What can leakage tell us about new business production?
When it comes to key performance indicators, there is an important, but sometimes overlooked one: leakage. What can leakage tell us about new business production?
Leakage is the difference between a firm’s organic growth rate and new business rate. For example, if a firm wrote 15% in sales velocity (new business as a percentage of prior year commissions and fees) and had an organic growth rate of 6%, its leakage rate would be 9%. There is a direct relationship between the three variables. Therefore, if a firm can minimize its leakage while maintaining the same sales velocity, its organic growth rate will increase.
Understanding How Leakage Impacts New Business for Brokers
In reality, many causes of leakage lay outside of a broker’s control, and thus, it is difficult to control directly. Causes of leakage include softening rates (e.g., lower premium rates resulting in less commission income) and reduced exposure base (e.g., less coverage per customer). Lost business is another contributor to leakage and often one variable that brokers can control. However, business can be lost due to a client being acquired or going out of business. Incorporating these key performance indicators should be an important part of a brokerages business planning. Certainly, as we witnessed during 2020, some sectors and geographic areas were hit particularly hard by COVID-19 restrictions.
There are also cases in which a hardening market, or increased exposure base, can cause an increase in revenue without a brokerage taking initiative to grow new business. This is called lift. It is uncommon for lift to more than compensate for leakage experienced by a broker.
Based on preliminary data from MarshBerry’s proprietary financial management system, Perspectives for High Performance, in 2020 the average firm’s leakage rate was 8.5%*. This means that the average firm will have to bring in 8.5% of the prior year’s total business in new business just to break even on the year.
Despite a tumultuous year, MarshBerry’s preliminary data shows that the average leakage rate has not yet significantly deviated from trends in recent years. Since 2010, leakage has averaged 8.3%, with rates essentially flattening since 2016. Notably, the average leakage rate in 2020 was also significantly lower than that experienced during the Great Recession, where the average leakage was 12.8% in 2008 and a whopping 16.2% in 2009.
While that is certainly positive, and if the trend holds true, it suggests that the pandemic had limited impact on retention for the average firm – the reality is also that new business production for the year is down, nearly two percentage points compared to 2019 (13.1% in 2020 vs. 14.7% in 2019). With leakage remaining relatively consistent, this translates into lower overall organic growth.
This illustrates the importance for brokers to focus on new business in order to advance their firm beyond the status quo. MarshBerry recommends that brokers strive for 15-20% growth in new business in order to produce predictable, profitable organic growth.
If you have questions about Today’s ViewPoint, or about creating an organic growth strategy for your firm, please email or call Frank Cox, Senior Vice President, at 616.426.8522.
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