Quality Control E&O Audits: Are they worth the expense?

Is the expense of hiring a consultant to conduct a quality control E&O audit really worth it?

Consider the following:

Myth: Agencies win some E&O claims.

How does an agency ever win an E&O claim when hours and hours have to be spent defending the claim? Think about the hours spent in discovery. Think about the time spent with attorneys. Think about the time spent with staff and producers. Think about the hours spent in depositions and think about the time spent testifying. These activities consume dozens of hours, and sometimes hundreds of hours.

Where is the benefit in spending all these hours defending the agency when the time could have been spent selling? Building the agency? Helping clients? Working with carriers? Aren't these activities more valuable, ultimately, than testifying?

Another perspective is the pure cost. Agencies spend $35-$50 per hour per person (based on industry averages). If an agency spends "only" twenty hours, that is still $700 to $1,000. Add outside fees, a deductible and increased E&O premiums and the total cost is an easy $5,000. If an agency has a 10 percent profit margin, every $5,000 spent equals $50,000 of revenue. How easy is it to find $50,000 of new sales? How then does an agency win by having to find $50,000 of new sales to make up the cost of defending an E&O claim? No matter how you slice it, the agency loses every time it is sued.

And don't forget about the agency's reputation. How will the agency repair its reputation even if it wins?

Fact: Agencies lose all E&O claims.

The Bottom Line:

A quality control E&O audit helps to minimize the risk of being involved in an E&O claim, which means it:

• Minimizes the risk of losing all that time defending E&O claims.
• Minimizes the risk of the additional expenses involved with defending E&O claims.
• Minimizes the risk of a damaged reputation when faced with an E&O claim.
• Minimizes the stress involved with defending E&O claims.

The bonus: more efficient operations. More efficient operations lead to more profit, better customer service, more professional operations and possibly credits on your E&O premiums. A lot of agency owners have a tough time accepting the reality that good E&O procedures are also profit and productivity enhancing. It is the best of all worlds.

Regardless of your E&O carrier, an audit by a good and approved auditor will benefit your agency. In these days, agencies are seeking to cut expenses and in the process are sometimes being penny wise and pound foolish, just like some of their clients. Don't make this mistake. Take advantage of this opportunity today.

Chris Burand, President of Burand & Associates, LLC, is an approved E&O auditor for both Westport and Utica Mutual.

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What is the One Thing You Do Exceptionally Well?
by Jack G. Nicholson

Knowing what you do exceptionally well is critical to your success. General Electric for example, was known for many years as an industrial powerhouse with manufacturing expertise in jet engines, locomotives, infrastructure, electrical appliances and medical imaging. The company's CEOs were legendary for their managerial skill and their ability to deliver double-digit returns on their earnings. Yet in September 2008, GE nearly went bankrupt. The company needed a $3 Billion loan from Warren Buffet and a cash infusion of $12 Billion in a quick stock sale to survive the economic downturn.

The October 2008 issue of Fortune Magazine entitled "GE Under Siege" documented how the company relied heavily upon GE Finance for its yearly profits and earnings, and through its leveraged portfolio of investments, had put the entire company at risk. GE went from using their finance arm to providing competitive loans for their infrastructure clients to investing in financial instruments and derivatives as an end in themselves. GE didn't stay with the one thing that it did exceptionally well.

Jim Collins wrote about this in this book, How the Mighty Fall (2009). He identified six stages of decline that can be avoided, detected and reversed if companies are conscious of where they are in their organizational life cycle. Based on extensive research, Collins described Stage 2 of his model as "The Undisciplined Pursuit of More. " This stage manifests itself in unsustainable growth strategies like that of GE Finance and can result ultimately in the decline and death of a great company.

The future of GE is still in doubt. What about the future of your company? Your future will be more secure if you do one thing exceptionally well.

Here are some questions to ask:

What is the one thing your company does exceptionally well?
To what extent are your company and its resources focused on that one thing?
How are you measuring and tracking your effectiveness in doing that one thing?
Is the one thing congruent and aligned with your vision, mission and strategy?

Jack G. Nicholson is a principal of SageQuest (sagequest.com). SageQuest provides services that help business and non-profit leaders navigate the human side of executive leadership. Jack can be contacted by email at Jack@sagequest.com.

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Myths Busted: Agency Trust Money and Capitalization

July 8, 2010 Insurance Journal: FBI Raids Tennessee Payroll, Insurance Firm Sommet Group

July 7, 2010 BestDay News: Former Agency Owner Arrested in $1.3 Million Insurance Scam

July 1, 2010 Insurance Journal: Louisiana Agent Accused of Misappropriating Premium

These are just three headlines of many that have been hitting the newswires and Internet almost daily for many months. In almost all cases, the headlines involve agents who have not forwarded premiums to companies. In other words, they have violated their fiduciary duty to hold in trust money paid to them by insureds until it is time to forward the money to the appropriate carrier(s).

