Aggregators, Clusters, and Networks: What are the Differences?
Agency Networks: Are They a Commodity?
What Does the Future Hold for Aggregation Organizations?
A generation ago, when a new independent insurance agency was created, everyone in the insurance industry stood back, scratched their heads in bewilderment and congratulated the new agency founder for having done something remarkable. It was remarkable because it was essentially impossible. And yet, occasionally, someone pulled off the impossible.
The reason that starting a new insurance agency was impossible was that insurance carriers were insistent that they would not contract with anyone who could not provide at least a half a million dollars in premium volume - and they wanted it now. Obviously, with very rare exceptions, this was difficult to do.
At the same time, most independent insurance agents struggled to consistently receive profit-sharing bonuses from insurance companies. Once agencies got to a certain size, usually above $500,000 to $1 million in revenue in a year, they might be able to receive profit sharing from some of their carriers based on being able to satisfy their minimum volume requirements.
But it was difficult. And it was inconsistent. It was important income, nonetheless, because only the larger agencies who consistently received profit-sharing made more money on a premium dollar and were thereby able to continue to grow, with smaller agencies at a perpetual disadvantage.
The other problem faced by most agencies, until they became very large, was finding or keeping enough competitive insurance markets to be able to sell insurance to all of the prospects they came across. Worse, they sometimes lost long term clients when they were unable to keep a contract with a given carrier, due to volume. All of these things conspired to make it difficult for smaller agencies to be as profitable as larger ones, and to grow at the same rates - if that was what their business plan called for - as larger agencies.
The thing that kept agency owners up at night was keeping the carriers they had, gaining access to the carriers they needed, and finding the income that they needed to grow their business.
Some creative insurance agencies began to solve this problem by creating something they called a cluster. A cluster allowed agencies to band together to share an insurance company contract. This satisfied the premium volume requirements of multiple carriers and made it possible for them to receive profit-sharing more often.
The two biggest problems that cluster groups had in being successful was the lack of control members had over the quality of the business that was written in a given contract. They were completely dependent upon the business practices of other people in this regard.
Another issue with clusters was that, as agency groups, they weren't professionally managed as an organization, and, being made up of several strong-minded individuals, they tended to have a fair degree of volatility both in member agencies and in actual survival.
Compounding these problems, was the fact that insurance carriers, while they would tolerate clusters, did not encourage them - in many cases, they actively discouraged them. They did this because from their perspective they gained little benefit from allowing a group of agents to share a contract. They did receive some spread risk. But from their point of view, what they mostly got was the obligation to pay more money than they would have otherwise.
In 1983, Jim Masiello, of Swansea New Hampshire, created a twist on the typical cluster which rapidly became very successful and ultimately led to the creation of Strategic Insurance Agents Alliance based in Hampton, New Hampshire, which currently has over 4,000 agent members.
The twist was the professional management of the books of business; a highly-organized, high-quality structure, which prevented the volatility that clusters had experienced; and a compensation model that rewarded organizers of the business, its members, and insurance carriers, primarily, when growth and profitability occurred.
This unique twist to the insurance aggregator model has grown to over $9 billion in size with roughly 12% of insurance agencies participating in it.
Following the success of SIAA, a number of other insurance entrepreneurs in the independent agency system saw that they could create similar business opportunities, and the rise of agency networks began.
However, these agency networks have tended to focus on market access as their primary benefit, and on combining premium volume to achieve profit sharing. In some cases, they have benefited from professional management. So while similar to clusters, in a historical sense, they have represented an improvement.
Today, roughly half of independent agencies belong to either a cluster, an agency network, or SIAA. Along the way, it has become commonplace for entrepreneurial independent agents to start new insurance agencies, since it is no longer as difficult as it once was before clusters.
One thing that has also become clear is that the independent insurance agency system, while a very traditional and conservative industry, can change and when it does other change becomes necessary.
As the ability for agents to have access to an increasing number of insurance companies, as well as to more easily manage access to personal lines and commercial lines; and, receive a profit-sharing, these things became commonplace, rather than unusual.
In economic terms, we describe things that are commonplace as commodities. When something becomes a commodity, the sole focus of prospective buyers becomes price. When price becomes the preeminent value for anything, there is a race to the bottom.
As an example, consider cell phones. The history of cell phones is that they were incredibly expensive in the beginning and became rapidly cheaper over time, until the primary competitive argument of one company against another was the cost of the phone or the cost of the service. When Steve Jobs and Apple introduced the iPhone, they turned that pricing model on its head. While the iPhone is a cell phone, it's also much more than that. It's really a supercomputer in your pocket.
Other companies immediately began copying aspects of the cell phone. Predictably a race to the bottom in terms of pricing began all over again, with one exception. That exception is Apple.
