Pay For Production: How To Calculate What Your Agency Can Afford

Are you trying to figure out how much to pay your producers by asking, 'What's the agency down the street paying?' Beware! 

Pegging compensation to what the competition is doing can be a costly mistake. Your competitors may be paying too much and headed for bankruptcy-or paying too little and riding a merry-go-round in turnover.

Every agency is different. Some provide their producers with leads, expense accounts, auto allowances, club memberships, sales management, and other costly direct-sales support. Others don't. Most agencies provide service support and invest in other retention-building tools. Some agencies are highly efficient and have low operating expenses. Others have very high overhead. Most are somewhere in between.

A few agencies make the fatal mistake of thinking they have $1 of commission to split with producers. They don't. They have $1 of commission minus the cost of operating the agency. A big percentage of that commission income usually goes to expenses other than production. Knowing where the money goes is essential for agencies trying to figure out how much they can afford to pay producers.

The worksheet at the end of this article is an easy way to get a snapshot of where your agency stands. It's a good exercise for any agency at any time. It's especially helpful for an agency looking to bring in a new producer, turn around a dwindling profit picture, or boost its value as a going concern.

Let's walk through the worksheet.

Add up the cost of office payroll, rent, light, heat, bad debts, dues, and subscriptions-every agencywide operating expense. Include advertising because the entire agency benefits from advertising. Exclude pay that goes to the principal, as well as federal and state income taxes or any other non-agency expenses. Also exclude business-development expenses for leads used by individual producers.

For an average agency, the sum you come up with will take about 50% of every dollar that comes through the door. High-performing agencies get it down to 45%. Inefficient agencies run 60% and higher.

MANAGEMENT FEE

Next, add in the cost of managing the agency, including the production staff. A sales manager or producer needs to be compensated because time allocated to management is time taken away from production for manager and agency. This typically costs 5% to 7% of an agency's total income.

Profit

The last piece in this puzzle is return for ownership. The target amount is highly individual and varies from agency to agency. Agencies often shoot for 10% profit, although many others are looking for 15% or even 20%.

Production

To get an idea how much your agency can afford to pay for production, add together your administrative expenses, management fee, and profit. Then subtract it from 100% -- or $1 of income.

An agency using 60% of every income dollar for administrative expenses, 5% for management fees, and 10% for profit has only 25% left over to pay for production. This includes direct sale expenses, which must be subtracted before paying commission to producers. If your agency provides leads, allocate that cost under business development. If your producers provide their own leads, it should be reflected in higher commission. Even at a minimum, sales support of 2% for lead generation, an agency in this scenario can afford to pay producers only 23% -- or 23 cents of every $1 of commission income the producers bring into the agency. By any standard, 23% is an uncompetitive slice of the commission pie for outside producers focusing on new business.

Even an average agency with administrative fees of 50% instead of 60% will have only 33% left for sales commission in this scenario. That's still not enough to compete with a the high-performing agency down the street, which is holding administrative expenses to 45%. It's lean and mean. It's growing. And it's looking for top producers. It can afford to pay more.

Agencies with higher administrative expenses may have to cut back somewhere to compete. Here are the options:

• Management. Cutting back here could cause production to suffer, which means even less money for everyone. Effective management is usually needed to keep a sales staff focused.
• Profit. Cutting profits compromises the agency's ability to invest in itself, increase its value, and ultimately perpetuate.
• Administration. Cutting here makes the most sense, especially if an agency is lumping direct sales expenses under administration. Direct sales expenses are not benefits and should not be accounted for as such.

But cutting costs can take an agency only so far. Agencies should also try to offset high administrative costs by increasing productivity. Here are two strategies to consider:

1. Improve the use of automation systems, or outsource service functions to a lower-cost carrier service such as SAFECO's Customer Service Unit.
2. Implement an effective sales incentive program.

Implementing a sales incentive program that rewards producers for reaching agency goals can greatly enhance an agency's ability to pay a competitive commission to producers. Establishing separate commission splits for new and renewal business should be the centerpiece of this effort.

Too many agents believe that they have to pay an across-the-board 50% commission to get and retain top producers. Unfortunately, these agents may be on their way to going out of business or seriously limited in their ability to grow. Unless the agency's administrative costs are below 35%, this level of commission eventually will depress profits, cripple growth and, most likely, blunt the sales incentive on new production. As a producer's renewal book grows, there's less incentive to go after new business if renewals pay 50%.

One fair way to compensate producers and maintain the sales incentive is to pay 55% for new business and 35% for renewals. The split is lower for renewals because-except on some large commercial accounts-the service cost on renewals is lower than the sales cost on new business.

Don't be put off by the 55% commission split on new business. It may seem too high at first, but over a five-year period, the 55/35 commission split averages out to a total 37% commission. At that point, renewals will begin to dominate a book of business, pumping profits into the agency and providing fair compensation to producers without compromising the incentive to sell new policies.

This is one solution. Every agency is different and may need to tailor producer compensation to individual situations. If producers are doing most of the service work, they should receive fair compensation for the retention gained by their time and labor. But this will work only if it's reflected in much lower administrative costs. In this strategy, agents must ask themselves whom they want to pay for renewal support-a customer service representative or an outside producer?

No compensation schedule is perfect. To get the right one for your agency, define your objectives and design a schedule around them. If you want your outside producers concentrating on new business, you need a compensation schedule that matches this objective by paying a premium for those results.

Getting it right is an important step toward building a strong sales culture in your agency, increasing its value, and securing the ability to perpetuate.

Use the following worksheet as a starting point for exploring how much you can afford to pay for production. You may be pleasantly surprised. You may also discover a need to make adjustments on both expense and incentive sides to propel growth and profits. Either way, it's better than doing whatever the agency down the street is doing-especially if that agency's just guessing!

(Office payroll, benefits taxes, rent, light, heat, bad debts,

dues, subscriptions, and so on. Include agency advertising.

Do not include owner income, federal or state income taxes,

or non-agency expenses.)

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