AGENCY FINANCIAL MANAGEMENT

By Paul J. Di Stefano, CPA, CPCU, and Jesse J. Watkins

AGENCY FINANCIAL PLANNING
AND DECISION MAKING

Proper planning can help an agency identify
both problems and opportunities

Financial planning and decision making entail the broad strategies related to maximizing profitability within the agency.

Planning for financial success is an integral part of a successful agency. More and more, we are seeing the financial decision-making process within many agencies potentially being the weak link in the chain of events ensuring the agency's success. When we speak about financial decision making, we are referring to how the agency principals deal with a myriad of issues but, most important, we are addressing the need to plan prior to taking action on issues which have major financial implications to the organization. Although it is generally recognized that most successful agency principals are proven producers, it does not necessarily follow that they are effective financial managers. Our experience is that these same individuals can easily become frustrated when confronted with the need to create and adhere to a viable financial plan for their agencies.

Although the decision-making process includes making decisions related to acquiring other agencies, the process goes way beyond dealing with merger and acquisition opportunities. Financial planning and decision making entail the broad strategies related to maximizing profitability within the agency. The following is a representative list of areas requiring financial planning and decision making:

* Agency shareholder equity purchases and purchase options

* Structuring buyout options for exiting shareholders

* Appraisal-related issues

* Development of agency revenue projections and expense budgets

* Producer compensation plans and expiration ownership

* Creation of strategic joint ventures

* Maximizing market relationships

It may sound strange, but agency principals regularly have difficulty identifying the source of financially related issues in their agencies. In these instances, agency principals may sense that they are not receiving the necessary management information regarding their agencies to identify the source of underperforming financial returns. In an attempt to fill the perceived organizational hole, some agency principals' first--almost automatic--reaction in an agency lacking financial management may be to recruit a new staff member who has that background. Unfortunately having a financial background does not automatically qualify an individual to perform the broader duties of a CFO. While receivables and payables may finally be reconciled, the person may never address the core issue--implementation of financial strategies which will maximize agency cash flow.

Many agency principals can relate to the unfortunate experience of making poor decisions regarding acquisition transactions. Decisions made with regard to structuring deals which have not been clearly thought out can have negative financial consequences which can burden the agency for years into the future. But on a less obvious basis, these same principals may be leaving material potential profits on the table year after year in the form of lost revenues or unnecessary expenses.

For instance, Harbor Capital has seen numerous cases where producer compensation and expiration ownership structures become major inhibiting factors to maximizing agency growth. In these cases we have found that producer compensation is structured in a manner that does not encourage new business production--the life blood of any agency. Poorly structured producer compensation can easily discourage new business production by making it easy for producers to "sit on their books." Without an effective stick-and-carrot approach, high levels of renewal commissions combined with a lack of new production requirements can result in producer apathy. Producer contentment with aggregate compensation may encourage more of a desire to spend time improving their golf game rather than producing new business.

Hiring producers with a book of business also can have a financial impact. If the compensation deal is not structured intelligently, the agency may find itself in a situation where poor loss ratios on the producer's book of business negatively affect the agency's overall contingent income. The agency could easily lose money with the loss of contingent income offsetting the anticipated profits from the relationship.

In an attempt to obtain assistance with the financial decision-making process, some agency principals have created advisory boards. Historically advisory boards have consisted of executives from other local companies, identified through formal mentor programs or informally through personal relationships. Advisory boards are typically comprised of individuals such as lawyers, accountants or local businesspersons, who the agency principals believe may be of assistance to the agency. While these individuals may be capable of offering general business advice, their lack of specific industry knowledge places practical limits on their ability to assist.

Alternatively, agency owners have retained one or more specialized consultants depending on their assessment of the issues involved. In the case of a family-owned agency, a consultant may be chosen for his or her ability to deal with family relationship issues while another agency may retain a consultant to assist with sales training or operational consulting. We find that the agency's attempt to compartmentalize issues for the consultant to address is usually a reflection of the consultant's skill sets and not the optimal way to seek consulting assistance.

More typically, we find that agency principals develop a relationship with a professional they have known over the years, such as an accountant or attorney. Using such a person may create a sense of comfort. These individuals have likely been utilized in the past on important issues within their specialties. In many cases, these professionals will recommend that their clients hire an insurance industry consultant to assist with specific assignments that the professional realizes is not within his or her skill sets.

Unfortunately, in other cases these professionals do not recognize or consciously ignore their limitations and proceed to render inexperienced advice related to industry-specific issues. This is at best not helpful and at worst counter productive to the client's interests.

Clearly, it is critical for agency principals to carefully review their needs in relation to the skill sets offered by any consultant whom they intend to use for help in this or any other area.

Author's note: Harbor Capital Advisors has implemented an Agency Advisory Board consulting service that provides agencies with a resource and sounding board in the development of rational financial planning and decision making. Our model includes periodic on- and/or off-site management meetings to review financial and strategic plan development, implementation and execution. *

The authors

Paul J. Di Stefano, CPA, CPCU, is the managing director and Jesse J. Watkins is an associate director of Harbor Capital Advisors, Inc., a national financial and management consulting firm that offers services to the insurance industry.

Harbor Capital Advisors, Inc., can be reached in New York at (800) 858-2732 and its Web site can be visited at www.harborcapitaladvisors.com.