How Are Insurance Agencies’ Customers Doing?

Construction is the No. 1 target market of independent insurance agencies. Before the recession, construction often constituted 20 percent to 40 percent of medium to large agencies’ books of business. Independent agency growth then can be tracked, to some extent, on what happens in construction, especially if the results are combined with hard versus soft market conditions.

According to the Bureau of Economic Analysis, commercial construction contracted substantially in 2001 and then began a free fall in 2002. The market did not recover until 2004, and in 2005 it experienced severely inconsistent growth. Then, as if someone had turned a switch, the market saw double digit growth six out of the eight quarters of 2006 and 2007, before wobbling in 2008.

Then the bottom just fell out of the market. Commercial construction was severely negative seven straight quarters. It declined 30 percent from what it was in 2001 by the end of 2010. Last year’s results in 2011 were so inconsistent that it is impossible to conclude from the government’s data whether commercial construction is trending up or down.

Residential construction is also quite important to independent insurance agencies. It recovered faster in 2002 and boomed until the fourth quarter of 2005. Then its negative spiral began almost three years before commercial construction tanked. Growth was then negative 14 consecutive quarters, and it was negative 17 of 20 quarters. Growth in 2011 varied hugely from one quarter to the next, and even though three quarters were positive, annual growth was negative. Total annual residential construction activity is now only approximately 56 percent of what it was at year-end 2005.

Using the S&P/Case-Schiller Composite Home Price Index, home prices began materially falling in July 2006 for the first time since prices were first tracked in 1987. In 2007, prices declined as a whole for the first time since World War II. Home prices proceeded to fall substantially, with the rate of decline slowing in the spring of 2009 and likely hitting bottom in March 2011. Prices have risen ever so slightly since. Therefore, new residential construction is unlikely to boom any time soon.

What This Means for Agencies?

This means many medium and large agencies had, and may still have, far too much concentration in the construction industry. With this much contraction, the problem became one of not only losing accounts to other agencies, the bigger problem was clients permanently going out of business. Many agencies lost more business this way than they have ever lost to competitors in a similar time period.

For those clients that remain in business, the exposure decreases were significant. And while the economy may have reached bottom, the problems are not over. With these clients pinching pennies, they are often looking to cut corners on their coverages. They are shopping more and are likely not buying adequate limits or coverages.

Many agencies have become so desperate to hang on, they are reluctant to discuss the need to maintain or even buy more coverage. This problem will only get worse with rising rates.

The result is that errors and omissions (E&O) exposures are building. Not discussing the need to purchase adequate coverage and not getting the insureds to literally sign off on coverage reductions is like throwing fuel on the fire. The agency is doing just as much work for half the commission and creating a greater probability of being sued.

An Opportunity: Diversity

Residential growth and nonresidential growth do not follow the same exact cycle. One market is often doing much better than the other. So if an agency is going to target construction, the agency’s revenues are much more likely to be stable if the book is diversified between residential and commercial construction.

An even better diversity play is to move into other areas. For example, personal lines remained much more stable than commercial lines. Benefits continued to grow, although being heavy in group benefits today may result in the same downturn heavy commercial construction agencies experienced the past four years.

Another consideration is outside construction. According to the Bureau of Economic Analysis, in 2010-2011, nonresidential, nonstructural investment was extremely strong. Growth in both years was better than any time in a decade. Similarly, export growth has been a bright spot in our economy for the past two years. In 2010, export growth was double digit and the best this century. Growth in 2011 was strong too.

Farming has been another bright spot, as has oil and gas. These areas require a true level of expertise that should be acquired and developed before entering this space.

The point though, is that too many independent agencies violated the old axiom of having too many eggs in one basket. They focused too hard on construction. Those that diversified have achieved much better results the past four years. (I’m excluding those agencies that have done exceptionally well in farm and oil and gas because they are making the same mistake. It is just that those markets have not tanked yet, but they will. Those two markets especially, always tank.)

The recession and soft market presents many opportunities, including the opportunity to rethink business models. As the economy hopefully rebuilds and insurance rates firm, now is a great opportunity to rethink your business model.