T H U R S D A Y ,   J U N E   9 ,   2 0 0 5

The Two Faces of Agency Growth |  Investigation Nabs Guilty Plea |
  Selling L&H in the Land of Oz |  FACT Act Spells Out New Requirements for Agents & Brokers |
  Monitoring the Mod | Big "I" National News

V I E W :   P & C   T R E N D S
The Two Faces of Agency Growth

Growth means different things to different people. Nowhere is that disparity more clear than when viewing growth from the "buy-side" versus the "sell-side" in an agency sale.

After reading " Who’s the Better Investment: You or Buffett " in last week’s IN&V, my old boss e-mailed me. Essentially, his e-mail was a fatherly message of "What were you thinking?"

He said that it’s hard enough to get two parties in a transaction to agree on price without the sell-side expecting revenue multiples of two-times commissions or higher. We discussed the fact that the mathematics are undeniable and agencies can be worth two, three, even four-times revenues given the right level of profitability and sustainable growth.

He also pointed out that agencies that justify pre-tax returns on revenues of more than 20% and sustainable growth rates of 5%, much less 10%, were the exception, not the rule. I chuckled to myself and said that since I take the view of the 23,000+ potential agency sellers who belong to Big "I," my leaning slightly to the high side of agency valuations in a few examples made complete sense.

Nevertheless, that brings me to the two faces of growth. The first is the benevolent face that can make you rich. The other is the joker face that can make you look, well, silly. As agency managers interested in the value of your agency, you need to be very aware that the sustainable growth rate assumption is perhaps the most important assumption implicit in any agency valuation exercise.

The chart below shows agency values as a multiple of revenues. The chart’s agency model is a nicely profitable one with an equivalent pre-tax return on agency revenues (commissions) of about 20%. If you prefer assuming a typical agency has pre-tax profits at about 10% of revenues, cut the multiples below in half.

As the assumed growth rate climbs, the value of the agency goes up (and up and up and up). You will note as the growth rate reaches three-times that of our economy historically (3% per annum or at sustainable growth of 9%), multiples exceed two-times revenues.

The up and up and up is the benevolent face of growth. So what about that other face, the joker? Be very careful in valuations that require high growth rates to validate them. Multiples of commissions over 1.0 generally require growth rates above the average.

Sometimes agencies will value themselves with extremely high growth rates and not realize what is implied is nearly impossible. For example, an agency with $10 million in premiums today may have grown from $5 million to $10 million over the two previous years, a compound growth rate of 41% per year. Is assuming that growth rate reasonable? I would say no. At that growth rate, in about 25 years, $1 out of every $10 spent on p-c insurance in the United States would have to pass through this agency, a 10% market share across the industry. While theoretically possible, it’s an extremely lofty prospect when you consider both Aon and Marsh & McLennan together do not equal that sort of marketplace domination.

Paul Buse ( paul.buse@iiaba.net) is a licensed agent and president of Big "I" Advantage, IIABA’s for-profit subsidiary. 

P R O D U C E R   C O M P E N S A T I O N   I S S U E   U P D A T E
Investigation Nabs Guilty Plea
Former General Re Exec to Help in AIG Case

John Houldsworth, a former senior executive of Berkshire Hathaway Inc.’s General Re, pleaded guilty Monday to a federal charge of criminal conspiracy related to two sham transactions between General Re and American International Group, Inc. As part of the agreement, he is cooperating with the investigations into the deals by the Securities and Exchange Commission and U.S. Department of Justice.

The SEC filed an enforcement action Monday in New York federal court, and the DOJ is expected to file a criminal complaint today. Houldsworth consented to a partial final judgment with the SEC resolving all liability issues against him but did not admit or deny its allegations. The determination of any penalties will be deferred to a later date. According to Business Insurance, Houldsworth agreed to plead guilty to one charge by the DOJ of conspiring with others to misstate AIG’s financials. He faces up to five years in prison for the activity to be covered by a settlement with the DOJ .

According to the SEC, its complaint charges that conversations between Houldsworth and others, as well as other facts, were evidence that "all parties understood from the beginning that they were engaged in an undertaking to create sham transaction documents for the sole purpose of allowing AIG to make false accounting entries on its books."

Because Houldsworth is cooperating with the SEC and DOJ as part of his agreement, the Chicago Tribune points out that, "The plea may increase pressure on other individuals involved in the [General Re-AIG] deal."

"They would not offer him a sweetheart deal if he wasn’t in a position to put larger fish on the frying pan," Jacob Frenkel, a former federal prosecutor, told the Chicago Tribune.

Houldsworth served as chief executive of General Re’s Cologne Reinsurance Company in Dublin up until Monday, when the company terminated him after learning of his guilty plea to the criminal charge. He had been on administrative leave for more than a month after receiving a Wells notice from the SEC, which informed him he was a target of an investigation..

To date, 10 insurance executives have pleaded guilty in New York state court to criminal charges in connection with New York Attorney General Eliot Spitzer’s investigations into the industry.

In AIG news, Reuters reported today that former CEO Maurice "Hank" Greenberg resigned from AIG’s board yesterday. In a letter to the board, he said he decided to step down due to his "inability to receive information regarding the company and its operations necessary to fulfill my fiduciary duties."

