Small Commercial Lines: The Good, The Bad, The Ugly

Small commercial lines is suddenly the Cinderella of the insurance industry. Previously the unwanted step child turned beauty queen being courted, pursued, and being offered dowries for marriage. Dowries and marriage are the correct metaphors because companies are clearly willing to pay extra for small commercial, especially if they can or think they can marry the books to their service centers.

Why did small commercial go from neglected to throne? Someone, a consultant probably, must have written a white paper and sold it over and over to carriers because they all became infatuated simultaneously. The more suitors, the higher the dowry.

The attraction: The company lines mimic one another. Small commercial price elasticity is less. Translation: Companies can raise rates and charge more for small commercial without a commensurate decrease in retention. Small commercial is less price sensitive in their opinion. Agents do not shop small commercial as much so they can raise rates without fear of the business leaving, thereby decreasing loss ratios and making more money.

A key tactic to successfully executing the strategy to build small commercial books is locking up the business in a service center. Otherwise, given the excess surplus that exists throughout the industry today, some company or another will begin cutting rates, others will follow, and then profits and retention will decline. The companies’ idea is that if the company “locks” up the business in their service center, rate competition will cease being a threat.

The Bad

What happens if some company decides to compete on price anyway? It has always happened previously.

The Ugly

Then the business moves. For agents the question is whether the accounts move within the agency or if the accounts move on their own to another agency/company. If the accounts move completely, the agency loses all the income. At $100 to $1,000 commission per account, the loss of any individual account is immaterial. The loss will not be limited to one or two accounts though.

Small commercial serviced by agencies properly is quite profitable once it is on the books in enough volume. There are a lot of ifs in that statement, which is why small commercial is not profitable for many agencies. They just cannot get their act together completely.

For the agencies that have the discipline to manage small commercial well, it is a cash cow. The catch is putting enough small commercial on the books to make it all work. Putting enough on the books is expensive and slow, so once an agency has adequate scale and is managing it well, no one wants to lose this book.

If the agency has to move the small commercial books to keep it, profit is lost too.

Additionally, errors and omissions (E&O) exposures increase because any loss of coverage should be disclosed to the insured upon moving the policy to another carrier. Moving an account is expensive.

However, if the agency controls the business, they have options whereas if they are not in contact with the client, because the client is in a company service center, they likely will not get the chance to be proactive. Moreover, if an agency is in contact with the client, it may have voided the E&O provisions of the service center contract (read these provisions carefully!). Even if the E&O provisions have not been voided, being in contact with the insured when the agency is being paid one or two percentage points less for the privilege of using the company’s service center eliminates most if not all the profit.

The results are really ugly if a company changes their appetite or they prove incompetent at underwriting and/or servicing small commercial in this suddenly desirable market. After all, companies have been known to change their appetite for no apparent reason and more than once they’ve proven incompetent underwriters when ramping up on some new line.

For example, what happens if a company determines it must raise rates 20 percent. The agency has to move the book out of a service center or risk losing a material portion of revenue. If the service center has been used well, the agency has reduced service staff because the service center is doing the servicing, not the agency. Now the agency has to find service staff quickly. That’s easier said than done.

The Good

Write small commercial but do it well, write it intelligently. Consider creating your own small commercial department rather than using company service centers.

Three keys exist to developing a small commercial department successfully.

First is a good workflow and compliance with procedures. In other words, from the point of first contact to renewal servicing, the workflow must be a machine that everyone does everything exactly the same. This means producers shan’t be allowed to bugger things up.

The second key is to staff with high quality people and do not cut corners. Quite a few small commercial units have been developed using lower quality staff and/or cutting corners. This is cutting off one’s nose to spite their face. What is the difference in dollars between a small commercial account’s E&O claim and a large account’s E&O claim?

Third, accounts that are commonly considered small commercial are often small because the agency has not sold or written them properly. Agencies tend to think subconsciously that $200 commission is worth X minutes of their time so they hurry through writing the account.

A much more profitable approach is to write the risk properly. A small commercial account written properly will usually generate more than $500 commission. On the other hand, small commercial accounts in many agencies almost always generate on average far less than $500 commission.

Agencies are leaving a lot of money on the table by not writing small commercial correctly. Moreover, if the companies’ analysis is correct and small commercial buyers are less price-sensitive, if the account is written well and the servicing is efficient, then an agency with 200 small commercial accounts at $250 commission each is now generating $50,000 commission. Increase this to an average of $500 with a 10 percent rate increase and no loss of retention, and that book increases to $110,000.

Why let the companies get your profit?

Burand is the founder and owner of Burand & Associates LLC based in Pueblo, Colo. Phone: 719-485-3868. E-mail: chris@burand-associates.com.