Coping With Disappearing Commission Dollars

COPING WITH DISAPPEARING COMMISSION DOLLARS

by Carol Hammes

The services of independent agencies have become increasingly valuable as the number and complexity of risk transfer options increase. Yet the current method of compensating agents is based not on the exercise of their risk management expertise, but almost solely on the price that their clients pay for coverage.

This doesn’t make sense.

The industry needs to take a hard look at commission compensation. An improved compensation system would reward the sales force for the specific services they provide in selling and retaining business, rather than the amount of premium in the account. Depending on the type of account, coverage written, level of automated support available, insurance company requirements, and demographics of the marketing area, an agent or producer will be involved in all, some, or only one of these activities:

Agents who perform most of these functions should receive more compensation than those that do only a few of them. Given the sophistication of today’s automation systems, it should be easy for companies to develop a performance-based flat-rate approach to paying for those services actually rendered by the particular agent on a piece of business.

Industry groups should work together to structure a compensation system that makes everyone (including insurance companies) accountable for how well they perform in delivering insurance products and services to their customers. Simply reducing commission rates to solve a company’s expense problems isn’t a long-term solution.

THE SOLUTION: CHARGING RISK MANAGEMENT FEES

However, because the industry might never get around to updating its compensation system, or the change might come too late for a number of agencies, you might do well to supplement declining commissions by charging clients fees for insurance-related services. These fees might be in lieu of commissions, with your agency obtaining coverages on a net basis from the carriers. Or you might supplement commissions by charging for loss control or other risk management activities that go beyond traditional sales and servicing.

Make the decision to charge fees part of your overall agency business plan. It might be tempting to charge a fee when you give up most of the account commission to retain the business against fierce competition. Unless you base the decision on solid cost accounting and a determination of the clients’ needs, the fees charged might be too much or too low, threatening your relationship with the account.

Before jumping into the fee game ask these questions:

• What services is your agency capable of providing and at what expense?
• What do your clients and prospects need?
• What will the market bear — is your competition charging fees or perhaps performing these services for free?
• What will the laws in your state (and/or the states in which the account is located) allow?
• Review your company contracts; how will your insurance companies respond to this move?
• Does your E&O policy cover charging fees?

PERSONAL LINES

Unless you specialize in big-ticket accounts, it’s difficult to find lucrative fee income opportunities in Personal Lines. Most states don’t allow agencies to charge fees for obtaining MVRs or preparing registration cards. Even though they can charge for videotaping the contents of a home or making inspections, don’t expect enough income from these sources to make the venture financially worthwhile. If you have to pay a college student minimum wage to do the taping, pay for transportation, buy the tapes and other materials, you’ll have to charge at least $25 to make a profit. Will people pay that much in your marketing area, particularly if some other independent agent or direct writer is willing to do the same thing as part of routine account servicing?

COMMERCIAL LINES

Although there’s no single set of criteria that makes an account eligible for fee-based risk-management and loss-control services, usually these accounts will have sophisticated exposures that require careful analysis and annual premiums of more than $100,000. Consulting activities can range from basic risk analysis to the creation of complex loss-control/cost-control programs with educational and inspection components. Sometimes, the primary fee activity is administrative, with the agency taking the responsibility for tracking loss severity and frequency. In other cases, the fee involves hands-on inspections and training sessions with the client’s employees. Base your decision about the level of involvement on the agency’s ability to provide the services and the client’s receptiveness to paying a fee for this assistance.

A prospective account does not have to be particularly large or complex to qualify for some kind of fee arrangement. The account might need only an initial risk management analysis that a technically qualified service person can handle. An agency providing this service can generate decent fee income, while getting the opportunity to know an account that’s not yet an insurance client. Some agencies will then waive the fee if the insurance is subsequently placed with them. Note: It’s important to make sure that your state insurance department and carriers will accept this practice.

WHAT AND HOW TO CHARGE

You can arrange fees on a fixed basis (per account or per service to be rendered). Or you can base them on hours and materials used in the assignment. In either case, management has to determine the appropriate pricing structure by creating a separate profit center for the anticipated activities. How much will it cost to provide these services and how much profit should the agency make? As part of this analysis, be sure to take into account the opportunity cost: If the same people who’ll be spending time on these fee-based services were to spend that time generating commissions, how much money would the agency make? If you can’t demonstrate that the fee-based profit will at least be as great as the profit that the agency is making off of commissions, why do it?

To determine your agency’s pricing structure and break-even level, start with last year’s financial statement, relating each expense item to the revenues generated from commissions. Remove contingent and investment income from this calculation since fee income will not generate these types of revenues. The example below, provided for informational purposes only, is based on an average commercially oriented agency that receives 88% of total revenues from direct commissions. Because agency expense structures vary significantly, you’ll need to do your own analysis.

The chart indicates that the break-even level for this average agency would be a 15.6% profit margin. Let’s say that you want to provide 100 hours of risk management consulting for ABC Manufacturing. The person who will provide most of this service currently makes $50,000 per year as an account executive. Using 1,880 hours, their hourly rate is close to $27, and employee benefits add another $5 per hour, for a total of $32 per person/hour. Clerical assistance for preparing reports will cost $15 per hour including benefits, and it’s estimated that this person will spend about 100 hours on the project. The client is located 50 miles away, with each of the estimated 20 round trips taking 100 miles @ $.32/mile. Supplies, postage, telephone, etc. will be minimal in this case, around $100 total.

Without any allocation for other agency overhead expenses, the direct cost for providing these 100 hours of risk management consulting service will come to $5,440. Factoring in the 15.6% profit margin, the total agency cost comes to $6,289. So the minimum amount to charge the client would be $63 per hour. If the consulting activities are to be expected to help cover basic agency overhead, add another 25%, for a rounded total of $80 per hour. If extra software or hardware will be necessary, amortize the cost over the consulting jobs for which it will be used.

Note that the appropriate charge will vary significantly, depending on the compensation level of the person performing the work. If the consulting will involve highly technical analysis that requires a $100,000 per year person, the minimum charge would be $95 per hour and the fee with operating expense allocation should be $120 per hour.

Once your agency has done a couple of consulting jobs, you’ll be in a better position to accurately determine the amount of time to perform the services, and you can probably charge on a lump-sum basis for specified services. Until you have this experience, however, you’ll probably lose money if you try to guarantee a price up front. And no matter how you structure the assignment, put the specific risk management services that you’ve agreed to provide and the associated fees and payment schedule in a written contract.

Try it – you’ll like it!

The late Carol Hammes, principal of The Middleton Group, was one of the Independent Agency System’s most widely respected management consultants. She will be sorely missed.