Moat Associates

This is the second part of a two part series. Don’t miss part 1:Business Loans for the Independent Insurance Agent

Spotting Trouble on the Horizon

When Lending Implement a Regular, Knowledgeable Follow Up

Inherent in the establishment of appropriate covenants and conditions should be acceptance of regular financial and operational reviews. These might be as frequent as quarterly in marginal loan situations or when trouble has been spotted. Such reviews should include not just the agency’s financial results but at least annually the owner’s personal financials whether or not personal assets have been pledged against the loan.

Operational aspects should include:

• the maintenance at all times of a fully funded premium trust account,
• insurance company loss experience,
• a comparative review of new and renewal experience,
• employee turnover
• numerous issues related to the agency’s book of business and major customers.  For example, is a changing underwriting climate affecting the agency’s larger accounts and are major accounts receiving favorable treatment regarding payment of their accounts.

Additionally at least once a year the review should be on-site. While many professional lenders feel that given the financials to review is enough, nothing can make up for the opportunity to meet with key employees and sense the level of morale and management support evidenced by the staff.

Identify any Failure to Separate Premium Trust Funds from Working Capital

The leading cause of insurance agency failure is the failure of the agency owner (and lenders when involved) to recognize that the cash on deposit in the agency’s account(s) is not all available to meet operating needs or loan maintenance. The nature of the independent agency interface with its carriers (insurance companies) generates a substantial flow of fiduciary funds in the nature of prepaid premiums. Notwithstanding laws and regulations to the contrary, many agency owners take advantage of this “float” to fund daily operating needs – both business and personal. Failure to distinguish the nature of available cash and monitor the maintenance of premium trust funds regularly leads to agency financial problems.

Spot An Emphasis by the Owner(s) on Building a Life Style Ahead of the Business

Running a close second in generating financial problems within an agency is the owner whose past, success has led him to regard the agency as a means to an end rather than an end in itself. One leading expert among agency consultants characterized this as the “Gucchi, Pucci, Porsche Syndrome.” It is manifested in the increasing size of the personal “perks,” the abundance of “toys” and non-business assets all funded by the agency. Occasionally it finds expression in an ever more demanding involvement in “ego-rewarding” community, social and political positions. One may even find the unusual situation where the owner(s), in the belief that they are being creative, use the agency for tax deferral/avoidance/evasion schemes that ultimately cause huge personal problems. Obviously the independent agency business is entrepreneurial in nature. Usually an agency is dominated by a sole proprietor. As a result lenders should not be surprised to find many, occasionally unusual, owner/executive benefits. The issue is to find reasonableness in each situation when making the loan and monitoring the resolution of excesses during the period the loan is outstanding.

Don’t Rely on Contingent Commissions to Support the Agency’s Expense Base or the Loan

Contingent commission income is exactly that – contingent

It is true that a history of growth and underwriting profit for the agency’s principal carriers augurs well for the continuation of contingent commission income. Nonetheless, one or two losses or the non-renewal of one or two of the agency’s larger accounts can mean a sharp, sometimes very sharp, drop in contingent commission income.

Realistically, the agency’s expense base, including owner compensation, should be covered by non-contingent income. This becomes particularly important when profits are needed to fund loan principal and interest payments.

Maximizing Asset Value

Unfortunately the occasional loan to an independent agency results in default or a breach of one or more of its covenants. If the initial valuation was thorough, the loan terms reasonable and the problem spotted in timely fashion, then the loss, if any, should be minimal.

Even those few instances where the owner(s) has depleted the agency’s assets, whether through irresponsible management or fraud, he/she was not able to dissipate even half of the fair market value of the firm. While there are probably no “secrets” for achieving a successful workout, the nature of the independent insurance agency business offers options, strategies and certain requirements for success that may not be present in other workout situations.

Determine the REAL Cause of the Problem

It should go without saying, but the first, and probably most important step, is to identify the cause of the problem.

