CNA CHAIRMAN LOOKS AT THE FUTURE OF THE AGENCY SYSTEM
Editor's note: Dennis Chookaszian, chairman and chief executive officer of CNA, visited the Rough Notes offices in November and spoke with Rough Notes editors about some of the issues facing agents and companies today. Chookasian will be leaving his position of CNA chairman at the end of March and will become the chairman of the executive committee of the CNA Financial Corporation Board of Directors. The following is an edited account of his conversation with Rough Notes editors.
Both insurance companies and agencies have undergone tremendous consolidation in recent years. How do you see the evolution of the changes taking place in the distribution system and what are the implications for independent agents?
There are vast differences between what's going on in personal lines and commercial lines. Let's look at the commercial market from the standpoint of where we've been and where we might be headed.
Fifteen years ago, according to Future One--a joint research study sponsored by major insurance carriers and the IIAA--there were 70,000 agencies. The latest Future One survey in 1996 put the number of agencies at 44,000. Twenty years ago, there were approximately 20 national brokers. Five years ago it was down to 10 or so significant brokerage entities. As those large brokers were consolidating down to 10, they gained significant control of the large commercial market--to where they were writing about 90% of the accounts where premiums are over $1 million.
Then during the last three years, both independent agents and the national brokers have continued to consolidate. The 40,000 independent agencies are heading toward 20,000, and the large brokers are essentially down to two entities (AON and Marsh & McLennan). Today about 85% of the large account market--the Fortune 1000 company business--is controlled by AON and Marsh. Willis Corroon controls another 7% or 8%, and the rest of the firms have a small percentage of the business.
But in the last three years we've gone from a two-tier market (the large brokers and independent agencies) to a three-tier market. The third tier, a middle tier, consists of about 20 firms which are consolidators, such as USI, Acordia, Poe and Brown, Hilb Rogal Hamilton, Summit Global Partners, ABI, Willis, and Gallagher. These firms are consolidating the smaller firms and will become a very significant part of the market over the next five years.
With the big brokers dominating the large commercial market, how do you see competition shaping up in the remainder of the commercial market?
Outside the large account market the two big brokers, AON and Marsh, control less than 10% of the market. Smaller independent agents control the bulk of the market, but the middle tier of consolidators is increasing its market share. The middle tier of 20 or so brokers operates much differently from Marsh or AON. Each one has a different strategy, but a significant number of them are consolidators, rolling up independent agencies. When they buy an agency, they generally want the agency principals to remain and run the agency as a local office of the larger firm. The consolidator may try to standardize the computer systems and back-office services but the marketing will generally be guided by the local office principals. When Marsh McLennan or AON buys an agency, they generally will consolidate the operation with one of their existing offices and the business will conform to the Marsh or AON business model.
This difference in approach to consolidation has a distinct effect in the small commercial marketplace, where the independent agent or the consolidator of independent agents continues to be a strong market force. The offices of Marsh and AON have traditionally been more focused on large account business but are more recently developing programs that are attempting to gain market share in the middle-sized commercial business.
Let's talk a little more about consolidation among independent agencies. Where do you think it is headed?
Some of the 20 or so third-tier brokers are rolling up independent agencies at a pretty significant pace--20 to 50 a year per firm. I think it will continue to happen in a bigger way. One thing these consolidators are able to bring to the table is capital. Computer systems are very expensive these days. The consolidators can provide an agency with a good computer system and all the back-office support services and let agents concentrate on production which is what they're good at.
There's also a problem with some of the consolidation that's taking place. It attracts a lot of venture capitalists to the business, backed by Wall Street money, who do not have a long-term time frame. It puts an unstable capital structure in place. For instance, Kohlberg Kravis Roberts (KKR) owns Willis. The one thing you know for sure is that Willis will have a different owner in 10 years. You just don't know who it will be. Willis has indicated that it intends to consolidate smaller firms, and the structure of Willis will then determine who the new owners will be when KKR decides to exit. It is possible that Willis will again become an independent publicly traded firm, or they may be consolidated with another firm. In the end, the economics of the highest sale price will determine the outcome.
We see this middle tier as a successful part of the system and are concerned about the instability of some capital going into it. So we announced about two years ago that we would partner with firms in that middle tier--more than one--and take on an equity interest, supporting their growth.
Our preferred approach, though, is not to do it by ourselves, but along with two or three other insurance companies. We don't know anything about running agencies. We just want to provide the stability of a capital base and be a good strategic partner to them and let them do the consolidation. We have started those efforts and we are now a significant owner, along with four other companies, of USI. We're also talking to five other middle-tier brokers about the same kind of arrangement.
