Was the Credit Crisis an Unforeseen Event?

I went digging into old issues of my favorite magazines to learn if the credit crisis was unforeseen and therefore whether all these executives’, bankers’, financiers, brokers’, and politicians’ excuses for their poor performance had credibility or whether they are just trying to avoid taking responsibility for their companies’ and organizations misery.

I only had to find one article from The Economist’s September 23^rd, 2006 issue. The Economist ran a special report titled "The Credit Markets; Business is being reshaped by a massive borrowing binge, but much of it is unseen, unregulated and little understood." In fact, the title says it all.

The article gives many examples of companies that were making much larger acquisitions than they ever could have made historically, simply because they could borrow so much more money in ways that possibly did not even show up on their balance sheets, thus permitting much more debt to be borrowed and for that debt to be much more at risk. The article also stated the following warnings:

"...as the debt and derivatives markets have grown out of all recognition, they have moved increasingly into the shadows. Regulators worry that some of the complex financial instruments conjured up around the lending and borrowing of money–worth trillions of dollars–may sow the seeds of the next financial crisis.

"Central bankers and supervisors increasingly worry about the risks to financial stability that may be lurking in the complex debt instruments dreamt up by the finance industry. One of their biggest concerns is how much danger there may be to regulated banks from the faceless institutions they now do much of their debt trading with: hedge funds."

They quoted our new Secretary of the Treasury, Timothy Geithner, from a speech he gave on September 14, 2006 in Hong Kong, "The same factors that may have reduced the probability of future systemic events, however, may amplify the damage caused by, and complicate the management of, very severe financial shocks. The changes that have reduced the vulnerability of the system to smaller shocks may have increased the severity of the larger ones." Was that ever an understatement!

He went on to suggest that banks may not fully understand all the positions of a hedge-fund counterparty before lending to it since hedge-funds are not required to divulge this information. Think about this. While a lot has been made of mortgage companies giving mortgages to individuals with no provable income, at least there was a house as collateral. In lending to hedge-funds, the banks did not know if they had ANY net collateral!

So what did bankers do with all this cheap and easy money? They talked people and companies into borrowing more money! "Egging borrowers on are bankers, who sometimes admit to lending amounts, as a multiple of underlying cash flows, that are against their better judgment."

The result of all this very easy and cheap money is a necrosis. Private equity funds were almost having banks force free money on them. The borrowers could not let the money just sit, so with a lot of debt, they overpaid tremendously for firms and forced those firms that did not want to sell to borrow trillions of dollars to buy back stock to jack up their stock price or make overpriced acquisitions. Banks were not alone in financing these deals. Pension funds were huge players too. The sad fact that so many retirees are now hurting should not be blamed any more on "unforeseen market gyrations." It should be blamed on greedy pension fund managers.

This article clearly reveals that we had a top regulator that saw the problem years ago. We had journalists that saw the problem developing. We even had bankers who clearly knew they were making loans they should not have been making (kind of like some insurance companies now writing risks for far too low of a price against their better judgment). In fact, financiers had coined a phrase for it, "I’ll not be here and you’ll not be here when these deals blow up, so let’s just get the deal done." But it happened anyway.

Just because the herd is running toward a cliff but they haven’t gone over yet, it is not safe to assume they will never go over. It is just a matter of time and because turning the herd before it goes over the cliff is unlikely, one has to have the personal courage to cut out early, sit on the side while others are making money, protect one’s assets, and build for the opportunities that will be very present once the herd goes over the cliff. A lot of personal courage is required too because as George Bernard Shaw wrote, "The power of accurate observation is commonly called cynicism by those who have not got it."

Going forward, if you want to avoid going over the cliff, the key is going to be to make your agency as efficient as possible so that you can generate the cash required to invest in growth. If you can borrow money for this investment, then you are better off provided your balance sheet is strong and your agency remains in trust. I am not sure acquisitions per se are the best strategy because so many agencies that will be selling are wasting assets. Organic growth is going to be much less expensive for well-managed agencies because more accounts and more key employees will be in play than at any time in a decade. Is your agency ready to take advantage of this unique opportunity?

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The Value of Employees

Many years ago, before my insurance career, I had the opportunity to use software developed by SAS. It was great software, relatively easy to use and powerful. SAS is possibly the largest privately owned software company in the world.

I was reminded of my great experience with their software as I read an article ("Face value, Doing well by being rather nice," The Economist, December 1, 2007) about SAS regarding not their software, but their relationships with their employees and I am now even more impressed. Their accomplishments can definitely be applied to insurance agencies.

First, becoming a SAS employee is very difficult. They are very careful about who they hire and because their reputation is so good, they always have plenty of applicants. While most agency owners believe this applies to them too, I really only know a handful of agencies who truly have such fantastic reputations. These agencies have the awards and the newspaper and magazine articles to back them up, and they also have plenty of high quality applicants awaiting an opening in their agencies.

