Based on what’s happening in claims and the way rates are rapidly increasing, no one would ever think insurance companies are charities. They might think they are cheats, voracious capitalists, necessary plagues, and those are the nicer terms.
But the best insurance companies are run more efficiently than a great many charities. I began thinking about this when I realized that some insurance companies are running on 15-16 cents. Out of every premium dollar, after subtracting claims (their largest expense), loss adjustment expenses and agency commissions, they are running the rest of their company on 15-16 cents. That pays for all their salaries, travels, reinsurance, audits, state filings, etc.
Not all carriers are this efficient, but some are. I did a quick, and anything but a thorough, review of the 100,000+ charities to learn how much they distribute. A quick review of eight large charities ranging between hospitals and generic and environmental shows that, with one exception that distributes 100% of all their donations, these charities keep between 10 and 33 cents, with most keeping around 20 cents. It’s pretty amazing that some insurance companies are run on less money than charities.
This fact has huge implications for the industry’s future. The first is, how much is realistically left to save? I think it is unrealistic to expect an insurance company to pay all their bills on much less than 15 cents of premiums. Yet the pressure they’re under to do just this is enormous. What they must achieve, argue innocently or pointlessly otherwise, is they must greatly increase their productivity.
While most are focusing on IT, and others are laying off people in masse rather than strategically, the better answer is that a full rethink of insurance operations is required. An easy point is that either something is broken, which if true needs fixing, or the realization hasn’t yet set that companies are paying three entities to do one underwriting job. They’re paying underwriters, they’re paying agents, and they’re paying their predictive modeling vendor. Given how poorly trained some underwriters are today and how they really don’t underwrite, they are low hanging fruit, but agents’ contingencies are not far behind if a carrier has honed their predictive models well.
Procedural consistency in companies is lacking as much or more than in agencies. Inconsistency is extremely expensive (see the book “Noise,” by Daniel Kahneman, for fantastic examples of just how expensive inconsistency is). Inconsistency is solved with better leadership, management, and training, not IT.
Next, pay for performance. Pay agents for performance rather than size and loss ratios. Size and loss ratios are outdated metrics. With procedural consistency, many more important performance metrics become available better enabling a company to differentiate the combined ratio of one agency vs another agency. Good predictive modeling minimizes the importance of loss ratios and with aggregation and consolidation, everyone of importance has a big book negating the importance of differentiating by size.
Then take some of these savings and pay for smarter employees who have the authority to make intelligent decisions. Paying people to make blanket decisions is a waste of money. Instead, just post a note on your website that you are not writing in wildfire zones regardless of how fire safe the house is. I can hear certain insurance company executives expressing frustration that they don’t blanket underwrite, but the reality is they do. Go ask your most honest agents.
The bottom line is how much longer can carriers afford to pay their agents more than it costs to run all the rest of the company? And agents, how much longer do you really think such commission rates are tenable?
Carriers don’t really need to pay order taker agents 15% commission, and even if they need to pay that amount, they can’t afford it. The proof is in a comparison of carrier results. Certain carriers are paying far less in commission rates and yet their growth and profits exceed industry averages by large amounts. They are beating everyone else and for some reason or another, agents place even more business with the carriers paying less commission!
Agents need a strategic plan for lower commissions. A compromise that would benefit everyone including consumers is paying the professional agents more. They bring more value to consumers and carriers in my analyses. The return on investment to all involved is provable. Of course, someone has to tell the order takers they aren’t worth full commission, but they’ve been skating a long time.
When expense ratios must be so low, the market must be consolidated. Regardless of the industry, many firms lack the management and leadership to thrive in a low expense environment and insurance is not an exception. Quite a few carriers will be eliminated. Some of the new entrants touting low expense models should be carefully evaluated by the regulators because if their low-cost model is dependent on holding less capital (i.e., surplus) or low-quality surplus, consumers may be left hanging. Financial engineering in the insurance industry often benefits specific people, including consumers, until a catastrophe hits. Insurance finance really should be kept fairly simple.
A number of carriers have worked themselves into corners relative to cutting expenses. They don’t have the surplus whereby they can reasonably not buy reinsurance, but reinsurance is expensive. They have borrowed large portions of their surplus so they’re paying interest instead of making interest. Some are so far behind in IT they will never catch up and they may not be able to afford to catch up. Some are simply too small. Low expense requirements favor a specific scale, and several hundred carriers lack scale.
The leverage in carrier/distributor relationships has tilted in favor of distributors over the last ten years with the aggregation and consolidation that has occurred. But with fewer material carriers and a number of carriers with limited futures, the stronger carriers are regaining some leverage. This will enable them to institute those commission cuts.
When a company is run on such a shoestring that charities can’t match their expense platform, carriers’ choices as to what to do next to build their business are limited. Awareness of reality helps shorten the psychological denial of reality so prevalent, focusing executives’ minds more quickly. The carriers and distributors that are first movers in this space will win. It’s not like technology which resembles lotteries as to which technology will win. Low expenses managed well will win.
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None of the materials in this article should be construed as offering legal advice, and the specific advice of legal counsel is recommended before acting on any matter discussed in this article. Regulated individuals/entities should also ensure that they comply with all applicable laws, rules, and regulations.