What happens when a Network/Cluster fails?
I have a suspicion that a few networks/clusters are made up of some combination of fraud, Ponzi schemes, and nice people who are incompetent but well-meaning, all of which results in their members losing their shirts.
Other than calling a few agents from a list provided by the network to ask about the existing member's experience, few agency owners, if any, conduct due diligence before joining a network. Has it been a good experience? Have they been treated fairly? Have they gained anything of value? Great questions and there is value in asking such questions. However, those questions are entirely inadequate due diligence questions. A clue as to why comes from within some networks' agreements -- the anti-disparagement clause. In other words, the members CANNOT say anything negative or they will violate their contract!
Therefore, begin your due diligence by reviewing the contract and providing an expert with a copy to read. Give it to a high-quality attorney and someone who knows a lot about clusters/networks to evaluate. This IS NOT a Do-It-Yourself project. With no offense to any reader, most agency owners are not qualified to competently evaluate networks on your own. An expert who has read dozens of these contracts involving dozens of different networks has insight and knowledge you do not possess. They know what should be, but may not be, in the contract you are considering. They know why a franchise agreement is not necessarily the same thing as a regular network agreement. They know the differences between accounting systems and how specific accounting systems will leave members holding the proverbial bag if or when the network goes bankrupt.
Experts understand, even when the contract does not clearly state it, that all liabilities are joint and several. If a small agency signs onto an agreement with joint and several liabilities, that small agency now has responsibility for the liabilities of an agency member 10 times to 100 times larger!
At the very least, if you are going to evaluate one of the contracts on your own, write out how you will get OUT OF the network, per the contract, if you decide you need to get out. Read the contract all the way through for all the hidden clauses that limit your ability more than the exit clause itself limits your options. I recently read a contract that looked like it had an easy exit clause. However, the noncompete portion was an entirely different story.
It is a serious mistake to think all networks are financially solid. I sounded this warning to many of my clients prior to Brooke failing and feel bad about how many small agency owners lost everything when that failure occurred. Doing what I do, I hear rumors and know some are certainly true about other networks that are currently financially problematic.
What happens then when a network fails? A whole lot depends on the contract. If it is a franchise contract, the dominoes will fall in one direction. If it is a joint ownership contract, the dominoes will fall in another direction. The dominoes will fall, but the direction depends on the contract and the exact nature of the failure.
One place to always look is at the ownership of the carrier contracts. If the network owns the carrier contracts and the network fails because it fails to pay the carriers' premiums, then typically the carrier becomes the owner of all the expirations -- yours included. How would that feel to work so hard and lose everything because you did business with "nice" people but failed to read the contract or request audited financial statements?
Audited financial statements should be readily handed to every potential network member. 99.9% of members and prospective members never request audited financial statements before joining a network (and the same goes if you are selling your agency and some of the price is in the buyer's stock). When you join a network, at some level or another, you are putting your future into someone else's hands. If they are not financially solvent, then in the worst case scenario, immediately after signing the contract you have transferred ownership of your expirations to the carriers. Carrier contracts and many state laws make it clear that the failure to abide by state trust measures means the transfer of expiration ownership is automatic. This is true in every state. For those of you who think your state is not a "trust" state -- YOU ARE WRONG. All states are trust states, but a few prohibit commingling of funds. Do not confuse the two laws. Both involve trust monies, but they deal with very different aspects of trust monies.
Another possibility for loss is if the network borrows money using its members as collateral. What are its members' collateral? Expirations and the cash on your balance sheets. Some networks have more than likely borrowed quite a sum.
When the last large franchise failed, dozens of agents who thought they could continue to service their clients discovered they could not because their contracts were with the network that the carriers pulled. If the agent could service the client, they were not going to be paid because the contract was with the network so carriers could not directly pay the agent. The tangled mess just grew larger from there.
From an insurance regulator's perspective and from a carrier's perspective, the goal is the continuation of coverage for the insured. However, if an agent cannot service a client because of difficulties due to a network, then regulators and carriers will seek a fast, immediate, clean solution. This sometimes means they will cut a deal with a high quality, friendly distributor and sign over all the business, without any attached liabilities, on a blanket broker-of-record basis. The local retail agent may or may not be completely cut out and if so, will be left holding an empty bag of promises -- and also some share of the liabilities.
Carriers are not in a position to immediately reappoint 100 agencies overnight, each with their own code, which is what they would need to do if the agencies were to retain the markets. A better solution for the carrier is to turn the entire mess over to a larger network capable of managing the problem. The larger network may not necessarily want the problem because depending on geographies, they may upset their existing members by creating new members who may not meet their qualifications. Also, the potential new members will not be able to review and sign the applicable contracts immediately, and so on and so forth. The agents who signed up for the wrong network are likely stuck.
It is a funny thing about networks. Some of the networks that catch the most grief about being run in a less friendly manner, i.e. members have to meet certain criteria and have tight contracts (as opposed to having tight contracts where it is an open secret that no one pays any attention to enforcement), are the "bad" guys. The looser networks advertise that you can still run your business however you like, and so on and so forth. Those kinds of promises should be red flags because when you join forces under joint contracts and everyone still gets to operate everything any which way they want, someone is going to get hurt. When you operate jointly under any contract, you give up some freedoms and to believe or promise otherwise is idiocy and/or disingenuous.
Quite honestly, the better networks are typically the ones that tell you what freedoms you will lose and what you will gain in return. The better networks are the ones who manage themselves carefully and audit members to be sure they are in compliance. The better networks are run as solid businesses rather than some combination of a good ole boys' network where everyone makes more money without contributing any real value, with everyone pretending a price is not being paid for pretending there is not a cost for everything. I used to ask agency owners which of these two models they preferred and too many answered they preferred to take their chances on incompetency and Ponzi schemes. "They felt lucky!" So I'll ask, do you feel that lucky?
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.
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.