In addition, we have financed agency perpetuation and acquisition for many years. These efforts have been very successful, and we have had very few problems with the loans we have made. It makes sense for us to provide some capital at various stages of operation for a firm such as USI. Under USI's original model, they got money from venture capitalists, but eventually that doesn't work because the venture capitalists want to take some money out and the agency organization needs more capital to continue its expansion. Having insurance carriers involved in the capital structure of the agency allows for further expansion and provides a more stable platform.
How big an equity position would you or other insurers take in these mid-tier brokers?
A good model would be something like this: The insurers own 50% jointly--10% to 20% per company; the management owns 20%; and then maybe you get some outside capital for 30%. There could be many other models, but that's a nice balance. There are some where the broker prefers to have a larger equity stake and be a little more leveraged with debt instead.
I like having the insurers own 50% because as these firms get big, they need both continuity of management and the long-term stability which the insurers can provide.
What do you want from this investment?
A couple of things. One is stability. We're looking for stability from the distribution source. And then the second thing is strategic partnerships. We're not looking for any exclusives or commitment of premium volume. We just want the agency to be strategically aligned with us and to work with us on new programs. We're very bullish on these mid-tier brokers. There are about 20 of them that we think will grow and expand.
Are these mid-tier firms capable of using their clout to achieve better efficiency in automation?
Yes. USI, for example, is moving all its agencies to the AMS Sagitta system. Acordia and Hilb also are likely to move in the direction of a single vendor.
All independent agents are benefiting from some of the consolidation that has occurred among automation vendors. It's easier for agents to make a long-term automation decision based on the strength of the remaining automation vendors. With AMS, which is owned by CNA and a number of other insurers, we bring agents a stable firm that will support their long-term growth.
The Y2K issue is a good example. AMS has about 35,000 agent customers now for one product or another. The AMS back-office system is in 11,500 agencies, and 10,500 had already been converted to a Y2K certified system by November of 1998, with another 500 scheduled to be converted by the end of '98. That leaves 500 still to convert, and 250 of those are scheduled for conversion at the very beginning of '99. The remaining 250 have no plans and will be out of business unless they respond quickly.
You mentioned earlier that there were vast differences in what's happening in the distribution system for commercial lines and personal lines. How do you view agent opportunities in these two markets?
In commercial lines, we see the independent agency system as being a viable model and the long-term model. For a $50,000 account, the agent gets paid $5,000 in commission and performs a risk management survey and other important services. It can't be done more cost effectively other ways. The independent agency market is not losing market share to direct writers such as Liberty Mutual.
The Internet will assist in the sales process for commercial products, but it's not going to convert into a sales machine. You'll be able to use the Internet to communicate information, but commercial lines is still a face-to-face sale. Selling commercial lines through traditional channels will continue to work, and we're very bullish about it.
We believe that independent agents are rediscovering personal lines in an effort to diversify and be less vulnerable to the down cycles in the commercial business. We are seeing some shrinkage in market share for the independent agent in writing personal lines. However, it is still a huge market. Let's remember that many consumers find insurance and related products confusing, and they choose to do business with an independent agent for guidance. Agents need to go beyond just servicing their customers to protecting their customers' assets by offering customized products and solutions. This is the role of a personal advisor that we believe is so important. We are committed to the independent agent as the foundation of our distribution; and through our training programs and other efforts, we are helping agents to invigorate their personal lines marketing efforts.
In addition, successful independent agents are taking the steps to make more than one sale at a time. We support the Insurance Deduction System (IDS) software that allows agents to write employer groups. One significant change in our business is customer choice; that is, the customer will choose how and where to buy his/her personal insurance products. We see the more self-sufficient or price-sensitive customers on the Internet, and we are partnering with InsWeb and other companies to better understand their buying habits and preferences. There are customers with bank relationships that they will access. Independent agents committed to personal lines understand the nuances of customer choice and are identifying new customers and marketing to them in ways that make the most sense for that customer segment.
Is CNA taking specific actions in the marketplace which might reduce your total agent base?
Our growth objectives are dependent on appointing more agents and deriving more business from the independent agent. We intend to grow our independent agency force from our 3,500 agencies today to 7,000 agencies or more. CNA Personal Insurance is committed to being the carrier of choice for the independent agent. More important than size is helping our agents do more business more efficiently with us.
We come to this from the position of strength as the largest package writer and the fifth largest premium writer through the independent agency system. We understand that to fill the role of carrier of choice, we should be able to write the risks that an agent brings to us. Our tiering program gives us that capability. With four tiers, Platinum Plus, Platinum, Gold and Silver Select, that are being filed, we are able to serve a broader market from a risk diversity perspective.
We have also partnered with Progressive Insurance to market personal auto insurance to large employer groups and association-based groups using the independent agency system. Under this arrangement, independent agents bring large employer groups (1,000 employees or more) or affinity groups (50,000 or more members) to us for the marketing of personal auto insurance. We assume the majority of the underwriting risk, but we use Progressive's products and rating structure, so we can cover anyone.
