Brokerage Ops the September 2011 issue

Overcoming Commodity Addiction

Capacity-based pricing means a permanent price war.
By Bob Rheel Posted on September 15, 2011

“When it comes to the future, there are three kinds of people: those who let it happen, those who make it happen, and those who wonder what happened,” says Dr. John Richardson of American University. The closer we get to the future, the farther away it seems to slip, defying our efforts to make sense of what is yet to come.

At a recent Council function, I noted that brokers and insurers share most of the challenges we face as an industry. Our job is to do exactly what the future doesn’t want to allow us to do—to make sense of whatever tomorrow brings. That task involves the delicate art of prediction—a tricky business in the best of times. After an unprecedented recession and a tenuous recovery, forecasting the future becomes substantially more difficult.

What will the market do next? There is no lack of theories as to which direction the market might turn. Each theory carries its own assumptions. Here are a few examples:

  • Event Theory predicts the market will not turn until there is a catastrophic event hitting the industry. This could be a natural catastrophe, a market-based upheaval, a political disturbance, or some other unforeseen societal event.
  • Investment Income Theory is based on the sharp reduction in investment returns during the recession. The diminished yields will reduce carrier income to an unacceptable level for shareholders.
  • Negative Cash Flow Theory predicts that when insurers’ cash flow turns negative, the soft market will likewise turn.

Of the many other predictive theories that exist, most share a common element, namely that market pricing is based on the capital surplus available to address customer needs. Capacity-based market pricing is no different than the airline industry’s seat capacity—available seats on a given route vs. customer demands—which determines market price. As long as the planes arrive safely to the destination, customers focus on their commodity-based decision, which focuses on price.

The problem with predictions is that most of them turn out to be wrong. Because there are so many predictions, most of them are contradictory and, therefore, cancel out one another. History never repeats itself in exactly the same way. There are always seemingly minor—but extremely significant—variations that make prognosticating so prone to failure.

In the end, prediction is far less important than preparation. Since we cannot know in advance which theory will turn out to be true, why not adopt an approach that sidesteps the whole controversy? Taking a cue from Dr. Richardson, instead of letting the future happen, or wondering afterward what happened, brokers and insurance companies would be wise to actively make the future happen. Regardless of any turns the market might take in the near future, the kind of preparation I recommend ought to serve and improve our industry across the board.


Capacity-based pricing helped transform consumer air travel into a commodity industry. This is the opposite of what we ought to aim for in our own industry. The thought of a permanent price war based on capital capacity does no one any good—not insurers, not brokers, not even customers.

After an unprecedented recession and a tenuous recovery, forecasting the future becomes substantially more difficult.

In our industry we face a stark choice: Follow the (mis)fortunes of the airline industry or create a value-based pricing market in which we set our prices based on the value that brokers and insurers deliver to customers.

I know what you’re thinking: Isn’t it always the “other guy” who ruins it for the rest of us? Maybe so, but we should remember that none of the participants are immune to the impact of the current recession.

Sooner or later the pricing market will take a sharp turn, leaving you with routine conversations with clients who ask: “Why are premiums increasing by 10%, 50% or 100%?”

Because we face a joint challenge, we also face a joint responsibility to prevent our industry from deteriorating into a commodity quagmire. Allowing your product to submit to a price war is a slippery slope that is extraordinarily difficult to climb back up.

The insurer or broker who cracks the code of creating true value-based pricing will enjoy epic success in selling to customers. Whoever cracks the code will enjoy immediate and preferential advantages. Jumping off the surplus capacity-driven market cycle will ultimately benefit everyone involved.


Here are 10 actions to create value-based pricing (or, to look at the problem another way, 10 ways to conquer price addiction):

By putting in the time to understand our clients’ business plans, supply chains, cultures, vulnerabilities and ambitions, we build the foundation for an atmosphere of mutual trust.

Create value-added relationships. Adding value to a business relationship reinforces a social bond between the broker, the customer and the carrier. The direction of added value always moves toward the customer or between the players within the insurance industry.

A value-added relationship is based upon deeper understanding. By putting in the time to understand our clients’ business plans, supply chains, cultures, vulnerabilities and ambitions, we build the foundation for an atmosphere of mutual trust beyond that of the traditional buyer/seller model of business. Similarly, when we take the time to understand our partners within the industry—the brokers and the carriers—we reap comparable benefits.

