Producer Equity: Good Idea Or Bad?

Never offer equity only in a producer’s book of business if the goal is to reward a producer for success or to cement the relationship between producer and agency. The forced “acquisition” of a producer’s equity can eliminate the profit for each account for as much as 10 years! Al Diamond explains why in this document.

You hire producers and compensate them for their time and effort. You support their sales efforts with advertising to gain the public’s attention, prospecting to gain sales opportunities, and marketing to the carriers. You support the customers for which they continue to achieve renewal commissions with internal administration and servicing. Even so, it’s hard to convince these producers that the business “belongs” to the agency, not to them.

True, the producer is an integral part of the team that drives business to the agency, convinces prospects to buy, gets carriers to provide the right product at the right price to facilitate the client’s buying decision, and satisfies them after the sale to retain their business for many years.

However, other team members — the marketing representative who develops the product and places it with the carrier, the service representative who maintains primary communications between the agency and the client to assure their satisfaction, and the claims representative who assures that the claim service the agency provides lives up to their expectations — play equally important roles.

When you proffer any level of “ownership” in the book of business that the producer develops, a number of things happen:

• The producer will pay more attention to the business in which they have ownership than to other agency business. Although you want a producer to pay attention to the customers to whom they sell (that’s why you pay renewal commissions), you also want that producer to pay attention and assist every customer with equal vigor and care.
• If the producer is not successful (builds a smaller book of business than expected or projected), the equity provided to them is a waste. If you ever have to get rid of the producer, the agency must pay for the book of business again through a buy-out, or it won’t recoup its expenses with the income if the producer buys the book from the agency.
• Successful producers might consider their equity to be a savings account that builds until they can take their book of business and either strike out on their own or leverage it to make a better deal with you (or with a competitor). We’ve seen many cases in which a new agency sponsors the buy-out of the balance of a producer’s book of business in order to accommodate a new producer, bring them on with a pre-existing cash flow for the agency, and entice them with other incentives as a result of the accommodation.
• Regardless of success, the producer will consider that book to belong to them, and will expect to be able to buy it from you (or sell it to you) if your relationship with them ever sours. Considering that average agency acquisition costs don’t permit an account to become profitable until the second or third year (at the earliest), and that service costs, combined with continued payment of renewal commissions, provide only a 10% to 20% profit per normal account (when profit levels can be achieved), the forced “acquisition” of a producer’s equity can eliminate the profit on each account for as much as10 years!

If the producer wants to buy out your portion of the equity in their book, the return that you achieve will probably not return as much as you’ve spent in acquisition and service costs to acquire and maintain the account (unless you’ve had it for more than five years).

For instance, if an account is written that generates $1,000 of commission, the combined acquisition costs can easily top $2,000 (Agency Consulting Group, Inc. Acquisition Study). Based on a 5% per year premium growth, the agency will net a 7% profit at the end of the third policy year.

If the owner achieves a 50% equity position, the agreement of value is twice the commission payable over three years. If the producer leaves and buys the business after the third year, the agency will net $1,319 over six years, a 7% return for its cost basis. If the agency is asked to buy out the producer, the combined acquisition costs will take five years to recoup (assuming that another producer is assigned to maintain and retain the account and earns renewal commissions). Equity relationships with a producer can work under very specific guidelines:

1. Set goals. Equity is an issue only if ongoing goals are met. Make sure those goals are aggressive, but achievable. They should provide adequate growth and profit for the agency to permit equity sharing, while still increasing the owner’s value in the agency. Remember, even if the producer doesn’t pay attention when the equity offer is made, it will become readily apparent if the goals set in order to gain equity are unachievable.
2. Make the equity position one of equity in the agency, not in a book of business. That way, the success of the agency, not of a few accounts, is of prime importance to the equity-sharer. They’ll pay attention to the value of the business and to all of the accounts, not just to the ones that they produced.
3. Vest the equity over five years. In this way, a long-term relationship must develop before the producer achieves full vesting in the equity.
4. Don’t make equity a one-time percentage (or stock shares) event. If equity is a reward for continued success, permit the evolution of additional equity in each year in which goals are met.
5. Protect your ownership position. Limit the equity potential to assure that control remains with the agency principal until and unless the equity relationship has developed into a succession and perpetuation-planning tool.
6. Either set substantial enough goals to compensate the agency for the equity being offered, or make the equity an option to be offered to the producer at a beneficial price. Something that’s earned or paid for is more valued than something that’s given.

We support producer (and other management) equity within insurance agencies for two reasons:

• Groom successful producers for ownership succession. You won’t live forever, nor should you stay with your own agency once you’re no longer a productive, profit-generating part of it. When that time comes, you should sell your equity to the next generation. A producer should not go from sales to management overnight. Equity relationships enable a maturing of producers into management roles.
• Seek out successful producers and give them opportunity after opportunity during their careers. Two things will keep a successful producer with you: Appreciation for their efforts and success, and a stake in the future of the agency that translates into growth and retirement benefits for the producer. Equity provides both.

We recommend that you create equity opportunities for current successful producers and as incentives to get new producers. Although the equity incentives for new producers will only be achieved after a number of years of successful goal attainment, this opportunity for equity might be exactly what differentiates you from the agency in which the producer already resides.