Author: VU Faculty

In the past year, we have averaged an "Ask an Expert" question about every other month involving agency clusters. In this article, we'll present the questions, our faculty responses, and an article by Chris Burand on cluster tips. In addition, an article and FAQs by Al Diamond are presented on an alternative concept he calls "The Virtual Insurance Agency."

I am interested in obtaining more information regarding agency "clustering"...what it is, the concepts behind it and some of the variant ideas or examples as to how a cluster may be established. Can you answer that question or direct me to a resource?

Where can we find information on Agency Clusters? We have been approached by another agency and are considering the possibility. We would like information to read regarding pros and cons.

We are interested in forming a cluster. Would like to know where I can obtain information on forming a cluster that discusses the major issues and pros and cons.

One of our agency members has asked for contracts or sample agreements for cluster arrangements. Can you recommend or provide a source that is accessible on the internet or elsewhere?

Do you know where I can find information on how to set up an agency cluster?

Below are some comments from the VU agency management faculty, as well as a few internet resources. The bottom line, as pointed out below, is to consult with someone who knows what they are doing. Articles and sample agreements can be helpful as a starting point for understanding the issues, but few agents have the necessary experience to go solo in forming a cluster.

The general concept of a cluster is that two or more agencies place all their company contracts into the same pot so they can meet volume requirements, increase contingencies, and increase company access. The agencies continue to own their own business. Usually a shell corporation is formed that owns the company contracts and nothing else although there are other ways to do it too. For example, one agency becomes the owner and administrator of all company contracts.

Sometimes the agencies also share office space, systems, and even employees. Other times, they are not even in the same town.
 
That's the basic concept.
 
In reality, it sounds better than it usually works because different agency owners have different concepts of how to do things, where to place business, and whether upfront underwriting is or is not important. Furthermore, when the time comes to sell the agency, how valuable is it if it does not own any company contracts?

The Master Agency Manager had a lot of information on clustering. Contact JudiNewman@aol.com for subscription details.

Forming clusters from scratch is sometimes a bad idea. The main reason I say this is that the agents forming the cluster and their attorney rarely know enough to write an appropriate contract.

Second, they are unwilling to spend enough money to get a proper contract written.

Third, few have enough management skills to manage the cluster.

Fourth, many agents too often want their cake and to eat it to.

For a cluster to be successful (by purpose, rather than accident), certain rights and privileges must be forsaken.

Al Diamond has some information on his web site at www.agencyconsulting.com involving clusters and a concept he calls the Virtual Insurance Agency:

Virtual Insurance Agency
http://www.agencyconsulting.com/article.asp?source=pipeline&linkID=319
 
Virtual Insurance Agency - Update
http://www.agencyconsulting.com/article.asp?source=pipeline&linkID=44

More articles about The Virtual Insurance Agency....
http://www.agencyconsulting.com/pipeline.asp#VirtualInsuranceAgency

In fact, you can access Al's article and FAQs on "The Virtual Insurance Agency" on the VU by clicking here.

Chris Burand

Cluster Tips In this article, agency consultant Chris Burand examines the issues of clusters, specifically looking at the pitfalls in cluster contracts when drafted by someone who knows nothing about clusters.

An agency owner called me the other day and asked about doing a cluster. I asked if I might take a guess at what his accountant or attorney had advised regarding how best to create a cluster contract. My guess was that the accountant or attorney advised they set up a shell LLC to hold/own all the company contracts with all the money passing through this holding company to the individual agencies, with profit sharing to be determined by some prearranged formula probably involving premium per company. He said, "Yes. How did you know?"

I further suggested his accountant or attorney probably failed to mention any governance requirements for the individual agencies, buy-sell covenants, trust fund/money covenants, or dissolution provisions.

I could see his face of disbelief through 1,300 miles of telephone lines, as he said, "How did you know?  Am I ever glad I called today because we were about to sign the papers and no one ever even mentioned these key points."

I have reviewed dozens of cluster contracts and have yet to find one written by an attorney who understood insurance agencies well enough to write a proper cluster contract. Cluster contracts between individual agencies or groups of agencies (not necessarily the major cluster type agency organizations) are almost always grossly inadequate. For example, what happens in a three-agency cluster where one member cannot pay their companies? Most cluster contracts de facto make the other two liable, with no recourse. The contracts almost never require members to maintain certain financial requirements or include checks for financial condition. Considering that 40%-50% of agencies are out of trust (they have a trust ratio less than 1.0), this is a huge issue.

Another example is protecting the other members if something happens to one. Even if a buy/sell clause is included, are the terms feasible?  With most cluster contracts, they are not. Similarly, if a retiring member wants to retire, can they without being held hostage by the other members?

Clusters are ripe for mismanagement and having one member take advantage of other members. A simple example of this is when one member practices poor up-front underwriting causing everyone's contingencies to plummet.

Even without mismanagement and unfair play, cluster contracts are generally fixed in concrete. They are written as if circumstances never change, that no one retires, dies, becomes ill, or gets a divorce. They are often so fixed that even voluntarily changing carriers is not feasible. Nor is changing partners.

Cluster contracts are also written as if nothing will ever go wrong. We are in insurance. The only reason insurance exists is because we know things will go wrong.

It is interesting to see how virtually every attorney and accountant that designs clusters designs them wrong in the same way. If you are considering joining or forming a cluster, you need someone that intimately knows insurance and someone that can consult with your CPA & attorney to design a contract that makes sense. Fixing a broken cluster or de-clustering agencies when things go wrong, which is inevitable, is one of the most expensive projects any agency will ever undertake, especially if any party is disgruntled.

If you are participating in a cluster or thinking of joining/forming one, do it right and hire people that know how to do it right. Doing it right is an investment that most certainly succeeds.

Chris Burand is president of Burand & Associates, LLC, an insurance agency consulting firm. Readers may contact Chris at (719) 485-3868 or by e-mail at chris@burand-associates.com.

Copyright 2004 by Chris Burand. Used with permission.