages that the combination of the personal computer, management software tools and the Internet could achieve. “Independent agents have been forced to become more efficient,” Rusbuldt said. “As a result they’re a cut above the captives,” and, as their operations are less costly, they have more room to negotiate and can offer more choice to the consumer.
There’s a clear advantage in the area of communications capabilities—the “interface” between client, agent and insurance company. Citing current procedures adopted by Calgaro noted that “an agent can dial in a secure access code, and get any current policy information he needs.” This “point of sale system, first developed in 1994,” gives the agent the ability to present “a complete policy for signature right in the office.” When it’s accepted and signed, all the necessary data is transmitted back to the company. Told about this, Buchanan observed that “we certainly aren’t talking about Farmers.” He described the system its agents must use as “antiquated,” and added, “Sure they have PC’s on their desks, but they’re all tied into Zurich’s system.”
Personal Auto Market Share
Homeowners Market Share
Personal Lines Market Share
|National Agency Companies||13.45||13.22||12.43||18.34||19.37||18.49||14.50||14.59||13.80|
|Regional Agency Companies||19.13||19.38||21.81||17.32||17.46||19.15||18.87||19.08||21.34|
|Captive Agency Companies||58.48||57.60||56.04||60.14||58.84||57.96||58.79||57.83||56.42|
|Direct Response Companies||8.95||9.79||9.72||4.20||4.33||4.39||7.85||8.49||8.44|
|As the chart illustrates, the regional agency companies using independent agents and brokers gained market share in both personal auto and homeowners in 2001 at the expense of the captive agent and national agency companies. The market share for the direct companies was flat for both lines of business.
Source: A.M. Best
Rusbuldt and Calgaro agreed that “Companies and agents both profit [from using advanced technology],” and from the flexibility it gives them. It has also meant that captive agents no longer have cost advantages. “Their costs are actually higher,” Calgaro said. In an effort to counter that disadvantage the companies have introduced cost cutting measures, Allstate’s changeover from employee to independent contractor is one. Calgaro noted, however, that “they lost around 2700 agents when they did that, and they’re currently losing around 150 a month.”
Another response has been expansion into financial services. While this seems logical, as the post World War II generation nears retirement age and its members have more money to invest, it puts additional pressures on the exclusive agents, who are now more or less obliged to sell their companies financial products to their clients, if they want to remain in good standing. As Guilmette noted, they resent “mining” their clients for investments, especially when the commissions they receive are a fraction of what they earn for selling insurance.
Pyorre pointed out another problem. “I’m not comfortable with this [selling financial products to his insurance clients], but they set quotas, and we’re expected to meet them.” Guilmette observed that if the exclusive agents “don’t get [financial services] licenses, or they drop them, they are terminated.” For him the real problem goes even deeper. “Insurance is about surety risk, about making a person whole for casualty losses … sudden and accidental losses. Agents aren’t experts in protecting financial well being, which requires a great deal of time and experience.” Buchanan commented that his “personal prediction” for the next big series of class action lawsuits is going to “involve thousands of untrained [insurance] agents selling securities.”
A third big three response has been to set up direct writing operations, which inevitably puts the company in competition with its agents. One of the main complaints in the NASFA lawsuit attacks the company’s use of agent customer lists to solicit additional insurance and financial business. The agents allege that they’ve lost sales, commissions, and frequently their clients. They’ve also charged that using direct selling channels amounts to invading territories that have been allotted to them.
If Allstate’s experience is any guide, the big three’s efforts haven’t been very successful. Guilmette pointed out that the company had gone into direct writing through the Internet and the use of 800 numbers in a big way, spending many millions to set up the system, “but nothing has come out of it, more than 90 percent of their business is still handled by the agents.”
More importantly, “It’s impossible to make all policies the same,” he continued. “Insurance isn’t a commodity, all customers are different.” A big part of any agent’s job is to obtain sufficient information to enable the company to measure the risk, and this can’t be done, if the people on the other end of the line only take orders. In addition to the problems caused by misquoted premium rates and other glitches, Guilmette also noted that Allstate’s directly written policies are eventually sent back to the agents for servicing, with an initial commission of 3.5 percent, which decreases after a few years to even less. “No wonder the agents don’t want to handle them.”
Things came full circle last October when Allstate acquired CNA’s personal lines business with about $2 billion in premium, renamed it Encompass Insurance, and announced an ambitious plan “that focuses exclusively on the sale of personal property-casualty insurance products by,”—wait for it—”independent agents.”
While the end of the hard market may see some rollback in the gains made by independent agents, and the consequent diminution in sales of personal lines through exclusive agents, it will be hard for the big three to reverse the direction of a trend that has so many interrelated elements supporting it.
For more information on Safe Harbor Alliance, log onto: www.safeharboralliance.com, or call (866) 968-5646. For information on UFAA, log onto: www.ufaa.com, or call (800) 275-8668. For information on Insurance Technology Consultants and Insurance Data Technologies, log onto: www.itc-systems.com, or call (888) 799-0797.
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