Also, last Friday Standard & Poor’s lowered its long-term counterparty credit and senior debt ratings to AA from AA+.

"The downgrade on the holding company reflects both the size and scope of the accounting adjustments in its recently released 10-K filing," S&P credit analyst Grace Osborne said in a press release. "Although AIG’s overall earnings are considered strong, its property-casualty earnings, as restated, indicate greater volatility as well as less robust profitability than was previously reported, as demonstrated by both the ROR and combined ratio."

Additionally, Connecticut Attorney General Richard Blumenthal subpoenaed Prudential Financial Inc. seeking information about its reinsurance transactions. The company said in its 8-K filing with the SEC that, "given the publicity surrounding the issue, [it] has already begun an ongoing review of the accounting for its past and current reinsurance arrangements," reports Business Insurance.

Jennifer Sikorski ( jennifer.sikorski@iiaba.net) is IA’s associate editor.

L & H   T R E N D S
Selling L&H in the Land of Oz

Remember the end of "The Wizard of Oz" (if you haven’t seen it and don’t want to spoil the ending, skip ahead) when Glenda the Good Witch tells a tear-stained Dorothy that all along she had the ability to return to Kansas, thanks to the power of the ruby slippers? Of course as a kid I wished I had known that earlier so I wouldn’t have had nightmares about the flying monkeys.

What does this have to do with independent agents who sell life-health and other financial services products? A quarter of a century ago, many career agency companies held back their most attractive insurance products for their career agency sales force. There was a fairly limited roster of vanilla-type products for independent agents to offer. As the variety of products has evolved, most insurance companies now offer virtually all of their financial products to both distribution channels. This provides an obvious advantage to independent agents.

As life insurance and other products offer riders and secondary guarantees, the ability to seek out the financial product that best meet clients’ circumstances is an inherent advantage. Certainly, agents know that some insurance companies are more liberal when it comes to the underwriting process for a current or previous health issue. Some carriers add flexibility with unique riders. For example, a client who wants to purchase long-term care insurance down the road without having to satisfy the underwriting requirement, but isn’t ready to purchase coverage, will value a rider to their term life insurance policy that lets them purchase it later without evidence of insurability.

Don’t assume that customers know you have the flexibility to access multiple insurance carriers. Tell them one of the reasons that you are an independent agent is so that you can seek solutions from different insurance companies to meet their needs. And many states and life insurance companies allow and facilitate appointments at the time of sale, so that you don't have to go through a cumbersome process to provide an illustration.

One of the most important distinguishing aspects of successful independent agents is creativity. Having broad access to a variety of companies and financial products goes hand-in-hand with the creative ability to develop solutions to meet customers’ needs. And, the ability to provide creative solutions is the most enjoyable aspect of being an agent.

Don’t hide behind the curtain like the wizard. You have the advantage of the ruby slippers. Remember to get out of your office and see your customers!

Dave Evans ( dave.evans@iiaba.net) is a certified financial planner and life-health contributing editor for IA magazine.

L E G A L   A D V O C A C Y
FACT Act Spells Out New
Requirements for Agents & Brokers

Beginning June 1, 2005, the Fair and Accurate Credit Transactions Act of 2003 (FACT Act) went into effect. It is targeted at combating identity theft by requiring all organizations and businesses (including associations and insurance agents and brokers) that use consumer reports to "take reasonable measures to protect against unauthorized access to or use of the information in connection with its disposal," whether it is stored in paper or electronic form.

In other words, information cannot be disposed of in a way that makes it easy for potential thieves to obtain it. For example, it is easy for someone to "dumpster dive" to get information thrown in the trash, so it is unlikely that simply throwing sensitive information in the trash will be considered a reasonable measure to prevent unauthorized access to it. Similarly, if the information is stored electronically on a computer, the computer should not be thrown out, sold or donated until the information has been deleted properly.

While the FACT Act cites examples of how to dispose of paper by burning, pulverizing or shredding it so that the information on it cannot be reconstructed, what is "reasonable" will be determined on an individual basis, taking into account the sensitivity of the consumer information, the nature and size of the insurance agent or broker’s business, the costs and benefits of different disposal methods and relevant technological changes. Depending on the circumstances, reasonable measures may include shredding paper documents, destroying CDs and properly deleting electronic copies. Reasonable measures also are likely to include establishing policies and procedures to governing disposal, as well as appropriate employee training on those policies and procedures.

Also under the FACT Act, businesses accepting credit or debit cards for payment may not print more than the last five digits of the card number nor may they print the expiration date upon any receipt provided to the cardholder at the point of sale. This applies only to receipts that are electronically printed. It does not apply to handwritten receipts or receipts displaying an imprint or copy of the card. The effective date of this restriction is Dec. 4, 2006 for any machine or device that prints receipts for credit or debit card transactions that is in use before Jan. 1, 2005, and was Dec. 4, 2004 for any machine or device that prints receipts for credit or debit card transactions that was first put into use on or after Jan. 1, 2005.

