What Part Of Your Practice Is Most Profitable?

Youre working harder. Youre working smarter. But your net earnings are stagnating. Why cant you increase the bottom line? This is a question every agency faces; yet few are able to answer from a profit perspective. Much has been written about refocusing your business, but how do you decide where to make that change?

In our overactive, current results-oriented world, we tend to focus our energy on near-term rewards. This is typically measured by cash flow or by the commission on the last case placed. Only when we reach a cash shortage do we look at our expenses and how they relate to our activities.

Yet, if we want to grow the value of our business, we need to understand how these items affect the long-term value. How do we create a process to help us analyze and improve our business?

The best approach is to look at your business like an investment opportunity for a third party and apply standard investment techniques, just as you would for a client. This requires you to know the relative profitability of your activities and to relate your expenses to the revenues they generate, as well as understand the impact on the total value of your organization.

Ultimately, you will want to channel your activities to the high-profit segments just as a well-run business channels its capital investments to high-profit opportunities.

The process can be described by Figure 1, The Value Circle, which represents the continuous linking of four activities: gathering data from carriers, analyzing your cost/activity structure, performing projections, and reviewing/monitoring results.

The Value Circle process involves understanding the continuously changing nature of your business and how it impacts your financial results.

As shown, the “Value Circle” relates goals, activity and product/carrier choices to your current profit picture and creates a path to increasing that value over time. Regardless of the size of your agency, creating, communicating, and managing your goals are critical to success.

1. Gathering Data From Carriers. To start, you need to project future income, including your future commissions and bonuses as far out in the future as they go. Here is where many projections take a short cut and make a rough estimate using their commission statements and a spreadsheet. That is not very reliable, and it will be obvious whenever you negotiate with a buyer, a bank, or a home office. To maximize the opportunity, the most reliable method is to base your projections on in-force data from your carrier.

The number one problem for most agencies is getting usable, understandable data from carriers and then knowing how to use it. Companies provide producers with data developed for ease of use by the company, typically for actuaries and accountants. Agent needs are generally secondary; a commission check and some supporting information are deemed enough.

Many carriers cant routinely provide a projection of future commissions for an agency, but this information is critical to your evaluation. You require detailed data from each of your carriers that will allow you to create projections that are as important to your business as the companys projections are to them. This must be done routinely and consistently. If a carrier wont, or cant, you should be persistent. Maybe you havent asked the right person.

For projecting commissions from new business, you can use your existing contract data.

2. Cost Analysis. Do you spend your time on the most profitable cases? How much time, and money, does each carrier relationship cost, especially the time away from the office on maintaining those relationships? What is your process for determining where to prospect for new business? You dont need a detailed cost analysis of your operation, but you do need a good model of your costs and how they relate to activity in the office.

For example, you may find you are closing one of five cases in one market but one of two in another. Is the latter market a better profit opportunity? Not if the cost to develop a case is five times as expensive as the former (the actual cost per closed case is twice as high). Factor in the commissionable premium on the case and you can see how widely the cost to obtain a dollar of commission can vary. It is important that you reflect your unique cost structure in these projections.

However, numbers are only part of the answer. You may not be able, or want, to switch your market, but you might be deceiving yourself if you blindly expand in a marginally profitable sector. Thus, you cant just turn the analysis over to your bookkeeper; you need to inject some of your unique business sense into the analysis as well.

3. Evaluating The Results. After you have performed the calculations and produced a set of values and projected income statements, it is time to see what you have. Based on your production assumptions and expense levels, what will future earnings be? What is the value? And does the value grow in future years? Which products are providing that growth? Do the results make sense?

At this point you can change the assumptions to see how earnings and growth are affected. It is important to determine which factors most affect the value of your business. Is it persistency of the in-force block? Expense levels? Are costs for supporting a product higher than what youre earning? If you add another agent, what are the costs and profits? If you eliminate a certain market and its related costs, what are the short-term and long-term results? When you have settled on a product mix that is doable and staffing and expense levels that are achievable, you now have a plan with projected earnings.

4. Monitoring Results. The first time the analysis is performed, the process has two valuable outputs. First, youll understand the value of past activities, including the source of that value. Second, youll gain insight into how you might alter, or expand, your business plan to increase long- and short-term profits. But this is only a first step in understanding your business and radical change is not advised. Rather, results should be reviewed to spot trends, as well as verify initial conclusions, before dramatic change occurs.

Additionally, your model will allow for “what if” analysis to develop alternatives and their expected impact, before change is undertaken. Even if no change is made, you will have better expectations for your activities. You may need to make minor changes to your financial process to improve the analysis.

The process is straightforward, and the mathematics are basic. So why hasnt this been done already?

In a phrase, “lack of coordination and differing perspectives.” Companies must provide data in usable form; then, you become better equipped to analyze situations and develop alternatives, and you dont want to rely on your carrier or people that dont understand how your business operates.

Through integration of these skills, a better picture emerges. In fact, this information will be valuable to the carriers. Chances are that where you are most profitable, the company is also very profitable. Do you know a better way to get the company to support your primary needs than to find mutually profitable alternatives? Analyze your results and youll probably find a company to partner with you as you expand or change your business.

Les Durland, FSA, CLU, is president of Durland Consulting, a firm specializing in distribution, marketing, and product development for the life insurance industry, Tucson, Ariz. He can be reached at lesdurland@aol.com.

Larry Corbitt, CPA, is a principal of ASI, an actuarial/financial consulting firm in Atlanta, Ga. He can be reached at lcorbitt@asicorp.biz


Reproduced from National Underwriter Life & Health/Financial Services Edition, November 11, 2002. Copyright 2002 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.