Learn how to increase the value of your insurance spending

I'd like to offer you a synopsis of how insurance markets work, and some suggestions for making them work well for you. If you wonder about my qualifications, I am a partner in 185 agencies in six states with over 800 employee agents and we sell about $650 million of this stuff, so I have a bit of knowledge here.

Insurance is made out of money. It's a manufactured product just like an airplane. When the raw material prices go up so does the finished product price. Now, the insurance industry gets complicated, because while general overhead costs are known upfront, claims costs aren't. And for liability lines, the ultimate costs aren't known for a long time (average 7 years).

One of the ways carriers structure the risk financing is to invest the money they receive in premiums for the time before they pay it out in claims. They are limited in what they can invest in, but they have the same issue that all investors have which is that the low-interest-rate environment of the last dozen years means that investment returns support less of claims costs. This is one long term fundamental that has raised costs and price.

For example, 15 years ago insurers targeted a 100-105% "combined ratio" (claims costs plus expenses) in order to make a profit. Today carriers must achieve between a 90-95% combined ratio due to lower investment returns.

For what it's worth it's a tough business. It's the least profitable segment in the financial services sector for example and the property and casualty industry has only made an "underwriting profit" (see above on combined ratio) a few times in the last 50 years.

Carriers who write only one or two kinds of insurance can gain advantages through expertise. But they face increased risks due to smaller market sizes and concentration of risk. What this means is that things can go well until they don't and they get clobbered. That is in part what has happened in the aviation market which is very small.

Larger carriers, who write many lines of business, can offset losses in one line with other lines. Auto insurance has been a huge loser for the industry for the last 7 years, for example, due to increased frequency of loss driven by lower gas prices and more driving, and increased cost of claims due to the increasingly expensive repair costs of cars. That was offset for a time by other liability lines, but those claims costs are increasing as are property loss costs, which are increasingly unpredictable due to climate change

All this to say that insurance manufacturing is highly complex. It is also amazingly competitive.

On the distribution side of the business (insurance agents and brokers) it is also fairly complex, but let's start by defining the parties.

  • A "broker" is someone with specialized knowledge that stands in between the parties to the transaction (insurer and insured) and facilitates for a fee. That individual owes duties to both parties.

  • An "agent" is governed by the laws of agency, and while they owe obligations of honesty and fair dealing to the buyer, they work for the insurer effectively (independent agency owners and agents as contractors, and captive/direct agents as employees). Agents often have the authority to directly impact pricing and/or place the carrier on the risk, brokers almost always do not.

Why is this important? Because as a buyer you need to understand in order to know what to expect, and what not to.

Regardless of whether a broker or agent, these people get paid a commission which is a percent of the policy, and typically it ranges from 8% to 15% or sometimes more. Agents (not necessarily brokers) also get paid bonuses based on the profitability of the business they place with a carrier and also sometimes volume. This affects behavior. Agents have an incentive to place business with a given carrier based on how they get paid, which is tied to how much business they do.

Agents and brokers are more valuable to the manufacturers when they sell more. Because some agents are more valuable, they may be able to get more favorable pricing than someone else, all things being equal. On the other hand, some smaller agents or brokers are more aggressive because they are hungrier than larger sellers are sometimes. It's nuanced and balanced.

insurance spending value

Agents and brokers also have an incentive to negotiate the pricing for customers, because if they don't deliver competitive pricing to the marketplace they won't make sales. So, they must balance. They also have professional responsibilities imposed by codes of ethical conduct and state laws which are backed up by the courts, which regularly see lawsuits against agents and brokers for errors and omissions. So, agents have strong incentives for thoroughness, fair dealing, careful field underwriting, etc.

Both carriers and their sales representatives are businesses, and so they cannot grow and thrive without being efficient as well as competitive: for an insurance business owner, the book of business and cash flow are important, but so are client relationships. That's why they don't like to deal with people who buy solely on price (however competitive pricing is "table stakes" i.e. important, necessary, required). They know that the business may not stay with them long-term, and that a price-only buyer likely doesn't understand the value they can bring in designing, recommending, selling the appropriate coverage for a given circumstance, or the value they can bring when a claim arises. Agents and carriers don't break even typically the first year they write an account. Often it isn't until the third year, so retaining business over time is important to profitability as well as growth. Smart business people pick their customers as their customers pick them.

As has already been said, insurance companies in the property and casualty side of the industry will only recognize one agent or broker at a time for a given risk. This is to create not only efficiency, but to ensure that the pricing they quote is as competitive as possible given a set of facts. In the health insurance business, carriers will give quotes to any number of brokers but they will be equivalent to rack rate pricing. They'll only sharpen the pencil when they know they are dealing with someone who actually can deliver the business (again for efficiency with time and money).

My Recommendations for Maximizing Your Insurance Value

1. Start by understanding that you're buying a promise to pay if TSHTF.

So, what's the promise? There are thousands of insurance policy coverage forms. Some say similar things and some are very different. When you have a claim you want to know what to expect in advance. Almost all insurance consumers don't.

So, the great agent/broker relationship starts with the question, in one form or another, "when TSHTF what do you want to happen?" It sounds like a simple question but it's not. Depending on what you are buying, and what you have at risk, it can be quite complex. Anytime you or your insurance broker/agent says something like "give me an apples-to-apples quote" or anything like that, it means that you aren't going to get the best coverage for the situation in all likelihood. It's not as simple as buying fruit.

With a good mutual understanding of what you want and need, a competent professional insurance person can design a coverage plan (AKA policy) and then put together a business case (AKA applications AND narrative which explains the uniqueness of your situation) for why various carriers should want to take the risk in the first place, and at as low a price as possible in the second.

2. Understanding insurance, and risk, is complex as well as costly how do you pick an intermediary (broker or agent)?

Referrals from others are an excellent means for agency growth, especially if those others have had claims with a given agent/broker or carrier.

Ask how long they've been in business (a youngster can do an excellent job but should be well supervised, and that's not a question that youngster should be offended to be asked)? Longer is better.

How big are they? Bigger organizations may have more stroke with a carrier as I already said. Also, how big are they with the carriers they represent? How many carriers do they represent that write insurance for people like you?

agent referrals

Bigger can be better but remember younger, smaller can be too if they are more aggressive and have found ways to write for enough carriers to get the job done well for you.

Now, for the most important. How many questions did they ask you other than what is on the standardized application? Did they ask what you want to have happen when TSHTF? Did they give you examples, scenarios, options to elucidate your thinking? Did they push back, politely and respectfully, when you asked for the bare bones so that you were sure that's what you really wanted?

In the second, and succeeding, years that you do business with the same broker/agent, do they update these questions and your answers? Do you hear from them during the year with helpful suggestions, advice, and so forth? Do they always give you options on carriers and coverage? Have they proven that they shopped the market on your behalf?

If they do these kinds of things routinely you'll find that over time you are well covered (based on what you want) and the premiums you pay are competitive (some years less, some years more but on balance at the market). If your agent/broker does this you probably are better served with staying there. If you don't get all of this you should either outright move and start over, or at least shop around. No legitimate agent/broker minds competing, but they want to compete on the whole enchilada, not just price, and they'd prefer to work with people (and will work harder for) who don't make them do it every year.

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