Second, their benefit package is phenomenal. Snacks are free and the cafeteria food is subsidized. The headquarters has sports facilities, subsidized childcare, early schooling and a primary healthcare center that is free. This health care facility does not cost SAS money. In fact, they figure they save millions every year in their health insurance premiums. They have a wellness program too which has contributed to additional cost savings from employees rarely taking sick days.

Obviously, most agencies cannot afford all these benefits. But if you could afford one or two, would your ability to attract high quality employees improve?

Third, SAS has measured the benefits of their superior employee relations. Many companies have attributed much of their profit to treating their employees exceptionally well only to painfully realize that their high profit margins were the result of some other competitive edge and when that other competitive edge dulled, no amount of great employees could maintain high profit margins. IBM is a good case study of such a situation from the '70's and '80's.

SAS has left nothing to chance. For example, their turnover rate is only 4% versus an industry average of 20% which saves them $85 million per year. This same measure is absolutely applicable to insurance agencies. Our study of more than 100 agencies shows the average staff tenure, excluding bookkeepers (who seem to stick around forever regardless of how good or bad the agency, or the bookkeeper may be) is only about 5 years. Rough estimates from HR firms suggest that every new hire consumes at least 50% of wages in training cost and lost productivity. With five CSRs at an average of $35,000 each, an average agency is spending $17,500 on turnover alone every year. What if you could reduce that to $5,000 and then split the difference with employees on additional benefits?

An agency with, say, three commercial and two personal lines CSRs, probably generates around $1,000,000 in commissions. $17,500 is almost an extra two percentage points of profit! That is a huge improvement!

Fourth, SAS keeps their employees interested and challenged. High quality employees that are going to find ways to grow the agency are going to want to be challenged. They will be bored if they have to do the same thing every day. Do your people want to be challenged or do they want to just put in their time and get the basic job done? There is nothing wrong with the latter and most agencies need such people, but if too many employees are like that, just how strong is the agency’s growth engine?

What does your agency do to keep your employees challenged? What do you do to keep your employees learning new skills? New knowledge? What are you doing to help your employees grow as people? Of course, this is not necessarily an employer’s responsibility. It is just something one of the most successful private companies does.

SAS may be a very large company in a totally different field than insurance, but their success is undeniable and insurance agencies can directly apply their philosophy. I personally know three agencies that are blazing this path within their own markets and they are growing organically a minimum of 8% in a very soft market while maintaining world class profit margins.  And these are not small agencies that can grow 8% much easier than large agencies today. This model does require hard work and leadership from management. But, the rewards are incredible.

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Anyone Searching for Silver Bullets Shall be Filled Full of Lead!

Do you seek solutions where you don’t have to think too hard about how to improve your agency? For example:

Agents with silver bullet disease spend their time searching for easy solutions where simple is the primary criteria. Agents searching for simple solutions waste valuable time and money on solutions that will not work. They waste time and money they could be spending on implementing more difficult solutions that actually work. Searching for silver bullets often results in temporarily believing you have discovered a perfect solution, only for the pain to be worse once reality sets in. Some agents are truly addicted to buying silver bullets from consultants because the pain of dealing with the real problems using real solutions is just too great.

The greatest damage done by the U.S. government’s easy money and low interest rate policies of the last ten years is that a lot of people made a lot of money without having to work or think hard. Thinking is very hard work (which is why the brain consumes more calories than any other organ) and a lot of thinking is going to be required to succeed now. If you are searching for silver bullets, if you prefer easy solutions over the more correct but more difficult solution even though you know in your heart you’re making the wrong decision, you are doomed. If you choose to work hard on real solutions, you have great opportunities and success will be yours. As John Hiatt said, "We ain't no amoeba.  We can choose."  The choice is yours.

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NOTE:  The information provided in this newsletter 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 & 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.

Burand & Associates, LLC is an advocate of agencies which constructively manage and improve their contingency contracts by learning how to negotiate and use their contingency contracts more effectively.  We maintain that agents can achieve considerably better results without ever taking actions that are detrimental or disadvantageous to the insureds.  We have never and would not ever recommend an agent or agency implement a policy or otherwise advocate increasing its contingency income ahead of the insureds’ interests.

A complete understanding of the subjects covered in this newsletter may require broader and additional knowledge beyond the information presented.  None of the materials in this newsletter should be construed as offering legal advice, and the specific advice of legal counsel is recommended before acting on any matter discussed in this newsletter.  Regulated individuals/entities should also ensure that they comply with all applicable laws, rules, and regulations. 

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Copyright 1995 - 2009, Chris Burand