Producer Compensation

PRODUCER COMPENSATION

Producer compensation plans among independent agencies vary tremendously. Pick up several compensation surveys and you'll observe variations that seem to confuse more than clarify the issue.

There is no best way to compensate producers. However, there are some principles that you can observe in order to ensure that producers are fairly compensated and motivated to produce.

Throughout this section, the term 'producer' will be used in the broadest sense. Many titles are given to those who are assigned production responsibilities-salesperson, producer, account executive, professional service representative-these are just a few. If any of these positions require the production or sale of new business to prospects or clients, you may consider these employees producers.

Given all the other factors that influence compensation, the underlying motive of management is to pay people what they are worth or less. The producer desires to be paid what he or she is worth or more. These forces tend to cause compensation to seek an equilibrium point. The principles and methods discussed in this section are designed to help agency managers maintain an equitable producer compensation policy and to ultimately obtain sales success.

Many principals want to know the right way to compensate a producer. As previously stated, there is no single right way; there are many right ways, each depending on the results you want for your agency. The way to develop an effective compensation plan is to first determine your goals, and then model your compensation plan to reward producers for meeting those goals.

Chances are, you won't be hiring a pure producer-very few agencies are able to have someone simply selling full time. Usually, there are other administrative or service-oriented tasks that this person must handle. Although you may base your hiring decision purely on selling skill, your compensation plan must reflect all the responsibilities you expect the producer to fulfill-or the responsibilities will probably not be carried out.

The first thing to do is to clearly define the tasks you expect the producer to perform-as we've said, this can be accomplished with detailed job descriptions for every agency employee. Many agency owners also establish the relative value of the producer's job to other positions. For example, if the major responsibility for prospecting and X-dating has been shifted from the producer to the Sales Center, the compensation for that function should shift as well.

But if you want your new producer to spend part of the work day performing administrative, managerial, or customer service duties, your producer should be paid on a salary basis for those duties and on a commission basis for his or her sales activity. This allows you to keep the producer accountable for his or her performance in a number of areas.

Compensation for sales must directly reflect the amount of business produced and/or retained. Some agencies pay producers on a salary basis, but the amount paid is not a direct function of the amount of business produced. Such salaries, pegged on a discretionary basis by management, are likely to result in inequities, undermotivated producers, confusion, and resentment.

Regardless of the type of compensation-salary, commission, bonus-the method used to determine the amount must be based upon a quantitative formula that is documented and communicated to producers.

And agency objectives must be supported by the compensation plan. Profit, growth, new business, retention, agency loss ratio, collections ... all of these are key objectives for an agency and must be supported by the manner in which producers are paid. For example, when determining compensation for sales, determine your primary goal:

• Do you want to encourage heavy sales activity? Set your first-year (new business) commissions at higher levels.
• Do you want a strong customer service commitment from the producer? Keep your renewal commissions at a higher level.

Do you want long-term business that you can count on for stability? Tie the producer into the future of the agency with equity ownership.

It's important to reward and recognize individuals for major accomplishments. In addition to the compensation for ongoing production, a compensation plan should provide incentive and motivation to accomplish major goals or to devote attention to special agency programs- Additional financial or non-financial rewards may be designed for these goals or programs. This permits the manager to focus the producer's attention on special tasks and motivate him or her toward short-term goals.

Keep your ear to the ground and determine what the competition is paying. This is important in order to know what must be paid to attract new talent and retain existing talent.

Promote fairness and equity between producers. Competition has its ugly side-and to promote unhealthy competition with a compensation plan that plays favorites is unproductive. The more closely your plan follows a set formula, the less danger exists of this occurring. But there is the possibility that through benefits, perks, and indirect incentives, a producer may feel that his or her worth is not being recognized in comparison to others'.

Design a plan that is simple to administer, easy to understand, and effectively communicated to producers. These are the three benchmarks of effective producer compensation. Be careful that the plan is not so complex that it suffers by generating confusion and distrust among producers. You may have the best compensation plan, but if it isn't communicated to producers effectively, it could be perceived as a poor plan or no plan at all.

The first step in designing a producer compensation plan is to determine how much you can afford to pay your producers. This involves identifying administrative expenses and direct sales expenses and deducting them from every commission dollar a producer generates, then determining what percentage of the agency commission dollar you wish to retain for profit, so that you can add that percentage to expenses and determine how much of the commission dollar is left to compensate producers.

Once you've determined how much you can afford to pay, you'll need to begin structuring the plan to fit your agency goals. Financial rewards are delivered to producers primarily through one of the following compensation methods:

So, first you must determine what producers are paid to do; hence, the detailed job description. Next, determine how they should be paid for doing their duties, creating a mix of salary, commission, bonus, and equity that suits your agency. The materials and forms on the following pages will help you do just this.

The percentage of commission dollar a producer receives may depend upon the amount of equity interest he or she receives. You may think of equity in terms of negotiated dollars out-back versus dollars up-front (commission income) . If you give a larger share of one, you should retain a larger share of the other. This concept can help you to attract talented producers whom you might not otherwise be able to afford.

