We have recommended that drastic action be taken in many turnaround consulting assignments in order to ensure the long-term viability of the agency.
By Paul J. Di Stefano, CPA, CPCU, and Thomas Pepe
We have recommended that drastic action be taken in many turnaround consulting assignments in order to ensure the long-term viability of the agency.
In spite of the fact that there are numerous agency newsletters that analyze agency expenses as a function of agency revenues--the so-called "best practices" numbers--most agency owners find that they are not able to achieve the highest possible margins since for the most part they don't know where to start in rationalizing expenses to peer group levels.
Some agents like to know how they stack up among their peers and would like to hone their operations into more finely tuned machines (the good). Other agents may be dissatisfied with the amount of money that they take out of their agency (the bad). Still other agents, believe it or not, find themselves struggling to survive (the ugly). While many may be able to relate to the first two groups, some of our readers might ask why, with a hardening property/casualty market, would an agency be in a ugly, precarious financial position?
The answer to that question is multi-facetted. In many cases, the agency principals are not strong financial managers and unfortunately have not surrounded themselves with a qualified financial manager or controller. In fact, many of the agency financial managers we encounter are former bookkeepers who started in business with the agency principals.
The larger issue is that without sound advice the agency principal may make poor financial decisions. These decisions can obligate the agency to onerous agreements and can easily drain agency cash flow. Those poor financial decisions can come in the form of poorly structured acquisitions where, for instance, acquired books of business are lost to former producers who were not signed to non-competition agreements as a part of an acquisition.
Another example is poorly structured producer agreements where producers in some severe cases continue not only to own all or part of their books of business but are at the same time overcompensated for their new business production, as well as the servicing of their book of business. In some cases, we have seen agencies paying level commissions as high as 45%. Imagine what that can do to an agency's bottom line.
The remedies are always tough and in many cases disruptive. We have recommended that drastic action be taken in many turnaround consulting assignments in order to ensure the long-term viability of the agency. In our experience, staff and producer compensation issues typically require immediate attention. A specific example of complications that can develop when addressing financial turnaround issues is the case of producers whose compensation is excessive. In some cases we have seen, producers may have outstanding advances that are basically uncollectible. The producer is likely to leave if he/she is forced to pay back those advances. How does one protect the book of business in those situations?
In some cases where the agency's producer deals need to be restructured, producers may decide to leave and take the books of business that they service. At times, it may be best to lose a producer whose deal the agency actually loses money on. The reality is that while some business will be lost through Broker Record Letters, the majority of the business will stay at much reduced compensa-tion levels.
Agency financial management is difficult at best when financial statements are often months late--if prepared at all. In many cases where the agency is actually substantially out of trust, the agency principals know of the problem but they have no idea how bad the situation is. The trust issue, however, is symptomatic of the larger issue of agency financial mismanagement.
A client who recently was considering selling retained Harbor Capital Advisors to represent his agency. While the Harbor Capital Advisors team was in the process of preparing an acquisition profile, there was an unexplained delay in the ability to obtain financial statements. Financial statements were being issued on a quarterly basis but the data was three to four months old by the time it was released to management. Not only was the information late but the information also was very misleading. The internal accountant was showing the balance sheet in trust when the reality was that the agency was over $1,000,000 out of trust. The accountant must have thought that he was doing the agency principals a favor by presenting this information to a banking institution for lines of credit.
When we informed the agency owner that his operations would not pass due diligence in a sale, he became quite upset because he was banking on retiring within one year of a sale. We immediately suggested that the Harbor Capital Advisors engagement be modified to encompass a turnaround consultation engagment for the agency. We implemented the following detailed plan of action:
* One of the members of the Harbor Capital Advisors financial team was installed to work on site to reconcile the financial statements so that they were in balance with the supporting subsidiary ledgers.
* A projection of the agency's cash needs would be completed so that management would understand the magnitude of the situation with which we were dealing.
* Agency receivables and payables were analyzed and reconciled to carrier balances.
* Producer commissions were reconciled against their individual agreements with the agency to ensure that no over payments were being made.
* A functional analysis was made of the agency's employees and their roles, and efficiency was reviewed looking for overstaffing.
* Branch offices were reviewed for consolidation.
While all of this sounds fairly obvious and straightforward to implement, it is quite the opposite. Once cultures are established in an agency, it is not easy to deal with entrenched interests. In many cases it takes the knowledge and expertise of a third party such as Harbor Capital Advisors to cut through the myriad of misinformation and make recommendations based upon what is already being achieved in well-run agencies.
Even the large public brokers are not exempt from this problem. We occasionally read in the trade press that some large entity is taking one-time charges associated with mass layoffs and in other cases they are being sold to other public entities that have the ability to combine offices and eliminate redundant expenses.
In summary, at times drastic action is necessary in an agency to forestall financial problems. The senior principals of Harbor Capital Advisors have the hands-on experience necessary to put a troubled agency back on sound footing. Some agencies need help to get them to their most efficient operating levels while in some cases agencies like the one we have described require emergency first aid. *
The authors
Paul J. Di Stefano, CPA, CPCU, is the managing director of Harbor Capital Advisors, Inc., a national financial and management consulting firm that offers services to the insurance industry. Services include agency appraisals, merger & acquisition representation, strategic and management consulting.
Thomas Pepe is an associate director for Harbor Capital and previously was president of A.J. Gallagher of New Jersey. Tom was a partner at the time of the sale of his agency to A.J. Gallagher and spent six years with A.J. Gallagher.
Harbor Capital Advisors, Inc.,
can be visited at its Web site (www.harborcapitaladvisors.com)
or can be reached in New York at (800) 858-2732.