Only with such knowledge can you recommend and implement specific solutions to minimize future damage and constructively protect the existing assets. Lacking an intimate knowledge of the insurance agency business many lenders and their workout specialists fail to see the real cause of a problem. Thus their responsive actions are unsuccessful in bringing about initial stabilization and ultimate success.

For example, exorbitant and increasing write-offs of customer receivables may not necessarily be a “collection problem” but rather a “selling problem.” In the desire to bring in new commission revenue an agency may make payment deals with customers, or to assure renewal of a large customer the agency may “finance” premium payments out of its own capital or, worse, premium float. Similarly, the invasion of premium trust funds may indicate personal requirements rather than excessive agency expenses. A drop-off in agency income may not be detected if the sources of that income are not understood thus responsive action that eliminates key people may be exactly the wrong response.

Determine where the Agency’s Value Resides and Take Steps to Protect and Enhance It

Owing to the nature of GAAP accounting as it applies to the independent agency business (and of course to many others), the agency’s book value generally grossly underestimates the fair market value of the agency. The reason lies in the fact that an insurance agency’s expirations (customer list), from which it derives its inherent value, remains unbooked. Accordingly, in any workout situation it is imperative to quickly appraise that value and initiate steps to protect, not diminish, it. In most agencies, there are several quite separate sources of value. The most common distinctions are between: property/casualty and life insurance commissions; personal lines and commercial sales; commodity and specialty products; standard sales and endorsed or program sales; and, owner versus brokered accounts. As one might expect there are even combinations of these. Each is likely to have a different value, each is likely to contribute differently to the agency’s profits, management problems and opportunities and each is likely to demand a different workout strategy. Almost always the successful plan involves identifying the best of these opportunities and implementing a plan that allows the agency to stay in business and preserve, restore or enhance its value.

Seek the Support of the Agency’s Key Markets and Personnel

Assuming that the book of business, or significant portions of it, can be shown to have “profitable” loss ratios, then the insurance companies that underwrite those portions are likely to want to continue to receive the premiums. As a result, many will work with you to help preserve the agency or its underlying assets. They can do this in several ways. Among the helpful responses that we have been able to negotiate are: delaying and spreading out payment of amounts due under the accounts current; advancing commissions, especially any contingent commissions that can be expected; making loans against secured assets and, occasionally, even providing cash, guaranteeing loans or temporarily increasing commissions in exchange for an increased share of the agency’s profitable business.

Obviously the nature of the appeal to the carriers and their responses will reflect the kind and severity of the problem and the opportunities that may inure to them. In any troubled situation it is important to motivate the agency’s key staff. The loss of sales personnel can exacerbate the production problem, notwithstanding the existence of non-compete agreements. The loss of knowledgeable service people can immediately affect relationships with significant commercial accounts and even the agency’s major insurance companies. In most instances conveying an understanding of the problem and the solutions being implemented will engender the confidence needed for these people to support the rehabilitation plan. Occasionally modest bonus programs will result in immediate positive responses. In rare cases “stay-put” incentive agreements, ownership options, raises or promotions may be required. As in any workout situation, appeals to vendors, lessors and other creditors based on a reasonable plan can result in support.

Liquidate All or Part of the Insurance Agency

While it should be considered a last resort, the sale of the agency or some of its expirations may be necessary. Unfortunately in the haste to limit the loss or achieve a quick recovery many such sales prove disappointing and actually result in worsening the chances for increased, if not full, recovery. The market for the purchase of insurance agency expirations is an active and substantial one. Assuming that the subject agency is not located in the “far boondocks” or does not have a poor underwriting history, then immediate opportunities will exist for recovery through a sale of the agency or some or all of its assets. Unfortunately it is this immediacy that causes the problem. In the rush to get something on the record, many workout specialists, lacking knowledge of the industry, fail to find the right buyer or negotiate the best deal terms.