Optimal Long-Term Producer Incentives

OPTIMAL LONG-TERM PRODUCER INCENTIVES

The optimal program for producers involves training and support, short-term compensation and incentives, and long-term incentives. This article focuses on long-term incentives. These incentives have seven major objectives:

• Improve motivation
• Retain good producers
• Provide a reward for contributions to your agency
• Protect the agency
• Improve account retention
• Raise agency value
• Accomplish these goals at the lowest possible cost to the agency

In most cases, the program outlined here will achieve all these objectives. It can be used with new or long-established producers alike. If you have existing producers without an enforceable contractual agreement not to take agency accounts when/if they leave, a program such as this can impel you to consider how to make such a non-piracy agreement enforceable.

PLAN OUTLINE

Validation: The producer must develop a minimum-size book of business before beginning to vest in the plan. That validation level may be set at any level you wish, typically $100,000 to $150,000 in annual commissions. As you well know, many new producers will not work out for a host of reasons. These producers are unlikely to have validated before they leave, meaning that you will not need to pay them any incentives under this program.

Vesting: Once the producer has 'validated,' progressive vesting begins. With this type of plan, vesting may be on any schedule you wish; 20% per year for five years is common.

Book Ownership: The producer does not have any actual ownership interest in the book itself (be careful not to refer to it anywhere as 'his' or 'her' book-a common and dangerous mistake), but has a financial benefit comparable to ownership.

Payments: When vested producers leave the agency, payments are made to them based on retention of the book then carried under their producer code. Payments are typically 15% to 20% of renewal commissions for five years (approximately half the value of that book).

Assignment of Accounts: In most cases, you'll need to reassign those accounts to another producer to retain that book. The producer assigned those accounts did not originally produce them, and can therefore reasonably be paid a reduced commission over that same five-year period during which the retired producer is receiving incentive plan payouts. Once those payments to the retired producer end, the producer assigned those accounts will begin receiving full renewal commissions on the assigned accounts. In effect, the producer assigned the accounts has 'bought' an interest in the value of those accounts (not the accounts themselves) for a 'price' of 15% per year for five years. Most people would consider that a bargain!

RESULTS

Golden Handcuffs: Successful producers gain the financial equivalent of ownership in the book of business for which they're responsible, but leave a portion of that benefit behind if they depart before becoming fully vested. This type of arrangement is sometimes referred to as 'golden handcuffs.'

Account Retention: Producers nearing retirement then have a powerful incentive to prepare their clients for a new person handling that account. Retirees' payments are made strictly on a retention basis, and their incentive to make a quick phone call or otherwise lend a hand continues even after retirement.

Account Ownership: The accounts are clearly owned solely and exclusively by the agency; ideally, this is made explicit in each producer's contract.

Although we generally recommend against it, you can give producers an additional right to depart and buy those accounts at a favorable price. If you do so, we recommend that you don't let them 'cherry pick' those accounts. They should buy all or nothing-with no retirement payments to the departing producer for accounts that decide to remain with the agency. As gross volume and resulting contingent bonus levels have become increasingly important, this option, once common, has grown less desirable from the agency's standpoint.

Competition: Along with the financial benefit given to the producer comes the obligation to treat the agency fairly. At a minimum, producers must agree not to take existing agency accounts with them when leaving the agency.

The rules for non-piracy and non-competition agreements vary significantly by state, but a general requirement is that the employee be given 'timely and adequate consideration' in exchange for the rights they've given up. Contracts signed at the time of employment generally meet this standard; they're much more difficult to enforce if signed after employment has begun, unless material new consideration is given. The financial benefit of the incentive program just discussed can often serve as the consideration necessary to make those restrictive covenants enforceable.

Another practical advantage of the program is that all payments are retention based. In a worst-case scenario, with no enforceable non-piracy agreement and the producer trying to take accounts, no incentive plan payments need be made for lost accounts.

Agency Cost: Since the successor agent(s) assigned the retired producer's accounts acquires an interest in their value through reduced commissions over that same five-year period, the cost to the agency is essentially zero. In addition, incentive plan payments to the producer will be entirely deductible to the agency when paid, and taxable to the producer only if and when received-whereas buying the producers' half ownership of 'their' book under a conventional plan would have been deductible to the agency only over 15 years, regardless of the duration of such payments.

Agency Value: When done in this fashion, agency value should be improved as well. Retention of good producers will increase, and account retention when a producer leaves should also be better. Each of these has a major impact on agency value.

A subtle but potentially even more important benefit can be the creation of enforceable non-piracy agreements for agencies that are currently unprotected. An unprotected agency is more difficult to sell, and often worth less due to uncertainties involving producer and account retention. A recent appellate court decision supported a two-thirds reduction in agency value for an unprotected agency!

Free Lunch: At a cost of basically nothing, producer retention is improved, account retention is improved, and agency value is raised. Who says there's no such thing as a free lunch?