Agencies Can Capitalize On Rising Interest Rates

Looking at it from an agency's perspective, every $300,000 of monthly past-due receivables means a $72,000 decrease to agency value. That is, if you give up 30 days' float because you don't collect premiums on the effective date (and forfeit the month's float before paying the carrier), it's a double whammy. You're losing interest income (today's value) and negatively impacting your agency's value (future value).

Imperial A.I. Credit Companies–the newest sponsor of the Independent Insurance Agents and Brokers of America "Best Practices Study"–asked us to conduct some research on the collection practices of some "good collector" agencies.

Much of what we found won't surprise industry veterans, but the true dollar value of good collections did surprise even us. It's something we all talk about, but the actual numbers were surprising.

We'll address that first–then review the collection practices that make a difference. Those practices are common sense, but it serves us well to be reminded of them from time to time.

First, let's look at float and interest income. We have to begin with the appraiser's clarification of investment income as it relates to agency value. The only interest that counts toward agency value is the operating interest you earn on your "float"–the excess of your carrier payables over your accounts receivable.

(The other cash in the bank is related to tangible net worth. You get paid for that cash in the event of a sale, so that interest income goes away, because you're now keeping it!)

Float is the cash in the bank from premiums collected prior to paying carriers. As a conservative estimate, premium collected by the effective date is held for an average of 30 days. (If the transaction is effective on the first of the month, you get 45 days' float if you pay the carrier on the 15th of the next month. If it's effective at the end of the month, you get 15 days' float.)

Let's look at a hypothetical situation:

o You have $1.2 million in agency commission–two-thirds of which is direct bill (some commercial lines, all personal lines, all benefits business)–and an average commission rate of 10 percent. That leaves $4 million of agency-billed premium.

o If you collect that premium by the effective dates, you have an average of about $300,000 premium in your bank account each month. At 4 percent annual interest (.333 percent monthly), your monthly interest income is $1,000–or $12,000 per year. Voil?!

o Now, multiply that by your agency's actual agency-billed premium and you'll see the value of good collections. In fact, I suspect some of you are reaching for your aged-accounts-receivable report right now!

Let's review the "common sense" best practices of collections:

o Producer guarantees encourage collections.

As a wise agency principal once said, "I ask my producers a simple question: 'Let me be sure I understand this. You want me to pay your client's premium for them?'"

o An enforced collection policy reduces bad debts.

Think about it. Just as $1 of interest income equates to $6 of agency value, so does $1 of historical bad debt expense. Bad debts mean a decrease to agency income and agency value.

o Producer charge-backs reduce bad debt write-offs.

First, the producer "makes the agency whole" for some or all of the bad debt, and they'll chase after a past-due premium if they know they'll have to pay it otherwise. (Keep in mind that we're talking premium here, not just the loss of their commission compensation.)

o Holding a producer's commission until the accounts receivable are collected encourages collections.

A deferred paycheck works effectively as an incentive to collect premiums.

o When senior management monitors accounts receivable, items get collected.

As the old adage says, "What gets watched, gets done."

o Late fees lead to better collections.

We were a bit surprised to see that many agencies still charge and collect late fees.

As we interviewed our project participants, we heard them say something that we all know, but bears repeating: It is important to have effective collection policies, but it's meaningless if you don't enforce those policies.

In most agencies, the producers are responsible for collecting premiums. We feel it is wise for an agency to provide support for the producers' efforts, such as in the form of a formal or informal credit manager (to call the insured's accounts payable department).

A producer's focus should be sales (in the form of collected premiums), so providing collection support is money well spent–especially if it improves the agency's float and ultimately the agency's value.