Dozens and dozens of agency owners have told me that because their states have no trust laws, they don't have to be in trust. The states in the headlines don't have trust laws either, per se. So why are these agents in trouble? They are in trouble because all states and the federal government require that money that is supposed to be held in a fiduciary capacity be held in a fiduciary capacity. This means agents are not supposed to spend this money under any circumstances!

I continually find agency owners who believe that because their state does not have a trust law, they can spend their clients' money as long as they pay their carriers on time. Generally, the lack of a trust law only means that an agency can commingle trust monies with operating monies. It does not mean an agency can spend its clients' or carriers' money!

It is also a myth that as long as the agency pays its premiums on time, it does not have to be in trust. A generic definition of being "in trust" is: (cash + receivables) / (premiums payable + binder bill) > 1. If the agency's trust ratio is less than one, it means the agency has spent money that does not belong to it. If the agency's trust ratio is less than one and it is current in its premium payments, the agency must be robbing Peter to pay Paul. In other words, it must be using customer B's premiums to pay customer A's premiums.

How is this ethical or right? Too many agents believe the myth that this is permitted because the company is being paid on time. The problem with this musical chairs is that sooner or later someone is not going to get paid, the agency will have to be recapitalized with expensive after tax dollars, or it will have to be sold at a steep discount because the agency has violated its fiduciary responsibility.

I get the impression some consultants downplay the significance of this issue. I can tell you with certainty that a consultant who delivers news that the $500,000 or $1,000,000 missing from the trust account is diminishing the agency's value to almost nothing is not a very popular person. More than once I have had agency owners ask me, "Why haven't any of the other consultants told us this was an issue? We've been doing this for years." Sometimes they fire me, sometimes they get mad, and sometimes they go into denial. Other, more pro-active owners realize the situation and work immediately to fix the problem.

Some consultants have perpetuated another myth by contending that agents are currently better capitalized than any time in recent history. That has not been my experience and the headlines certainly do not support this supposition. Perhaps part of this difference in views is that some people may not know how to read a balance sheet. If this is the case, agency owners need to be quite careful whom they choose as advisors.

I have heard it said that balance sheets do not matter because an agency can always find more cheap capital. Maybe that was true a couple of years ago, but I do not believe that is true today. While being out of trust is not always an immediate death sentence, especially now as some companies are helping agencies that cannot pay on time out of fear of losing books of business, it is a major mistake to think this makes being out of trust OK.

Well-capitalized agencies have the opportunity today to invest in top people, buy distressed agencies, invest in better sales tools, and contract with better carriers. With all these benefits, now is a great time to make being in trust a top priority.

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Are you in business to make a Sale or a Profit?

The title of this article is the title of a popular seminar I've given across the country. I've asked this question of hundreds of people, mostly agency owners. Between 95 and 99 percent of audience members have stated they're in business to make a profit.

If only that were true. It is hard to accept that agencies are in business to make a profit when the new Growth and Performance Standards (by the National Alliance Research Academy) shows the average agency has almost no profit without contingencies. It is hard to accept that agencies are in business to make a profit when agencies regularly write hundreds of unprofitable accounts and when at least 25 percent of producers are unprofitable. One fact to remember—because it is too often forgotten—is that not all sales are profitable.

This is the softest market the property and casualty insurance industry has ever experienced. Agencies today are desperate to increase sales to make up for lost premiums. In their desperate search for help, more and more agencies are turning to the myriad of sales and marketing programs being sold.

Some of these sales and marketing programs are good but many are not so good. Even if they result in sales, the return on investment is often still negative or, at best, marginal. The agencies make sales, but not profits.

The fact that not all sales are profitable is a key factor missed by these programs. Some of them appear to address this fact by suggesting agencies avoid small accounts, but large accounts can be just as unprofitable as small accounts. Some of the web-based marketing programs are excellent examples of not differentiating between sales and profitable sales. This begs the question of what an agency is really getting for its money.

I have reviewed and analyzed some of these web-based marketing programs. Some contain great advertising, assuming the services and benefits promised are real. If prospects see that advertising, and the agency has decent rates, then the agency using these programs should write lots of accounts. But the agency is likely to lose a lot of money in the process because the truth is that few agencies can live up to the promises advertised. Sooner or later, the agency will lose its shirt in an errors and omissions (E&O) lawsuit because it is not performing the services or the quality of services advertised on its web site.

Agency owners need to understand that while advertising hyperbole has never been smart, only small portions of people ever paid attention to the hyperbole in paper brochures. However, Internet advertising never disappears. Search engines can quickly find all the promises an agency has ever made, meaning the agency facing a complaint stands little chance. How many sales does an agency have to make to cover an E&O claim? When calculating this cost, be sure to include your time, frustration, stress, higher E&O premiums, and damaged reputation.