And, it solves another agency issue. In many agencies, principals assume that to perpetuate, they will find good producers, pay them well, and eventually offer them a chance to buy the agency. But in this ' Catch-22 ' situation, if you tell a producer, 'You can buy the agency from me in the future, ' really good producers will build up the agency's business to a point where it's too expensive for them to afford. Allowing producers to earn or acquire a dollar value in the business they produce is a valuable means of compensation and perpetuation.

While the commission, commission/draw, or commission/ salary agreement may be attractive, consultants say a good producer will not stay with most agencies without an opportunity to acquire some ownership interest.

There are three ways a producer can obtain equity:

First, determine the agency's total investment, using the 'Producer Compensation Model'. Add new production for the first three years to first-year and second-year renewals, then determine the gross agency commission. At this point, you must decide what share is the agency's and what share will belong to the producer. You can then subtract commission earned by the producer from producer salary over a three-year period and determine the agency's three-year investment.

Take a look at the ' Sample Producer Compensation Model' we've figured the total agency investment over a three-year period as $33,326. As you can see, the total production is $463, 500, making the total new and renewal commission $69, 525. If that amount is multiplied by 1.5, we come up with an agency worth of $104,288, meaning that you have spent $33,326 to obtain $104,288 worth of business (assuming that the agency retains ownership). But let's take a look at some other possibilities.

• What if the agency doesn't retain 100% of the ownership? This can still work out to be a very good arrangement. Subtracting your investment, you're still left with $70,962 net equity value, meaning that, in a 50/ 50 equity arrangement, you and your producer would each end up with about $35,000--and you'd have recovered your investment in three years and have your producer.
• What if the producer chooses to leave the agency? Assuming you can pay him or her for 50% of net equity over a period of time (and ideally, out of earnings), you've obtained $69,525 of commission income for roughly $68,326 (the total agency investment plus the $35,000 that goes to the producer in a 50/50 arrangement)--you've gotten the book of business at approximately one times gross commissions.

And, finally, what if the producer leaves and wants to buy the book of business? For $68,326 for the agency's half of the net equity, plus repayment of the agency's investment cost), he or she will receive $69,525 of business-in effect, buying the agency at one times gross commission.

Once you've studied this sample, try applying this formula to your own situation-your agency production goals for the next three years, renewal income, the percentage you hope to retain as profit, and so on. How much will you be paying for this new business? And how much will your agency profit?

Let's say the producer in this situation wants a raise-he currently makes $24,000 annually. His annual income objective is $30,000 annually. We've calculated agency expenses at 60%, leaving 40% of the commission generated as the producer' s split. If we divide line 1 by line 2, we see that the commission required to meet this objective is $75,000 and that, when this figure is divided by the agency commission rate, the premium required is $625,000. Because our producer is presently generating $505,000, we can easily determine that he needs to produce $l20,000 more premium annually to meet his targeted income.

In fact, if we take a look at this producer' s present production, we find that he's overcompensated. Multiply that Net Renewal Premium ($505,000) by the agency commission rate, then multiply that figure by the producer share of commission (40%), and we find that the producer should now be making $20,240.

At the bottom of the worksheet, you'll see that we've figured what the annual, monthly, and weekly production in Personal and Commercial Lines should be for this producer to reach his goal.

In a recent survey called 'People, Performance, and Pay,' the American Compensation Association found that 56% of 657 companies used non-cash incentives to motivate their salespeople. The majority said they used non-cash rewards for:

In addition to producers' compensation packages, there may be time when additional compensation is in order to motivate your sales staff to meet a short-term goal. Most compensation experts agree that sales contests are a good way to motivate people toward that little extra effort, provided several guidelines are adhered to. These guidelines ensure that such a contest promotes healthy, not destructive, competition.

These options have worked for agencies across the country that we've interviewed. Have you considered them?

• Profit Centers: Under this system, the producer covers his or her operating expenses and profit contribution to the agency, then is able to receive every commission dollar generated above that threshold-with no upper limit. Generally, expense items charged to the producer include: salary or commissions paid; insurance or benefit premiums paid; pension or profit-sharing contributions; Social Security and payroll taxes; auto expenses; travel and entertainment expenses; club dues; bad debts and/or lost agency interest due to poor collections; and office management.

Establishing a profit center is usually a four-step process: First, the producer is on straight salary; second, an income level is set, below which the producer won't fall even if results are unprofitable during the year; third, the income floor is taken away-producers' income is based on their production; fourth, producers are allocated their full share of overhead costs, including the full agency profit contribution requirement (usually between 15% and 25%).

• Employee Stock Ownership Plans: One owner with an ESOP says, 'Employees have a lot at stake. Their very ownership depends upon every individual pulling his oar just as hard as the other person. If you remind them often enough that they're owners, it's the self-fulfilling prophesy . . . they'll remember that and they'll start to conduct themselves accordingly.'

Again, it can't be emphasized strongly enough that there are many 'right' ways to compensate your staff. The key is to define attainable goals and determine a method of compensation that rewards your staff for meeting those goals.