Producer Compensation: A Common-Sense Approach

PRODUCER COMPENSATION: A COMMON-SENSE APPROACH

The basis for a good producer compensation system for today's independent agencies and brokerages rests on two very important convictions. First, the producer should be paid fairly and adequately for the job, and second, the agency must make a profit on every producer in the agency.

It is important to realize there are as many producer-compensation plans as there are agencies that employ producers. In the past, compensation plans were based on a number of criteria, depending on the individual agency and its philosophy. Today, a fairly standard compensation plan is emerging, based on the assumption that a producer's job is to sell new business and maintain renewals. The producer is supported by a well-organized system of internal customer service representatives (CSRs) and, in some cases, an individual who markets all new and renewal insurance business to the insurance companies represented by the agency.

There is, at the other extreme, a system that requires producers to do most of their placing, take care of a major portion of the customer-service load, and generally receive little support from the internal agency staff. In this case, the producer is usually paid a higher commission, perhaps 10% to 15% more than the producer who works in an agency where there is full support. The no-support system is rapidly being replaced by the full-support system. For this reason, this article will describe a compensation system for the producer who is selling in an environment of full-agency support. In addition, a common-sense approach to making a profit on every producer will be scrutinized.

About two years ago, I was asked by an agency owner to provide consultation for their existing producer-compensation system. The agency was paying a commission rate of 50% for new and renewal P/C business. Not surprisingly, this agency had the usual expenses, including salaries for CSRs and sales-support people. Not only was the agency over-compensating in commissions, it was also going overboard with auto allowances, travel, and entertainment.

The first thing the agency owner wanted to know was how much the producers should earn and how to increase profits. This question, which is applicable to all agencies and brokerages, will be scrutinized, as will sales operations and the elements of compensation plans: salary-versus-draw, commissions, incentives, vesting in a book of business, and employee benefits.

Almost any publication concerning agency operating costs suggests that total operating expenses, including administration and service costs, run about 50% of gross revenue. This figure includes the basic portion of the owner's compensation. An agency should set a goal of 20% pre-tax profit, part of which should go to the owner or owners as a return on investment. The reminder should be used to help growth and development for such items as new computer systems, additional producers, and improved facilities.

This leaves 30% to be used for a producer compensation or, more expressively put, the total cost of sales. If this is the case, how is the 30% of the revenue made to cover a program in which P/C producers are paid, for example, 40% on new business and 25% on renewal business? The answer: A typical agency has agency-owned or 'house business' on which it doesn't pay commission to a producer. This helps offset the cost of the 40% commission on new business. The 25% renewal commission is right on target with the agency's overall goal of total cost of sales, including advertising, auto, and other sales expenses equal to no more than 30%.

A few efficient agencies take the approach that each producer is a profit center. They constantly monitor the income and expenses related to each producer to make sure that each is returning a reasonable profit. In Example 1, an actual case study is used as an illustration of agency concerns: administrative expense, producer compensation, and profit.

EXAMPLE 1: Income and Expense Statement For ABC Agency

Please Note: This Agency's staff consists of one owner, two producers, and three CSRs.

At first glance, it's not hard to tell there are some serious problems with this agency's income and expense statement.

Owner's compensation is $39,000; this is inadequate. By breaking down the commission figures, a clearer picture of this agency's expenses develops.

The following percentages tell it all:

CONCLUSION: The agency is paying a commission of 33% on its entire book of business. This is far too high. Commission on Personal Lines renewal business should be eliminated, or at least paid only on what the producers actually service.

CONCLUSION: At a 75% commission rate, the agency cannot cover the cost of handling this business. The usual compensation is 50% to 60% of the total. Even though service costs less on Life and Health business, a 75% commission does not leave room for profit.

Based on this cursory look at the income and expense statement, let's see what an adjustment in a few percentage cost figures would do:

Now the owner can have proper compensation, pay better salaries to service staff (and get better-quality people), and earn a 10% pre-tax profit.

About six out of 10 agency owners prefer a straight commission system; the other four choose between salary or draw-against-commissions, and the draw is a level monthly amount which is slightly less than the amount of the actual earned commission.

Eaglemark Consulting Group favors a commission-driven system for producers, as opposed to a guaranteed salary, because it motivates producers to hustle even harder. A guaranteed salary often results in the producer becoming complacent and reaching a comfort level commensurate with the salary.

The implementation of an incentive program makes a producer compensation program work even better. Any incentive plan that works effectively must be tied to some type of goal. Realistic goals can always be set for new business production and renewal retention. Examples 2 and 3 illustrate an incentive system that employs an increasing commission rate as production goals are increased.

EXAMPLE 2: Producer's Annual Gross New-Business Commission Goal

The goal we have set here is $50,000, or about $345,000 in premium. This assumes an average commission rate of 14 1/2% and what the producer will be paid 40% of the gross commission, or $20,000.

NOTE: The step rate increase applies to the entire commission earnings so that on the $55,000 goal, we would be paying an additional 1% on the entire $55,000 goal, not just on the $5,000 addition to the goal.