The fundamental key to developing a value-added relationship in business is the ability to listen carefully, closely and strategically. Every encounter with a client is a potential learning experience that we can either leverage or disregard. The difference is in how well we listen to their concerns, note their behavior, and interpret what we observe—and then act on it. The effect of value-added relationships is evident in the improved ways we deliver to our customers—together.

Reduce the number of trading relationships. Can people really manage relationships with 5,000 “friends” on Facebook? It isn’t realistic to believe that brokers and companies can manage an enormous number of relationships among themselves. There are 25,000 brokers and 2,000 insurers in the U.S. How many of them are really friends? How many of those relationships are mutually fruitful? Which is better, having a few close friends, or thousands of acquaintances?

In business as in private life, limiting the number of truly close relationships has a focusing effect. Profitability emerges from focus. The quality of relationships, not the quantity, accelerates a lucrative enterprise. The relationships are fewer, more effective, and simpler, and therefore more fulfilling. This law holds true as much for insurance companies as it does for brokers.

Collaborate. From prospecting to winning new customers to creating and accelerating organic growth, brokers and carriers have everything to gain by forging a closer collaboration with each other. Brokers must determine if they are working closely enough with their carriers by asking themselves, “How often am I winning business by broker-of-record agreements or RFPs? Are my profit margins different? Can I integrate a focused insurance company solution with the solution I offer? Is the joint solution stronger than either individual one?”

Align. Brokers should seek to shrink the gap between their business plans and what their affiliated insurance companies are looking to grow, and vice versa. More than just simple cooperation, alignment means coordinating and harmonizing efforts. The net result is new efficiencies for all concerned. Too often I hear brokers say, “Send all of my accounts to a market so that I am not surprised.” Or I hear underwriters say, “Send me all of your submissions.” These are just two examples of wastefulness that can be reduced by better aligning our practices.

Innovate in the face of challenging lines. We must demonstrate a genuine willingness to write difficult lines. As a unified industry, we have to consider the total solution to customers at a fair price, not just the “vanilla” part of the risk. How we manage to innovate and integrate different areas of risk for the client is a substantial part of the value we add.

Think globally, act locally. Borders are more porous than ever before. Unprecedented mobility of business, capital, and risk means that new solutions will look nothing like old solutions. In a globalized economy, we must offer much more than just coverages to our customers. Do we understand the customer’s or the prospect’s business? Can we help facilitate achievement of their business plans by providing global solutions such as international expansion or supply chain exposures?

Optimize the costs. Our job is not to justify the cost of each piece of the pie; it is to optimize the total cost of risk to our customers. We must deliver risk management solutions through proven pre- and post-loss approaches via integrated cost structures. Optimization of a 3600 solution adds real value to the relationship that price-based selling can never achieve.

Articulate the costs. Optimizing the costs is not enough. We need to be able to articulate the advantages of cost optimization accurately to our customers. Each of us needs a true understanding of the cost of risk and service pricing. Can we explain to customers why we are pricing them at levels that create stability and fair return?

Deliver solutions, not prices. Price setting is a fool’s game. We should not present ourselves as selling products or policies or underwriting. Instead of a piecemeal approach, we should always strive to provide integrated approaches that mitigate risk and help our customers surmount their business obstacles. We are not salespeople; we are problem solvers. We should not sell intangible products; we must deliver tangible solutions.

Synergize selling. When we brokers and insurers fully align our practices, we can begin to provide genuine value to prospects and customers. This synergy changes the equation from a price-sensitive mindset to a truly consultative, professional experience. By aligning our efforts both in attitude and in real time, as an industry we will deliver a united and capable image to the customers when it matters most.

When brokers and insurance companies focus and align their efforts, together we create the level of industry expertise, solutions and service that will sustain an authentic value-based pricing market.

The key word to remember is “together.” Without focus, we are diminished. Without alignment, we are isolated. Alone, we are merely providers of commodities, as other industries have watched themselves become to their everlasting regret.

Imagine brokers and insurance companies working as one: strengthened, aligned and focused. We can make the future happen together for what matters most—our customers.

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