1. THE MARSHBERRY LETTER
Volume XXV, Number 12 December, 2009
Cost Recovery Redux the effort expended in acquiring Cost recovery version 1.0 - recap
new business should be matched
When we wrote the July 2007 is- The cost recovery period mea-
or exceeded by efforts focused on
sue of The MarshBerry Letter on sures how long it takes an agency
retaining customers.
Cost Recovery and Retention, we to offset the cost of selling and
did so in an economic climate that servicing a dollar of new business
In the years since we penned
scarcely resembles the tumultuous and recognize a profit. The original
that article, we have witnessed a
business environment that we are cost recovery equation consisted of
steep decline in the U.S. econo-
now experiencing. At the time that the following three components:
my. Government bailouts, failing
article was written, agencies were banks, and sagging consumer
driving average organic growth ♦ Acquisition Cost – includes
confidence describe the new
rates in the 4% to 6% range. The commissions paid to producers
normal. Meanwhile, stagnating
influx of would-be agency buyers as well as selling expenses
spending levels have brought the such as travel & entertainment,
continued, preserving the seller’s economy to a virtual standstill and
market and buoying the multiples advertising, and promotion
economic growth measures indi-
that sellers commanded. Overall, cate that the overall economy has ♦ Servicing Cost – includes
the economy appeared strong contracted. And while this is bad customer service payroll and
as reflected by various economic operating expenses
news for every economic actor, it
indicators, including the Dow Jones is especially painful for insurance ♦ Account Commission – the
Industrial Average which crossed agents whose economic fortunes agency revenue dollars that will
the 14,000 point threshold for the march lockstep with the ebb and be generated by this piece of
first time on July 19, 2007. flow of the overall economy. The business
overall growth of net written pre-
Despite those halcyon economic The original formula is depicted
mium in the U.S. has been nega-
times, we maintained that most below:
tive since year-end 2007 and is
agencies were still overlooking an projected to be -2% for 2009. Cost Customer Acquisition Cost
obvious way to bolster their growth Recovery --------------------------------------
numbers: increasing customer re- This certainly paints a bleak pic- Period = (Commission per Customer -
tention. Our article posited that the ture for insurance agencies and
(Years) Servicing Cost per Customer)
key to understanding growth and has spurred us to revisit, re-eval-
profitability came from first measur- Based on this equation, there are
uate, and retool the cost recovery
ing how long it took an account to three ways to decrease the cost
formula. This new, more robust
become profitable (cost recovery recovery period:
formula better reflects the reali-
period), and then retaining the ties of doing business in the cur-
customer past that break-even 1. Reduce your Customer
rent market and accounts for the Acquisition Cost
threshold. The longer the account increased costs of acquiring and
was retained into the future, the retaining new customers. Before 2. Increase your Commissions per
more profitable it would be for the we delve into the new formula, Customer
agency. And, since it is cheaper we will quickly re-examine the old
(and usually more profitable) to 3. Reduce your Servicing Cost per
formula to demonstrate how and Customer
keep a current customer than to why we made the new changes.
win a new one, we concluded that
The MarshBerry Letter Page 1 December, 2009
2. While all of these are viable op- The new formula is depicted which may be controlled by the
tions, most are not practicable. below: agency. As this ratio decreases,
First, reducing your customer the potential profit per customer
Cost Cost of Selling
acquisition cost would work, but Recovery ---------------------------------
and total profit should increase.
most agencies are running lean Period = (1- (Cost of Retention + This version includes both ser-
and most of the fat has already (Years) Allocated Overhead)) vice staff and value-added staff
been trimmed away. Secondly, components to account for such
increasing your commissions As much of the underlying data things as maintaining value-add-
per customer is dependent on in the formula has changed, I ed service timelines and stew-
too many factors outside of your will briefly describe how each ardship reports and the requisite
control. Thirdly, reducing ser- component of the formula is communication with the insured.
vicing costs per customer is a derived below. Please refer to
strategy replete with pitfalls. If Chart 1 to see how the various Allocated Overhead
you are sophisticated enough to formula components fit together.
Also, please note this example This provides a tracking method
strip away some of these costs
is based on commercial lines for overhead expenses such
without negatively impacting
accounts. The formula will work as benefits expense and sup-
retention, then it is a plausible
with other lines of business, but port personnel. Our formula
solution. However, in today’s
some may not have value-added assumes that this stays fixed
market, many customers are
service costs associated with over the life of the account, but
now reviewing their policies
them. if things change in your agency,
and trading on the value-added
please make the necessary
services that are delivered by the
Cost of Selling adjustment to your formula. See
agency.
Chart 1 on Page 3.
