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Irs Shows Recession Took $100 Million In Commissions From Advisors

Did commissions fall during the last recession? They sure did, according to the new data from the Internal Revenue Service that illustrates the steep challenge agencies faced in the recession and explains some permanent changes in the distribution channel. Commissions that sole proprietor agencies and brokerages have deducted on their tax returns fell to $1.7 billion in 2009, down from the roughly $1.8 billion recorded in both 2007 and 2008, indicates the IRS data.

This information appears in the annual IRS publication, Sole Proprietorship Returns, for years 2007 through 2009. The 2009 figures, all of which are estimates based on sample tax returns, just came out this August.

These findings confirm widely circulated anecdotes about carriers cutting compensation in health insurance, annuities and some life policies. The cuts are said to be part of overall cost control measures, instituted due to the recession. Product sales may have slowed to a point during the recession where commissions suffered in comparison to prerecession years when sales were more brisk. The commission decline occurred even as sales or "business receipts" went for a roller-coaster ride. Receipts increased to $27.6 billion in 2008 from $26.3 billion the year before but then dropped down to $26.8 billion in 2009. "The numbers are showing that, as margins were squeezed due to recessionary pressures, the cost of doing business for agents continued to increase," says NAIFA President Terry K. Headley. Top line revenues became more compressed, so carriers and agents cut back, he says.

In short, sole practitioner agencies and brokerages were having a very "difficult time," says Headley, president of Headley Financial Group, Omaha.

How They Responded

The IRS numbers hint at answers to key questions about how insurance agencies and brokerages responded to the tough conditions they faced. Here are three for example:

1. Did sole proprietor agencies and brokerages suffer so much that some just didn't file tax returns? The answer is no. The data shows that the number of these returns actually rose steadily during the three-year period-increasing from 328 million in 2007 to 338 million in 2008 and 353 million in 2009.

Headley says this growth could be a reflection that more advisors who were in agencies-such as career agencies or larger life agencies-decided to go out and start their own independent practices. If that were the case, more agencies and brokerages would have started filing taxes as sole proprietors, he explains. However, an opposite trend may have been at work as well. This involves agents deciding to convert from sole proprietorships to LLC and S Corporation status. NAIFA started noticing the trend about three or four years ago, Headley says. Agents have done this to avoid the self-employment tax on earnings that sole proprietors must pay and thus recognize more net income, he says. It is possible that the IRS tax return numbers are reflecting both more agents signing up to be sole practitioners and more agents leaving that status to become LLCs and S Corporations. However, the data does not show this one way or the other.

2. Did agents stop advertising during this period? In general, yes, but with a zig and a zag. In 2007, for instance, they reported advertising expenses of $759 million. But the very next year, during the heart of the recession, deductions for advertising expenses plunged to $54 million.

Since many consumers were nervous about making long term purchases at the time, the agents may have just decided to stop advertising that year, Headley posits. Worth noting, however, is that expensing for advertising picked back up again in 2009-to $733 million, according to the IRS data. Perhaps the sole proprietors were starting to believe that the worst of the recession was behind them.

3. Did sole proprietor, home-office business deductions for agencies and brokerages rise? You betcha, but not in a predictable way. One might expect that, due to the recession, more agents and brokerages would have closed their small rental offices and started selling from their homes or their cars. That would be an expense-cutting move. However, what actually happened is that home-office business deductions plunged to $75 million in 2008 from $160 million the year before. Then, in 2009, they jumped back up, this time to $164 million.

The 2008 falloff could be a glitch in the data. Or, it might be a sign that many sole proprietor agencies just didn't do enough business from the home in that darkest hour of the recession to justify taking deductions for the office at home.

The Biggest Question

How did these agencies and brokerages fare overall? Their net income suggests they found ways to bounce back. Despite falling commissions, rising expenses and possibly reshuffling their business status, they reported an uptick in profits in 2009-to $10.2 billion- from 2008's $10 billion. Of course, the 2009 number is not as high as 2007's $10.3 billion. But then the recession did not really get started until December 2007. For much of that year, agencies and brokerages were selling in a fairly stable environment.

A point to keep in mind is that the IRS data for "insurance agencies and brokerages" is not a defined set of agencies and brokerages, as the industry knows them. For instance, the IRS materials do not indicate whether that category includes property and casualty agencies as well as life, health and annuity agencies.

Another category, "insurance agents, brokers, and related activities," refers to the above category ("insurance agencies and brokerages"), as well as firms in employee benefits and several other areas (but again, P/C is not mentioned). The IRS says it uses the North American Industry Classification System (NAICS) Code to classify its data. A search of the NAICS databank reveals that "insurance agencies and brokerages" comprise "establishments primarily engaged in acting as agents (i.e., brokers) in selling annuities and insurance policies." But the description does not say which "insurance policies" it means. Some P/C observers are treating the "insurance agencies and brokerages" data as applicable to their side of the industry, while some life-annuity practitioners believe it is more reflective of their own side of the business. (The latter is a more likely possibility since the insurance data is couched in a section of the report - called "Finance and Insurance"- that also includes data for investment firms, which often will "go with" life/annuity firms.)

Those caveats aside, the fact that agency/brokerage profits returned to nearly pre-recession levels in 2009 may be an indication that sole proprietor producers have found ways to adjust to the demands of the new environment. Future IRS reports will indicate whether, and to what extent, this proves true.

"The landscape has changed dramatically," Headley says. "It's a different environment."

Linda Koco, MBA, is a contributing editor to InsuranceNewsNet, specializing in life insurance, annuities and income planning. Linda can be reached at [email protected] [email protected].

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