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CARRIER RETURN RATIO – HOW MUCH LEVERAGE DOES YOUR AGENCY HAVE FROM ITS CARRIER RELATIONSHIPS? CONTINGENCY RATIO (CR) AND TOTAL CARRIER RETURN RATIO (CRR)

When we analyze an agency or value an agency one of the things we consider is the return to the agency from each of its major carriers. Most agencies consider their return from their carriers as their commission income and look at contingency income and bonuses as unexpected gifts. That is true if your contingency income goes from zero to thousands of dollars, or more from year to year.

However, if you are like most agencies, your Contingency Ratio (defined as this year’s contingency income divided by last year’s P&C Commissions) finds a relative consistency or trend over a five year period; and only exceptional years find contingency at zero or far above normal levels. With the exception of very small books of business (under $500,000 with a carrier) that are prone to a major loss ratio, and contingency changes from the presence; or absence of a single loss, agencies’ CR (Contingency Ratio) truly responds to the quality of its book of business.

It may go up or down based on the vagaries of a loss year but, over time the loss ratio will consistently represent the quality of business written by the agency for the carrier. This starts when an agency’s book of business with a carrier exceeds $1 Million premium and becomes relatively fixed for books of business over $2 Million.

If you can establish an average Contingency Ratio or Contingency Trend, then it is appropriate to use these numbers to calculate your CRR (Carrier Return Ratio, the ratio of total income received from each carrier to premiums generated by the agency for that carrier). What you find may surprise you.

For instance, an agency we recently analyzed had average commission ratios for its top ten carriers averaging 13.7% with all other carriers averaging 10.7% and its total Agency Commission Ratio at 12.7%.

However, when contingency and bonus income was included in the formula some very interesting things happened. Two of the agency’s major carriers, both very similar in nature and products separated by 5.8% in the total revenues generated by the agency for the premium dollars provided to each (over a 5 year period).

Placement of business, as typical in a non-managed agency, was at the discretion of the producers and CSRs. One company had $2.5 MM of annual premiums while the other, similar company, had $1.8 MM. The company with the larger book of business averaged 13.4% commission while the second company averaged 14.4%. The commission rate, alone sent no signals to the agency owner regarding how to treat each carrier.

However, each carrier provided value in contingency and bonus money each year based on the carrier’s emphasis. Over a five year period, Carrier 1 (the one averaging 13.4% commission) added $120,000 of additional funding to the agency through contingency and bonus. Meanwhile the second carrier (with a $1.8MM book of premium) added $280,000 of benefit through contingency and bonuses over the same five year period. The end result was a TCR for Carrier 1 of 14.5% while the TCR for Carrier 2 was 19.4%.

Eyebrows were raised at the agency when the owners realized that there was that much of a difference between the two carriers. They all understood that the smaller carrier was courting the agency and rewarding them handsomely for growth. But they never had the reason, or leverage to prompt the larger carrier to become a bit more generous or risk losing ground to the second carrier. They were sacrificing almost 5% of income, $125,000 each year, but remaining ignorant of how their carriers were paying them. From a financial standpoint, that 5% difference represented the difference between minimal profits and healthy profits each year.

Just as carriers strive to promote growth of their agencies, the agencies must use their own leverage to maximize their return on the premium dollars placed to their carriers each year. If an agency plans and budgets each year, they can and should negotiate for better contracts and greater TCR from the carriers it sponsors with strong, profitable business.

Any agency who believes that commission contracts and contingency contracts are fixed and common, should contact us to purchase one of several bridges that connect Manhattan to the rest of the United States. If you are growing and especially if your loss ratios generate profit to the carriers every year, you should be negotiating for greater returns on your premium dollar.