Is it time to stop pretending?
Updated: Aug 25, 2020
Pretending is expensive. An average Hollywood feature film costs $70-$90 million to make (2-23-17, Hollywood Reporter). A scripted television show costs millions per episode (from various sources with various averages but all were in the millions). Pretending is usually associated with entertainment and good entertainment costs a lot of money.
When carriers pretend for their own entertainment, the price is usually more, at least over time, in lost profits, lost productivity, diluted brand value, lost trust and inevitably worse execution because employees do not know if the goal is the pretend goal or what they see as the obvious, real goal. These results are clearly evident relative to how carriers treat agency contracts today.
When I work directly with carriers and when I speak at carrier conferences, the message I hear is always the same relative to clusters and aggregators: We can't stand most of them. They cost us a lot more money and the results are worse. The average cluster growth rate is rumored to be 0% which makes sense. When one amalgamates a bunch of agencies (small or large) that cannot grow, they are not going to grow upon amalgamation either and that goes to the definition of amalgamation where individuals get to hide within the bigger pot. The agencies join so they can hide! Anyone who expects improved performance is in that pretend world.
An interesting development is how large agencies are forming their own clusters. These agencies have seen carriers pay small agencies going nowhere more money. While they could negotiate on their own, for a variety of reasons they think they need to band together and use leverage to wring more money out of carriers. These new clusters have no other value but to get more money (they may say they do, and they may, but 80% is about causing carriers to pay more for the same, at best, results).
And yet, carriers appoint these organizations. They know the appointments will cost them more money for, at best, no improvement and quite possibly deteriorating results, but they appoint them anyway. Even Hollywood does not make movies where the plot is to do the same thing over and over where the results always disappoint.
Besides paying more money for worse results, the brand damage is real too. For example, I have a client who outperforms the industry in growth and loss ratios year after year. They are simply an exemplary agency. They represent their carriers proudly and treat them with respect. They outperform every other agency in their area and as a reward their carriers did not appoint other local agencies. Those other agencies, by the way, were not that good -- I know them. Then a couple of those agencies joined a cluster and immediately gained access to those carriers.
Why should a good agency protect their carriers when carriers will go to bed with any agency that is part of a cluster? The brand damage and relationships are not repairable. No one should realistically ever believe those carriers again when they tout how they value their relationships with agencies. The entire thought process of carriers is driven by fear, not value, because those specific carriers have no clue to how work with individual, high quality agencies any longer. They are simply in a race to the bottom.
A few carriers have figured this out and have addressed the situation by employing two distinct strategies.
The first is to simply give a direct appointment to every single agency with a license. What is the difference, after all, of giving access to every agency through a cluster or giving every agency access directly? In theory, possibly, the acquisition cost is less in the former but that is pretend savings in most cases. (As a note, a few networks truly do generate better results and lower acquisition cost to carriers, but these best run organizations are definitely in the minority.) Even if the acquisition cost is less, the marginal results offset the minimal savings, especially if the loss of the direct agency-carrier relationship and the extra expense resulting from paying profit sharing to agents who otherwise would not qualify for it are included.
In a capitalistic model, where real thought is applied rather than a pretend world, the resulting math would show that the "appoint every agency individually model" is a better approach, again, with the exception of the few networks that truly perform well. The few carriers that have used this approach certainly have far better than industry average results to prove it. One carrier, in particular, continually achieves best of class profit and growth measures.
The other model is to not appoint these networks and stick to select, versus everyone, individual appointments. Again, a few carriers are refusing to appoint networks and they too are often far outperforming their peers. In the right hands, this strategy works well too.
Either way, these two solutions focus on individual appointments, whether selectively or in mass. The carriers that really stick to this strategy have impressive results vs the "appoint every agency in every cluster model." The correlations are evident. More carriers probably fear the individual appointment approach because they do not have anything special to offer. They are a de facto commodity insurance company already, and therefore they are at risk of losing books if they do not appoint all comers. In other words, they feel it is less expensive to pay more for poor performance than to lose books to other carriers that will pay more, and compensation is all they have to offer. It is not a great solution, but better than the alternative. If these carriers had anything special to offer, the pressure would be greatly reduced. The best carriers have something special to offer so they appoint individually. This correlation deserves notice.
So now we have a situation where the carrier, seeing itself already as a commodity, commoditizes its distribution force further by giving contracts to every agency with a license, but pays more. Commodity economics means price is preeminent. In other words, the cost structure has to be low because the quality of the product is not differentiated. Working in a commodity environment with a high cost structure is a losing strategy even before considering the result of teaming a commodity insurance carrier with distributors that can't sell. I cannot figure out the movie script that ends with a warm glowing feeling given those facts.
