In our consulting practice we are routinely asked if clustering is a viable option for smaller agencies that desire to achieve a level of critical mass and as a result become more efficient. Our initial answer is that clustering does not have the best track record of success.
Many clusters are not successful because of the unreasonable expectation levels of the parties involved. For example, I recently had a conversation with one of our clients, who is in the process of selling his agency. One of the partners raised the question as to how he was going to feel after the transaction was consummated. My answer was simple. "You are certainly going to realize that your situation will not be exactly the same as it was before the sale for the simple reason that you will no longer be the ultimate decision maker." I further emphasized to this agent that as a result of this loss of control he might tend to exaggerate specific changes and turn small issues into big ones in order to regain a sense of control.
This is relevant to what happens in a cluster arrangement. In a cluster, things also change. Perhaps, to gain efficiencies, one cluster member may agree to forgo a CSR staff person as a part of the cluster transaction and instead make use of an underutilized CSR from a cluster partner's staff. The minute a client is mishandled by a cluster partner, fingers are likely to be pointed, even though it is realistic to expect some glitches when an agency makes the transition to a cluster arrangement.
The expectation of equal control in operations is part of the reason why some clusters work and some don't. To a large extent this is a function of cluster size and the number of participants. In our experience, clusters that work typically are larger organizations with many subproducers. The reason for the formation of most of these larger clusters is the desire of the producer to remain independent, yet have an infrastructure of effective support. Those desires typically bring together several agencies and within that group of agencies one or more leaders who have the foresight and ability to build a viable infrastructure that can effectively service a large book of producer-owned business.
There are several examples of larger agencies that are basically clusters of 10 to 20 producer units. In most cases the producer unit consists of producers and service people who handle the units accounts. The bulk of the earned commissions is split among the producer units with the balance used to support the infrastructure. The power of those clusters is their ability to operate under a common name in the marketplace with the perception that they are one cohesive unit. Another attribute of successful clusters is their ability to ascertain which units are demanding more resources than warranted by the size of the unit's book of business, and to address those concerns.
Perpetuation is another benefit of the larger cluster. Since individual producer units are typically less than 20% of the consolidated cluster's revenues, accommodating selling producers is usually easily accomplished.
These larger clusters have not only survived but also thrived for several reasons. The cluster itself, rather than the individual units, becomes the dominant force. The cluster is typically run by a management group of shareholders that often represent the larger books of business. To many of us, this should not be much different from the typical agency structure with several partners and a number of shareholders.
The successful cluster's resemblance to a typical agency is not a matter of accident. The reason these larger clusters are viable is that there is leadership within the organization and that the unit's producers willingly give up defined decision making to the leadership of the cluster organization.
As was mentioned earlier, many agency principals facing a selling situation are sensitive about giving up control. The personal dynamics are at work in any organization where key shareholders are faced with the option of relinquishing some part of their control. In a cluster arrangement, the recognition that specific individuals should be given some level of decision-making authority is, by definition, a necessary ingredient for success. As with clustering, the principals of agencies that consider merging are very concerned about losing control. One must keep in mind that there is nothing inherently wrong with granting some control to "partners" that can in fact create additional financial opportunities. We designate leaders all the time as well as delegate authority. Why should the insurance agency business be any different?
When considering the possibility of a cluster, think big. Think about the possibilities of taking that prototype and expanding it to a number of agencies. If you have a vision of growing an organization and working with partners in achieving common goals, your group stands a good chance of success. Keep in mind, however, that there is a downside to clustering. Breaking up a cluster will require each producer unit to once again have a self-contained agency, and I'm sure everyone is aware of the potential difficulties associated with that process.
Harbor Capital Advisors routinely works with agencies that want to cluster or merge. We advise the participants as to structure, valuation and corporate governance issues. We use the experience gained in that process to guide new clients who desire to explore similar options. *
The authors
Paul J. Di Stefano, CPA, CPCU, and William E. Ryan, CPA, are managing director and associate director, respectively, of Harbor Capital Advisors, Inc. Harbor Capital is a New York-based national financial and management consulting firm which offers services to the insurance industry. Services include agency appraisals, merger & acquisition representation, strategic and management consulting. They can be reached at (800) 858-2732.