Our agreement with Progressive is a marketing program for agents that allows them to participate in alternative distribution business. Agents who bring their employer and affinity groups to CNA take advantage of an exciting and growing business opportunity with minimal effort. CNA handles the sales and servicing of these accounts with a partner that has the best in class service and expense management capability.
About a year ago the president of CNA Personal Insurance listed a goal of increasing your personal lines premium from $1.5 billion to $10billion in 10 years. How much of your personal lines growth in the next 10 years is likely to come from traditional agent channels and how much from alternative distribution?
Today, 98% of our personal lines business is through the independent agents. Our goal is to be a significantly larger personal lines company in the future. We see a significant part--60% to 65%--coming from the expansion of our agency distribution channel with the rest coming from some alternative distribution ideas and also from a strategic alliance or merger with another carrier. Percentages can be tricky, so we should view these numbers as estimates only.
In the personal lines market, do you see the State Farm and Allstate models still working into the future or losing as heavily as the agency system?
I think the way State Farm and Allstate do business will work, for a couple of reasons. The State Farm and Allstate models are positive ones for the agent, and the agent can make a lot of money if he/she is a successful salesperson. Consequently, it's highly competitive to get a State Farm or Allstate franchise, and it attracts very good people who are highly motivated. These agents are going to figure out a way to sell no matter what the competition is. State Farm and Allstate control about 40% of the personal lines market, and they aren't going to dramatically lose market share. Their retention levels are in the 90s--no agency company comes close to their retention rates.
A couple of years ago, our book of personal lines business was actually decreasing and we recognized that it was due in some part to our operations. Over the past 20 months, we have grown our business dramatically. We are getting more of our agents' business because we have improved our operations. That growth speaks volumes about our ability to grow our business going forward. Again, we are working hard to be the carrier of choice for the independent agent.
Is it mainly technology that makes the direct writers and direct responsive companies so competitive? And if so, why can't agency companies match this technology and then be competitive?
Technology is a big part of our solution. Our goal has been to go beyond minimizing the unproductive back-and-forth between the agents and carriers by providing the solutions that put agents in control of their destiny. By providing our agents with upload, download, automated underwriting, automated rating, we connect our agents to the resources that we have developed for their use. The whole idea is to provide our agents greater customer outreach and performance.
What other products do you see as providing significant growth opportunities for agents in the future?
Two products come to mind. Life/health business and employee leasing, and CNA is dominant in both. We're the only carrier now in the employee leasing business, and we probably sell more life business through property/casualty agents than any other company. For term life insurance, we were the largest seller in the U.S. in 1997.
We find that what works in selling life through independent property/casualty agents is to offer them the help of a life professional for an assisted sale--either a CNA employee or another CNA agent who specializes in life insurance.
The employee leasing concept is potentially transformational. Companies cuts their costs because it's a lot cheaper for the professional employer organization (PEO) with 50,000 employees to buy workers comp coverage, for example, than it is for the individual company with 50 employees. And all their human resources administration can be outsourced.
We decided to buy a PEO about two years ago after agents in certain places like Florida kept telling us that they were losing accounts to PEOs. They would lose the work comp and the other related employee coverage, and of course work comp often drives the whole account. Today in Florida a quarter of all companies under 500 employees are in PEOs. Nationally, of the 50 million workers at companies under 500 employees (which is half the total workforce) two and a half million, or 5% of the total market, are in PEOs.
We bought ISI which is the sixth largest payroll processor in the United States, and that's the core of our HR and payroll services operation. So far, we have about 9,000 leased employees, and we should be up to about 20,000 employees in the next year which would put us in the top 10 of PEOs nationally.
We think we're giving our agents a tremendous opportunity by having them sell the services of CNA Unisource, which is our PEO. Instead of losing an account to another PEO, agents can offer their own and the customer becomes part of an organization that is backed by CNA.
It also elevates the agent on the list of a client's important advisors. Today the agent is somewhere below the accountant and attorney on the list. With the PEO, the agency becomes the administrative outsourcer for the client, raising the level of contact with the client.
To further round out the services our agents can offer to commercial accounts, we decided about a year and a half ago to buy a commercial warranty company. So now our agent can go into a business and provide complete electrical or mechanical breakdown coverage for phones, fax machines, copiers and computers in their office.
Next we want to look at the idea of partnering with other firms for services such as legal or accounting work, so we can offer those services to small business as well. We could also partner with building service contractors, postage meter companies, office cleaning firms and others.
The independent agent can be the rep for all of these services. We think we're the ideal company to do all these things because we're a multiline company. Twenty years ago if you listed the 20 largest companies in the U.S., 11 of them were multiline companies. That is, they had at least 10% of their premiums in life, 10% in health and 10% in casualty. Today only one company fits that multiline criterion, and that's CNA. *
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