In addition, the FACT Act provides that:

· Consumer reporting agencies must disclose to a consumer his/her credit report for a "fair and reasonable fee" (currently set by the Federal Trade Commission at up to $9.50, but if state law requires a free or reduced rate, the state law controls);

· Consumers are entitled to receive a free consumer report from the three major consumer reporting agencies (i.e., Equifax, Experian and TransUnion) on an annual basis;

· Consumers may post a fraud alert on their files with consumer reporting agencies, which requires potential creditors to contact the consumer directly before extending credit;

· Consumers must be allowed to opt-out of affiliate marketing; and

· Consumer reporting agencies may not include medical information in reports used for employment, credit or insurance transactions without the consumer’s prior written consent.

IIABA’s Office of the General Counsel recently updated a memorandum which discusses the FACT Act as well as two other federal statutes, the Fair Credit Reporting Act (FCRA) and the Drivers Privacy Protection Act (DPPA) and their impact upon the ability of insurance agents and brokers to use driving records, consumer reports and credit scores.

To review the updated memorandum, go to www.independentagent.com, log on as a member and go to the Legal Advocacy section’s "What’s New." For questions or additional information, contact Amy Hendricks, IIABA Assistant General Counsel at amy.hendricks@iiaba.net; 800-221-7917.

F O R M S   &   S U B S T A N C E
Monitoring the Mod

In your agency, I bet it is common practice to review renewals six to eight months in advance, right? Right! Well, if the workers’ compensation is experience rated, there are some things that may need attention that far in advance. Such vigilance may save your insured big bucks.

Columns seven through nine of the NCCI experience- rating worksheet show an insured’s actual workers’ comp claims. It bases the amounts on carriers’ stat cards submitted to NCCI. A stat card cut-off date six months prior to the renewal date of the policy usually serves as the basis for the amounts. These reported losses include both paid claims and outstanding (open) reserves for both medical and indemnity payments combined. The reserves typically are based on insurer judgment, except for paid medical and permanent total disabilities.

In column eight of the NCCI experience mod worksheet, each claim in excess of $2,000 will include either an "O" to indicate that a claim reserve has been established but the claim is still open, or an "F" to indicate that the claim has been closed with a final settlement.

One of the most common inaccuracies on the worksheet involves reserves. Although carriers must follow up with NCCI by filing subsequent unit stat cards that include open claims (see timeline in the downloadable " Monitoring the Mod" chart), sometimes reserved claims were closed with little or no payment, but the carrier failed to file a corrective stat card or the claim was closed after the stat card cut-off date Therefore, the original reserve amount may still show up on the worksheet with an "O" beside it. Here are several real-life examples:

Example 1: After reviewing a loss run, an agent discovered that a $60,000 open reserve shown on the worksheet was actually closed prior to the stat card valuation date. The mod on the worksheet was 1.26 and should have been 0.94, but the correction was could not be made until the next reporting period according to NCCI rules.

Example 2: A $35,000 open reserve was shown on a worksheet with a 1.17 mod. Although the claim had been proven to be fraudulent, the company failed to file a corrective stat card. The mod was ultimately corrected to 0.89, reducing the insured’s premium by almost one-third.

Example 3: The company never filed corrective stat cards with NCCI on open claims closed as far back as two years ago. When recalculated, the mod dropped from 1.24 to 0.93.

Example 4: A loss was originally reserved at $22,000 almost three years ago, and this value was continued on each subsequent stat card even though the reserve was reduced several times. After the valuation date of the last stat card, the claim was closed at $4,800. The mod would have been 1.15, rather than 1.21, but NCCI cannot reevaluate the mod until the next rating period according to their filed procedures.

As shown in the first example above, a claim may have been closed prior to the mod promulgation date of the upcoming policy period, but after the date of the last stat report (i.e., six months prior to renewal). According to NCCI, the open claim reserve shown on the stat card still will be included in the mod calculation and shown on the worksheet applicable to the upcoming policy period, even though it has actually been closed.

As demonstrated by the last example above, in addition to failure to file stat cards on closed claims, reserve amounts may have been lowered over time but not changed on the worksheet. Unfortunately, the failure to follow up on open claims may mean that the insured is stuck with a mod that could have been lowered considerably if the claim/reserve was more diligently tracked.

Finally, remember that reserves may be based largely on judgment, so it is not inappropriate that a reserve amount be challenged if it appears excessive. If, as the agent, you have reason to believe that a carrier has established a pattern of over-reserving (which some feel happens, particularly in residual markets), keep a file of reserve activity to present to your insurance department, labor department and/or workers’ compensation commission.

As mentioned previously, a reserve amount cannot be modified on a worksheet, due to judgment reconsiderations, after the stat card has been submitted to NCCI. From a preventative standpoint, open claims should be reviewed at a minimum of seven to nine months in advance of the policy renewal date since such losses are valued on the stat cards at intervals of 18, 30 and 42 months after policy inception.

For more information and a complete timeline of what an agent can do (and when) to ensure that open claims are closed by the stat card valuation date, click here.

Bill Wilson ( bill.wilson@iiaba.net) is Big "I" director of the Virtual University.