IS EMPLOYEE OWNERSHIP RIGHT FOR YOUR AGENCY? PART II
by Carol Hammes
Offering your employees the opportunity for agency ownership can help attract and retain quality people.
Sooner or later, most agency owners will need to decide whether to give their employees the ultimate incentive: The opportunity to obtain equity. This article (the second in a two-part series) will focus on two agency ownership incentives: Phantom stock and vesting in a book of business.
PHANTOM STOCK/PERFORMANCE UNITS
When such third parties as financial institutions, real estate firms, or the largest client-owned insurance agencies, sharing ownership with the employees might not be an option. In other situations, agency owners might not have decided whether they want to implement an internal perpetuation plan or if their children will be coming into the agency. In these cases, it’s still possible to give key employees a form of equity through profit-sharing units, often known as phantom or shadow stock.
The most common way to create these programs is to set up the same number of units as there are shares of common stock in the corporation and to value these units in the same way. As the value of the agency increases, the value of the phantom stock also goes up, although the employee doesn’t enjoy any of the other rights or benefits of stock ownership. When the employee retires or leaves, they’ll be paid the value of their phantom interest, usually over the same period of time and under the same terms that apply to the owners of the real stock. The contract can also include a provision for converting the phantom stock into actual stock in the future by mutual agreement of the parties.
Agencies can use a number of variations on the phantom stock theme to reward past performance by tying the individual’s eventual payout to the future success of the agency as a whole, or to the results of a specific department. For example, the agency can grant performance units based on commissions, revenues, profit, or some combination of measurable results. These units would either be valued at a fixed dollar amount (with the number of units varying based on performance criteria) or set at a fixed number (with their value increasing as results improve). Although this approach can be helpful in larger agencies where department managers might have extensive control over their own areas, it might not be appropriate to award shares based on the value of the total agency — such as the Life, Group, or Personal Lines departments of Commercial Property/Casualty agencies. Again, performance units can either be converted to agency ownership in the future or they can provide a means of paying deferred compensation.
Some executive employees or key producers might fear that the agency will be sold out from under them before they can become owners and that they’ll receive nothing in return for their past loyalty and service. You can allay these concerns by providing a deferred compensation program based on phantom stock or performance units and sweetening the deal with a “golden parachute” provision that boosts the value of the units by 10% to 25% if the agency is sold to an outside party.
On the other hand, if you’re concerned that the employee will take the phantom stock and then quit at the end of a very good year when the value is high, add “golden handcuffs,” such as a vesting provision that discounts the value until a number of years have passed, or set two values for the stock: One that kicks in at retirement/death/disability and another if the employee leaves before age 65.
VESTING IN A BOOK OF BUSINESS
More and more agencies are offering equity by allowing producers to vest in the value of their own book of business, rather than in the value of the agency as a whole. Under these arrangements, the agency agrees to pay the producer deferred compensation when they leave the agency. The agency generally bases the compensation on a percentage of the commissions produced by the person, with the percentage increasing the longer the producer stays with the agency (hence the term “vesting”).
If you’re considering a vesting program for new or existing producers, you’ll need to make some important decisions about what you’re trying to accomplish and then document these decisions in the employment contract so that there’s no confusion later on:
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Definition of commissions:
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All commissions, even agency business, given to the producer to handle.
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Life and Group business, as well as Property/Casualty.
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Only on the book that the producer brought to the agency initially.
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Only on new business produced after the first year.
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Length of vesting period: Generally from five to ten years.
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Percent of additional vesting each year: Generally from 10% to 20%.
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Maximum amount of vesting: Generally 50%, but some go to 100%.
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Value of deferred compensation: Generally from .75 times annual commissions up to 2 times commissions, with the amount depending to a great extent on the vesting percentage and number of years with the agency.
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Higher value opportunities: The agency might or might not pay more if the producer leaves at normal retirement, dies, or becomes disabled, rather than being terminated.
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Timing and method of payout: The price can be based on the past 12 month’s commissions and paid out over a number of years, with or without interest, or on the retention of the business during the two or three-year period after the producer leaves (I prefer the latter).
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Option for conversion of vested value into agency stock:
All producer vesting contracts should clearly state that vesting is simply a right to receive deferred compensation and that the ownership of the expirations remains with the agency. Further, it should be clear that the agency is paying deferred compensation in return for the producer’s agreement not to solicit this business for at least three years after leaving the agency. If the producer violates this provision, they’ll forfeit either their entire compensation or at least the portion based on the accounts in question.
Management must also recognize the impact of vesting plans on the total producer compensation program and available agency cash flow. If you’re agreeing to pay producers on the back end, you can’t afford to pay as much on the front end. In other words, the percentage of commissions paid producers for selling and servicing business should be lower in an agency that has a vesting program; how much lower will depend on the vesting period, percentage, and valuation method.
CONCLUSION
By using the equity programs discussed in these articles — or some variation — agencies of almost any size and orientation can obtain a number of the benefits of employee group ownership without many of the negative side effects associated with an ESOP. For example, you might expand the phantom stock or performance unit programs to include all employees, rather than just a select few. With a little creativity, you can translate the increase in unit value into increased 401(k) matching amounts, thus giving employees protection under a qualified plan that they wouldn’t have enjoyed with regular deferred compensation plans. Another option would be to give all employees who meet certain criteria the opportunity to purchase career shares at book value (very low in most agencies), which will then be convertible to agency stock at fair market value when both the agency and the individual reach specified goals.
Good luck!
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.