Author's note: This article is another in the series stemming from our April 1998 article, "Positioning For Opportunity: Is Your Agency Ready?" In this article, we discuss the role of profit centers and their value in helping promote strategic initiatives.
Chances are you've made or heard the comment, "I can't make money in personal lines." At Harbor Capital Advisors, we have heard this lament many times while working with agents and brokers in various consulting capacities. Almost always, upon further exploration, we find that the agency can indeed make money in personal lines as well as all other lines.
Why does this misconception persist among agency principals?
In most cases it is simply a way of expressing concern that the agency isn't as profitable as it should be. Often we find that this concern is fostered by a lack of proper financial information needed to support decisions. Thus the agency principal is frustrated with his or her inability to understand the real issues, which in turn constrains any ability to implement corrective actions.
For example, most agencies rely on the traditional profit and loss statement that reflects various revenues and expenses but calculates to only a single profit or loss number. Thus there is no insight into the true profitability of individual lines of business, specific carriers, internal departments, divisions or branch offices, or even individual producers or support personnel.
Why this lack of decision support information? In most agencies, the automated agency management system accommodates only the traditional and relatively simple accounting structure of a balance sheet and a profit and loss statement for the agency and perhaps one or more divisions.
Even when the accounting system does provide profit and loss by division, the expense allocation method is sometimes arbitrary, forcing overhead onto units that otherwise might be profitable.
This constraint is furthered by the inability of most agency management systems to effectively export general ledger information to management tools, such as spreadsheets, where data can be easily manipulated and used by management.
In addition, there may be some confusion concerning what information is needed for effective decision support.
What is a good profit center model?
At Harbor Capital, we find that most agencies can benefit from the simple profit center model shown in the table on page 91.
This model illustrates profit centers for the commercial and personal lines of business only. Other models exist for addressing additional profit centers. Each profit center is aggregated to form a total financial picture of the agency.
To support this model, the agency needs to:
1) Aggregate revenue by the defined profit center.
2) Identify direct expenses associated with the profit center.
3) Develop allocation methods for general expenses and allocate them to the profit center.
4) Calculate profit or loss for the profit center.
5) Optionally, perform "what if" adjustments to revenue and expense to determine the impact of these changes.
All the data required to support this model is embedded within the various reports generated by agency management systems. In some systems, this data can be exported to spreadsheets. In some the data may need to be compiled separately.
Direct expenses consist of those expenses that can be tied directly to a particular profit center--for example, a direct mail program provided for personal lines only. General expenses, such as utilities or rent, can't be tied directly to a profit center and therefore must be allocated.
For profit centers consisting of organizational units such as division or department, the easiest expense allocation method is to first determine the general expense per person, then allocate based on the number of people in the profit center unit.
Other allocations are based on the particular profit center. For example, expenses for insurance carrier profit centers can be allocated based on policies instead of people.
What are the benefits of profit centers? What do you do after you've aggregated revenue, determined expenses and calculated profit or loss by profit center?
"What if?" scenarios
In some cases, the information will confirm your intuition. In other cases, you may be surprised and want to find reasons behind the numbers. In all cases you'll want to determine the impact to your profit of changing the revenue and expense numbers.
For example, what if you increased revenue by 10% in personal lines? How would that impact your bottom line? Was the direct mail program profitable? How much did it contribute to your losses? Maybe you'd be profitable if you reduced your headcount by one or two. Or is everyone working at capacity? Is the fixed overhead you allocated creating a disincentive for your staff? Do they have control over the allocated expenses or are the expenses mandated? How much of the overhead is actually owners' compensation?
While the profit center models discussed won't answer all of these types of questions, use of such models will point to the need to ask the questions. And asking questions, then finding answers is the real management imperative for achieving profitability within your agency.
Final step: establish strategy
And understanding the profit potential within your agency is critical to establishing and implementing effective strategies. Should your agency acquire additional books of business? Should you focus on personal lines or commercial lines? Would you benefit from the addition of specialized staff that possesses critical expertise? Will your fixed overhead support more revenue generation effort?
As an agency owner and manager, try to look at everything in your agency as a potential profit center. Determine how you can make each profit center more profitable. Consider how each profit center contributes to your overall strategy.
As you move toward profit center management, you'll no longer have misconceptions about what "makes money" and what doesn't--you'll know the answers in advance. And with these answers you'll be better able to advance your agency's strategies and your own goals. *
Percent of Totals
AGENCY EXPENSE POOL
| Facilities | $52,000 | 9.19% |
| Utilities | 35,000 | 6.18% |
| Owner/Management | 350,000 | 61.84% |
| Insurance | 84,000 | 14.84% |
| Other | 45,000 | 7.95% |
Total $566,000
Staff 12
Expense Per Person $47,167
COMMERCIAL LINES
Staff 6
COMMISSION REVENUE $1,200,000
DIRECT EXPENSE
| Commissions | $380,000 | 64.52% | ||
| Sales Programs | 32,000 | 5.43% | ||
| Service Payroll | 155,000 | 26.32% | ||
| Auto | 12,000 | 2.04% | ||
| T&E | 8,000 | 1.36% | ||
| Miscellaneous | 2,000 | 0.34% | ||
| Total | $589,000 | 67.55% | ||
| ALLOCATED EXPENSE | 283,000 | 32.45% | ||
| Total | $872,000 | |||
| PROFIT (LOSS) | $328,000 | 27.33% | ||
PERSONAL LINES
Staff 4
COMMISSION REVENUE $600,000
DIRECT EXPENSE
| Commissions | $110,000 | 41.43% | ||
| Sales Programs | 22,000 | 8.29% | ||
| Service Payroll | 125,000 | 47.08% | ||
| Auto | 4,000 | 1.51% | ||
| T&E | 2,000 | 0.75% | ||
| Miscellaneous | 2,500 | 0.94% | ||
| Total | $265,500 | 58.46% | ||
| ALLOCATED EXPENSE | 188,667 | 41.54% | ||
| Total | $454,167 | |||
| PROFIT (LOSS) | $145,833 | 24.31% | ||
AGENCY TOTAL
Staff 12
REVENUE
| Commercial | $1,200,000 | 66.67% |
| Personal | $600,000 | 33.33% |
Total $1,800,000
DIRECT EXPENSE
| Commissions | $490,000 | 57.34% | |||
| Sales Programs | 54,000 | 6.32% | |||
| Service Payroll | 280,000 | 32.77% | |||
| Auto | 16,000 | 1.87% | |||
| T&E | 10,000 | 1.17% | |||
| Miscellaneous | 4,500 | 0.53% | |||
| Total | $854,500 | 60.15% | |||
| ALLOCATED EXPENSE | 566,000 | 39.85% | |||
| Total | $1,420,500 | ||||
| PROFIT (LOSS) | $379,500 | 21.08% | |||
©COPYRIGHT: The Rough Notes Magazine, 1999