This allows the agency to
So, based on the fact that most
monitor and analyze the cost of The Case for Measuring the
of these components are, in
producing new commercial lines Cost Recovery Period
effect, “fixed,” the best course
business. As the cost per com-
of action is to retain customers When we first undertook this
mission dollar decreases, the
long enough to reap the profit- project, we were interested in
profit potential increases. In an
ability on the account. But, as gauging the overall industry av-
effort to more accurately capture
we will demonstrate, increasing erages for both the cost recovery
the true cost of selling, we have
your retention rates has costs period and the average reten-
added both service staff and
associated with it as well. And tion period. Using data from
value-added staff components.
acquisition costs are, if anything, our proprietary Perspectives for
Value-added services include
increasing in this ultra-competi- High Performance database, we
such things as loss prevention
tive market. Thus the unveiling pulled commercial lines data for
engineers and risk management
of cost recovery version 2.0. every agency over the past few
consultants who work with the
producer and the insured prior to years and were startled by the
Cost recovery version 2.0 results. Please refer to Chart 2
the account being put to market.
on Page 4.
In order to better reflect the true
cost of acquiring and retain- Cost of Retention
In 2007, the average cost recov-
ing customers, we made some
In the previous article, we ery period was 5.41 years, while
tweaks to the cost recovery for-
stressed the importance of in- the average rate of retention
mula. By using data that is read-
creasing retention rates, but the was 7.14 years. So on average,
ily available to every agency, this
formula did not account for the agencies kept accounts on the
formula gives a better picture of
associated costs. This section books for nearly two years after
the true cost recovery period.
provides a tracking method for they became profitable.
costs associated with retain-
ing commercial lines business
The MarshBerry Letter Page 2 December, 2009
3. Fast forward to 2009 and we will see that
Chart 1 - Cost Recovery Period - Revised Formula
this spread has diminished considerably.
Producer Share
Our most recent data shows that the aver-
CL Production Payroll - New Business $300,000
age cost recovery period is 6.74 years,
+ CL Selling Expenses - New Business $40,000
while the industry average retention rate = CL Production Cost - New Business $340,000
is 6.86 years. In effect, this means that as Divided by: New Business CL Comm $ $200,000
soon as an account becomes profitable = Producer Share of CL Prod Cost per NB CL Comm $ 1.70
for an agency, it walks out the door. Service Staff Share
CL Service Payroll - New Business $50,000
The reduction in the spread between cost + CL Operating Expenses - New Business $35,000
recovery period and the retention rate in = CL Servicing Cost - New Business $85,000
years can be attributed to the fact that Divided by: New Business CL Comm $ $200,000
growth has been very hard to achieve in = Service Staff Share of CL Prod Cost per NB CL Comm $ 0.43
the past few years, and the costs of doing VAS Staff Share
CL VAS Payroll - New Business $5,000
business have increased. These facts
+ CL VAS Operating Expenses - New Business $2,000
should compel every agency to measure
= CL VAS Cost - New Business $7,000
its cost recovery periods and determine
Divided by: New Business CL Comm $ $200,000
how they will decrease them and/or retain = VAS Staff Share of CL Prod Cost per NB CL Comm $ 0.04
their customers for longer periods of time. TOTAL COST OF SELLING - CL: 2.16
The Options – Reducing the Cost Re- Producer Share
covery Period CL Production Payroll - Service $200,000
As mentioned above, the options for + CL Selling Expenses - Service $20,000
reducing the cost recovery period are = CL Production Cost - Service $220,0000
somewhat limited. Reducing payroll for Divided by: CL Comm $ $1,500,000
production, service and value-added ser- = Producer Share of CL Retention Cost per CL Comm $ 0.15
vice staff is an option, but in the current Service Staff Share
market environment, you need the best CL Service Payroll - Service $250,000
+ CL Operating Expenses - Service $240,000
talent to win and you need to pay the best
= CL Servicing Cost - Service $490,000
talent. Additionally, large cuts would have
Divided by: CL Comm $ $1,500,000
a negative impact on agency morale. = Service Staff Share of CL Retention Cost per CL Comm $ 0.33
VAS Staff Share
Because retaining customers is the key CL VAS Payroll - Service $3,500
to account profitability, dramatic cuts in + CL VAS Operating Expenses - Service $5,500
the area of cost of retention will serve to = CL VAS Cost - Service $9,000
erode retention periods and decrease ac- Divided by: CL Comm $ $1,500,000
count profitability. One thing to consider = VAS Staff Share of CL Retention Cost per CL Comm $ 0.01
is having producers trade down the bot- TOTAL COST OF RETENTION - CL: 0.48
tom 20% of their book to house accounts
so they can focus on selling, not servic- Allocated Overhead
ing, small low-margin accounts. Support Payroll - CL $80,000
+ Benefits Expense - CL $160,000
= Overhead Expense - CL $240,000
Our data shows that the best way to
Divided by: CL Comm $ $1,500,000
decrease the cost recovery period is to in-
= Allocated Overhead per CL Comm $ 0.16
crease new business production. In fact,
TOTAL ALLOCATED OVERHEAD - CL: 0.16
an increase in new business production of
2 percentage points has the biggest effect COST RECOVERY PERIOD - YEARS
of reducing the cost recovery period than 2.16
a similar improvement in any of the other (1-(0.48+0.16))
= 5.99
components. Our study showed a two
The MarshBerry Letter Page 3 December, 2009