Another factor to consider is: What makes a prospect's phone call or email funneled through a web site any better than one funneled through a Yellow Page ad? Is the hit ratio better? Is the retention rate better? Is the quality of the account better? In fact, what is the profitability of accounts generated by web-based advertising? If you invest a bunch of money on web-based advertising, or any advertising or marketing for that matter, without knowing what profit margin to expect, then you are in business to make sales, not profits.

I have asked this question regarding the difference between Yellow Page call-ins and web-based call-ins many times. The typical response is outrage, followed by charges of heresy. It is as though the web is the equivalent of medieval churches whose righteousness could not be challenged. I simply am asking a question to which a solid, factual answer should exist. Otherwise, you're just making sales.

Some agencies searching for sales, turn to sales consultants promising agencies that if they invest tens of thousands of dollars, they will increase sales. That is a pointless promise. If an agency invests enough in any sales system, sales will increase—the agency may go broke in the process, but sales will increase.

One popular program will work in extremely limited situations because it works well with large numbers. Otherwise, the investment in value-added tools beyond the original consulting fees is so high that most agencies will lose money. It is like a doctor telling a patient that the cost for a particular therapy will only be $10,000, which the patient thinks is a good deal. But the therapy requires drugs, other professionals and further treatments that cost an additional $100,000. Is it still a good deal?

The worst systems are the ones with high upfront charges that do not include a SWOT (strengths, weaknesses, opportunities and threats) analysis. This is usually an extra cost for the agency because the agency probably has to hire another consultant to complete the analysis. Agency owners should not do the analysis for themselves either—this is something best done by an outside party.

A SWOT analysis is a must because most agencies do not have the strengths or opportunities to make these sales systems work. Some sales consultants make this problem the agency's fault and most owners fall for it because they acknowledge they did not push their producers hard enough.

But this is a false premise. First, if an agency does not have the right people, the system used is meaningless; all systems will fail. A huge percentage of people employed as producers have as much chance of becoming successful salespeople as they have of becoming great surgeons. Every sales system will fail if this very basic fact is not dealt with first.

Second, an agency must have a sufficient number of quality accounts available. For a sales system to generate $1,000,000 commission in short order—as some of these systems promise and others require to justify their price—an agency MUST have access to many quality accounts.

Just think about the practicality. Writing $1,000,000 in $1,000 accounts in three years is 1,000 new accounts or 333 annually or almost one per day for 36 straight months including weekends and holidays. Even assuming a great 75 percent hit ratio that is 1,333 proposals. Take a look at your prospect list. Do you have 1,333 quality prospects generating at least $1,000 annually? Does the sales system or consultant have a way to generate this result? Will the consultant or system guarantee it?

Even at $2,000 per account, that is 500 accounts or 167 annually, which means 222 prospects annually or 667 total quality prospects. What does your market research show is feasible? Is the consultant even providing this research? Even at $5,000 per account, this requires 200 new sales and 267 new prospects. Few agencies can write 200 new, $5,000 commission accounts in 36 months.

So even if the sales program is great, the bigger question is whether it will work to make sales or profits. Today agency profit margins are in the basement due to the soft market and bad economy. Consider a 15 percent profit margin. In a $3,000,000 revenue agency, the agency is making $45,000 in annual profit. If it has to spend $100,000 on the system and E&O claims, how much new revenue has to be generated for the system to pay for itself?

No matter how much someone is willing to pay, there is no magic sales pill. This solution is basic. The first step is to complete a SWOT analysis to determine what is feasible and what strategies align the agency's strengths and opportunities. This includes an honest analysis of the producers' abilities and management's discipline in holding themselves and their producers accountable for results. It also includes analyzing the relevant market and carriers.

This analysis will put the cart after the horse so that any subsequent sales strategy will be going in the right direction. This may mean paying $50,000 for a marketing system or a sales consultant, but, then again, it may not. A great many agencies can make simple and cost-free improvements that will produce a bigger increase. One simple solution is to actually provide the quality service the agency's web site advertises rather than just paying for the advertising. This usually means analyzing ALL clients' insurance coverages annually.

Some of you may be thinking you cannot afford to do this. If that's the case, then make sure you do not advertise it! Sure, your advertising may then be then boring but at least it will only advertise actual services. Another option is to use a coverage checklist. Sales increase, E&O exposures decline, clients get the coverage they need, producers begin focusing only on profitable accounts and their clients' needs, and the quality of the accounts improves because price shoppers do not sit still for coverage checklists. The best thing about this option is that coverage checklists are free!

Someone will still have to generate new sales. However, with a SWOT analysis and discipline, agencies can increase sales in a much smarter way, with much less risk, and they can make profits rather than just sales.

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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.

If you wish to be removed from this mailing, please e-mail AgencyAdviser@burand-associates.com. Copyright 1995 - 2011, Chris Burand