That is why you can now buy an Android phone/computer for very little, while an iPhone still costs over $1,000 on average. Is it because iPhone users are stupid? Of course not. Is it because the iPhone is intrinsically superior to its competitors? Maybe. But I don't think that's the answer either. I think the reason that the Apple device sells for many times its competitors’ price is that consumers recognize that it provides many times the value.
It does that by combining state of the art hardware and software with an unmatched number of collaborators, known as app developers, who create increasing functionality the iPhone, compared to its competitors, and that's what makes it so valuable.
Insurance companies don't like insurance aggregation any more than they ever did. They still see that it provides the same thing to them, which is primarily an increase in the cost of doing business.
Certainly, organizations that provide aggregation have participated in a race to the bottom on pricing. The primary marketing pitch of almost all of them is that they cost less than everyone else. They become a commodity.
SIAA has purposely not done that, yet it continues to add hundreds of new members each year.
Why?
I think the reason is very similar to that of Apple Computer. Their size and market position, along with relentless efforts at improvement have created a unique collaboration between its members and insurance companies where they receive benefits that are simply not available anywhere else.
Carriers are willing to provide those benefits because they also receive benefits they don't get from mere aggregators or clusters: they gain organic growth, which is difficult for them to achieve at a rate greater than the rate of GDP growth from the industry as a whole.
The organic growth created by the unique structural model of SIAA is mother's milk to independent agencies and carriers alike. While SIAA has not changed its business model in the face of competition over the last 20 years, it continues to prosper. It really all comes down to value and the individual consumer or businessperson’s view of that. Some value cheap. Those are the people who tend to buy Android smartphones.
Those who value opportunity, growth, and access to the most advantages, tend to buy iPhones and join SIAA. There isn't anything intrinsically better in one choice over another, unless the choice doesn't meet the needs in mindset and worldview of the buyer. The Android phone owners would never own an iPhone. There are iPhone owners who would never consider an Android.
Occasionally, someone makes a change or tries an experiment that does not align with their personal values. In general, I find that to be a mistake. They return to where they're most comfortable. I see the same thing as being true in the insurance agency business.
As we go into the future, carriers, I believe, will be taking a very hard look again at their willingness to participate in pure aggregation organizations. This means that many agency networks, whose primary advantage is market access and aggregation, as well as clusters, face increase operational and even survival issues.
This is true because the COVID virus is driving significant (as much as 20-25% reduction in top-line revenue) challenges for most insurance companies. Insurance carriers are not designed to adapt rapidly to revenue swings like that.
In COVID times, while its ultimate length of impact is unknown, it is certainly going to create negative economic impacts beyond 2020. Even as informed an individual as Jerome Powell, head of the United States Federal Reserve, believe the impacts are likely to last into 2022 and 2023. In the face of these revenue reductions, insurance companies must cut expenses.
They have limited capability of cutting expenses internally without gutting their ability to grow in the future. That is why they usually turn to agent compensation as a relief valve for cost pressure, and they will do so again.
If they perceive that all they're receiving in exchange for doing business with a cluster or an aggregator is the right to pay agents more money than they would otherwise; if they believe that they are doing business with a number of smaller agencies that don't create the growth that they need now more than ever - while having to pay them more money, they will not be motivated to continue those relationships in the same way they have in the past.
These are serious questions that aggregators, clusters, and agency networks must grapple with and must answer to continue not only in business but to be successful.
SIAA’s situation alone is somewhat unique in that its value proposition to insurance carriers is not aggregation but growth. That is something insurance companies need now more than they ever have before. Their value proposition to insurance agents is not only increased income, which agents - themselves facing income reductions of 20-30% or more due to cancellations, free rights, lower renewals, and loss of profit-sharing due to similar property claims on a smaller premium base - also need.
So, to summarize, agents have responded over the last 30 years to the changing environment, in many cases by joining an organization to help them have more access to markets at a higher compensation level than they could on their own. This has benefited many of them.
Other agents have remained aloof from this process and made it through just fine until now. COVID is increasing the distinction between the various kinds of agency organizations, and agents who remain independent and don't belong to any of them. It is also going to make it harder for agents to profitably deliver insurance services without assistance.
If you're a member of one of these organizations, or considering joining an insurance cluster, it's worthwhile to step back now as you consider the immediate future of your agency and ask:
Can you use more income on your current book of business?
Can you use assistance in managing your book of business to produce more revenue?
Can you use assistance in marketing and selling insurance more effectively?
Can you use collaborative efforts to reduce expenses in your agency to help you become more profitable?
Could you use access to a bigger market of potential buyers at a higher price for your agency?
If you think about these questions, understanding the values that aggregators, networks, clusters, and SIAA offer, should you be considering changes in either membership in one of those, or perhaps joining one for the first time?
COVID is creating unique and urgent problems for all businesses including insurance agencies and will for the next several years. This is an important time for every businessperson to think carefully about how they're going to transition this period of history.
What will you do?