Part of the ultimate solution is the elimination of a few hundred insurance carriers. According to A.M. Best, around 900 P&C insurance groups (main carriers, not all the PUPs) exist. In some years that number seems to be around 950 and in other years it might be around 850, but 900 is the number around which the total hovers. Using A.M. Best data from 2018, 10 carriers write approximately 50% of all premiums and 90 carriers write 89% of all premiums. In other words, 810 carriers are fighting over 11% of the premiums. Some are specialty niche players, but most are generic carriers. In other words, they are commodity carriers. The insurance world is not like most industries in the sense that in most industries, those small companies would likely be bought up quickly. The insurance industry would not necessarily be healthier if we only had 100 carriers because we'd lose some spread of risk. However, the smallest 400 carriers are so small that any 100 of them probably are not even rounding errors on the top ten carriers' income statements and their elimination would not materially dilute the industry's need for spread of risk.
In a commodity environment, consolidation will happen proactively or reactively to achieve the least cost. Some of the large carriers' operating conditions, however, are worse and are the driving force behind paying clusters more for worse results, simply because they are the most afraid. Take a large carrier with a true profit margin of 3% (I analyze carriers' true profit margins vs. what they tell their agents their profit margins are). At 3%, the carrier cannot generate enough profit to build surplus without outside capital. They cannot easily invest in much, their cost structure is too high and they act as a commodity, so what does their pretend world look like? What is their realistic future?
Many clusters take advantage of such carriers which is why these carriers get frustrated. They know clusters are taking advantage of them and they do not have a solution. To some extent then, they just keep digging deeper holes.
The better positioned and smart insurance carriers have a great opportunity if they possess a strong awareness of where they stand. I have worked with insurance carriers for 30+ years and plenty of fantasies exist in the minds of many insurance carrier executives. To succeed like a small handful of carriers have succeeded in truly understanding their place, two events are most likely required.
The first is for everyone to take a reality pill. For example, I was working with the key executives of a carrier where I presented the actual financials of several carriers side by side. One executive became quite upset because their carrier's results were materially worse than their competitors' results. He tried to end the entire conference because he felt the numbers were unfair. If one carrier has a 20% profit margin and another has a 3% profit margin, assuming no accounting trickery, nothing unfair exists except in their pretend mind. That is just math.
Second, because many executives in my experience take every nick as a personal attack, it is best to have a third party facilitate the program. Doing so should help keep such people from attacking the team for discussing factual but "unfair" numbers by focusing their angst at the facilitator.
Carriers only have two choices for success in this harsh real world. The first is to become a true low cost commodity carrier. If a carrier is going to appoint every agency, especially through clusters where controls are usually severely lacking, low cost is mandatory. This is a pure commodity play. We have plenty of examples in this industry of carriers that have huge profit margin advantages over their competitors. When their cost is low, they can become king of low price commodity sales. For some carriers, a cost reduction of at least ten full percentage points will be required to achieve the cost structure they need.
The second option is to provide quality for a price. Whether quality is quality underwriting, quality forms, quality loss control, quality risk management, quality predictive modeling, or some combination of these factors, we have examples in the industry of carriers providing high quality for a price and succeeding. No one really needs to reinvent the wheel here.
Only actors at carriers still think they have brand value with their agency relationships (with the exception of the handful of carriers that do not appoint clusters or have some specialty). The brand value that used to exist provided protection to carriers at varying levels that no longer exists. Only pretenders think they can remain high cost while being a commodity insurance carrier. And with 500 plus extra carriers, especially those that appoint every agency possible through clusters, the industry has many commodity insurance carriers.
To emphasize, some clusters have strong controls whereby they avoid poor performing agencies, so I am definitely not throwing all clusters and aggregators under the bus.
As a carrier, what strategy makes the most sense for your firm: Be a true low cost commodity carrier or develop true, not Hollywood fantasy, high quality features that will enable you to partner with high quality distributors of your high quality product?
As an agency, what kind of agency will you run? What kind of carriers do you need to succeed given the kind of agency you want to run? If the agency has a limited future, then what kind of cluster should it join? Carriers with limited commodity futures and agencies with limited commodity futures probably are meant to wed.
Important decisions need to be made. Will you eliminate all the pretend elements that only exist in movies, forego rejecting reality, and deal with reality? Or, will you live in a pretend world where you think high costs in a commodity environment can be a foundation for success?
NOTE: The information provided herein is intended for educational and informational purposes only and it represents only the views of the authors. It is not a recommendation that a particular course of action be followed. Burand Insurance Education, Burand & Associates, LLC and Chris Burand assume, and will have, no responsibility for liability or damage which may result from the use of any of this information.