New Business Acquisition Costs

A while ago, I heard an executive at the IIABA declare that Progressive would soon be losing money because they were spending so much on advertising. I’ll be blunt: this is an ignorant statement. It does not matter if a carrier spends $1 million or $5 billion on advertising. The nominal amount is completely immaterial.

What matters is the return on investment for those dollars. If the return on investment is 18% for $5 billion but only 12% for $1 billion, spend the $5 billion. Calculating the ROI can be challenging and is susceptible to bad inputs, bias, and manipulation, but that is at least the correct approach. Because much of insurance advertising, though not all of it, is aimed at attracting new customers, the goal is to increase ROI by reducing the cost of acquiring each additional dollar of premium. This means that for every $1 of advertising, can we get $1.50 in new premium rather than $1.25?

I analyzed the advertising dollars and new business of the primary insurance advertisers a few years ago, and the results were astonishing. One of the main advertising carriers actually lost more premium the more they advertised. Whether this was because of their advertising or they are simply incompetent, I don’t know. But other carriers’ advertising dollars were extremely good investments. Using 2021-2023 advertising and premium data, my dataset shows a strong correlation between the change in advertising spending and direct written premium. Quality advertising generates net new growth.

If a carrier spends 2% of premium on advertising, but only pays 9% commission, then 11% is a good deal compared to a carrier that spends 0.5% on advertising but 15% on commission, especially if the former is growing twice as fast as the latter and simultaneously achieves a better loss ratio (which are real-world examples).

Another consideration is whether retention is impacted. That is difficult to measure other than on a net new basis because retention data is not readily available, and many insurance company IT systems cannot track retention correctly, even if the data were public.

New business is much more expensive than renewal business. Some advertising focuses on reinforcing why existing policyholders should remain with their carrier. This advertising is very subtle and not easily identified. Only a few carriers have worked on this strategy, while others take their existing clients mostly for granted. The focus is, otherwise, 100% on getting new clients.

Therefore, if I can decrease the cost of putting new business on the books, I don’t have to be as concerned about my retention.

At the agency level, the details are different, but the overall situation is the same. Assuming the producer is paid the same for new and renewal, and no time or resource differences exist between placing a new piece of business and a renewal, new business is very expensive because new business hit ratios are optimistically around 25%, while retention in a good agency is around 92%. If it costs $500, excluding producer compensation, for a $1,000 new or renewal piece of business, then for 100 proposals, the agency incurs $50,000 in costs, but at a 25% hit ratio, it only generates $25,000. Add 35% producer compensation, and the cost climbs to almost $60,000 to make $25,000.

On the other hand, on 100 renewing accounts at $1,000 each, with 93% retention, the agency makes $93,000 in revenue for $79,000 in expenses, including producer compensation.

My numbers are for example purposes only and are meant to illustrate the significantly higher cost of new business, largely due to differences in hit ratios. These numbers significantly underestimate the additional time and money required to place new business, so the spread is materially larger than my example indicates.

What happens, though, if my hit ratio greatly increases to 50%? I don’t have to emphasize retention nearly as much.

Every carrier I know is focused on reducing new business acquisition costs for these reasons. Some agencies are doing the same. But this emphasis, if achieved, changes the dynamics of customer service and customer value. Keeping customers becomes less important. At the carrier level, this might also benefit cherry picking loss reserve numbers, so there is a hidden benefit. If new business acquisition costs decrease enough, churn problems will increase. So will E&O exposures for agencies.

But maybe most importantly, compensation will change. If, as a carrier, I don’t need agencies to put so much effort into keeping clients because my advertising is so good I can always get more clients, then I can cut renewal commission rates. The same goes for producer compensation. It means that carriers and agencies that are not prepared for this change might find themselves at a serious disadvantage. Some already are because they put too much emphasis on retention relative to writing new business. They do not possess an adequate balance between the two, and the balancing point is shifting.

Insurance sales are mostly a zero-sum game. If an agency or carrier writes a new account, odds are almost 100% they are taking that account from someone else. Therefore, if a carrier or agency discovers a way to write new business at a much lower cost, they can put more resources toward writing new business (e.g., the effective advertising a couple of carriers have employed). That means retention decreases for the incumbent carrier (which is obvious when analyzing competitive carriers' financials) and the agency. And the incumbents won’t have the means by which to recover because their new business acquisition costs remain too high.

I don’t think most carriers or agencies are adequately sophisticated to have thought through these dynamics. But they should because even in the very hard market, around 15% of carriers shrank each year. A carrier has to work hard to go backward when rates are increasing so quickly. And many distributor acquisitions are ideal camouflage for not actually growing; i.e., competitors are taking more commission dollars in this zero-sum game, and therefore they’re forced to buy commission dollars at a high price.

Because a few very intelligent carriers have figured out how to materially decrease their new business acquisition costs, they have already changed the dynamics of the industry. And most in this industry are asleep at the wheel when it comes to what has already happened.

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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 & 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.

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