Responsibilities And Rewards Of Agency Ownership

RESPONSIBILITIES AND REWARDS OF AGENCY OWNERSHIP

Not everyone is cut out to be an agency owner. Some of the best producers and service reps either do not want to take the risk of investing in a business or are not comfortable with assuming the responsibility for making decisions that affect the organization and the other people who are working there. As long as these people are appropriately compensated and motivated they can be invaluable members of the team. Putting ownership out as the ultimate goal for which all good employees should strive can be a terrible mistake because it may discourage or drive off the very people who can be the backbone of the agency's future. In most insurance agencies, the active owners make up only 10% to 20% of the total employee group. You need to have willing and capable participants filling out the other 80%.

Whether he or she is sole owner or a member of a larger ownership group, the main responsibility of an agency principal is to be a leader. And never has this leadership role been more important than it is today. The challenging commercial marketplace, major advances in automation, and the changing nature of insurance company and account relationships have put a significant amount of stress on agency employees. They are being asked to do twice as much work as they did 10 years ago using entirely different procedures, and they must respond to that revised role with a positive attitude and enthusiasm. Strong leadership is without a doubt the one single characteristic that separates the agencies that are thriving from those that are struggling. It takes a leader to create a winning team.

Successful agency principals are able to identify the specific challenges facing their particular agency and to focus people's attention on meeting those challenges. They can regulate the level of distress caused by confronting the issues and are capable of pacing the rate of change so that people can keep their attention focused on the relevant issues. Leaders do not necessarily need to be charismatic, but they must always be aware that their demeanor and attitudes will set the tone for the rest of the agency; poise and inner discipline are critical qualities. Effective agency owners also demonstrate a constancy of purpose in solving problems, in making decisions, and managing personnel.

Agency principals must be visionaries who can define the dream, show the rest of the employees why it is important that they buy into that dream, and let them know what's in it for them if they do. A year ago, Gary Barnett painted a Rose Bowl picture for a group of athletes who had been playing for the smallest and probably least athletically oriented school in the Big Ten. You could count on one hand the number of wins this team had chalked up in recent years. What these young men achieved was far beyond the expectations of anyone except the Wildcats themselves. Like their leader, Coach Barnett, they believed in the dream-and they never gave up until they accomplished what they had set out to do-despite the odds.

Good leaders are coaches who respect the importance of every player and every position and who take the time to help each member of the group develop individually through their participation in the team effort. A leader is only as good as his or her followers. If the employees in your agency are not performing the way you think they should-it's your fault. They are either the wrong people, they have not been trained or directed adequately, or the owners have not created the environment in which these otherwise capable people can be motivated to strive for excellence. Leadership is not power over people, it is power through people.

Delegation is probably one of the most difficult leadership qualities for agency principals to develop, and many of them never do. One or two self-motivated entrepreneurs can often take an insurance agency up to 10 or 15 people largely through their own personal efforts. But they become too focused on doing it all and fail to develop a group of trained professionals with the capability and desire to help them get to the next level. So the agency stagnates at the dreaded 'million-dollar plateau' and the result is an outside sale, usually at a depressed price. A true leader will not be satisfied with this outcome and will find a way to delegate enough responsibility and authority to jump-start the organization out of the doldrums.

Unfortunately the commitment to make the necessary changes often means that a new group of employees must be brought on board before delegation can be effective. One of the most painful experiences that successful agency principals must endure is discovering that many of the people who were so instrumental in the early development of the agency do not have the drive or often the ability to continue to grow along with the firm. Real leaders possess the strength of conviction that will allow them to continue towards their objectives when the going gets tough.

Along with the difficult personnel issues and the worries over whether there will be enough money on the 15th to pay the companies, there is also a good side to agency ownership: the monetary rewards. According to our recent Market & Financial Survey the average salary and profit bonus paid to agency owners nationwide in 1994-95 was $158,146. In our consulting activities over the past several years we have seen W-2 compensation per owner range from $23,000 on the low side to a high of $769,000. Total compensation including profits to all owners averaged 28.7% of revenues last year, with some agencies producing a return to owners at or near 50% of revenues.

As long as there is a lot of money to go around, paying owners based upon any formula, even ownership percentage, is OK. People who are making a lot of money rarely get too concerned about what the other guy is taking out. But when profits start shrinking and the owners have to take cuts in pay, the issue of equitable compensation for agency principals inevitably rears its head-sometimes in an ugly fashion. Personal experience in consulting with independent agencies for almost 20 years has shown me that ownership compensation is one of the most prevalent reasons for disagreements between owners. And these problems can be so critical that they will eventually lead to the disintegration or outside sale of the organization. Dealing with the issue after it becomes emotionally charged is almost impossible. Start today to reevaluate how agency owners are paid and come up with a formula that will work for you now and as the agency continues to grow.

In fledgling or newly purchased and heavily leveraged agencies, the owners are usually paid under the 'what's left over' method. They get whatever money remains every month after all the other bills and payroll are taken care of. After a couple of years, however, cash flow should have improved to the point where the owners can take out steady income and they often do this based upon their percentage of ownership. This can set a dangerous precedent that will most certainly come back to haunt them at some time in the future. As soon as it becomes economically feasible to do so, we strongly recommend that principals be paid in return for their performance as agency employees first and as owners second.

The major function performed by most agency principals is sales. For handling sales duties, owners should be paid as though they were non-owner salespeople. Simply apply the agency's current sales compensation program to the owners' books of business. This might be 35% of commissions, or 40% on new and 20% on renewal. It might apply to only larger commercial accounts or it could include all business written and serviced. If Account Executives have been appointed to service the business, the agency principal should receive compensation as the originating producer, which is generally 10% or 15% of the commissions.

If the computation of sales compensation results in the agency principals being due more money than they are currently making, it is a sign that the existing producer compensation program maybe too rich or that it could be time to start treating personal lines and smaller commercial accounts differently. When the owners could make more money as non-owner salespeople in their own agency than they do as owners, something is definitely out of whack, and it is time to re-evaluate the whole system.

Determining appropriate management compensation is not as easy as paying for the sales function but it can be done somewhat scientifically if all the owners can look at the situation realistically. In addition to setting the overall strategic direction of the firm, there are four major areas of top management responsibility in an insurance agency: sales management; marketing and company relations; finance and administration; and client services. In total, the compensation for handling these functions should be in the range of from 5% to 7% of revenues. Larger agencies with over $2 million in revenues and more than 20 people are at 5%, and agencies with less than $500,000 in total revenues and fewer than eight people are closer to 7% of revenues.

If the agency has someone (owner or not) whose primary responsibility is to handle management duties, the salary for that person should be subtracted from the management compensation allotment before the remainder is assigned to the principals. For example, if an agency with $1.5 million in revenues has a Controller/Operations Manager to handle finance and administration whose salary is $60,000, that $60,000 should be subtracted from the $90,000 management compensation (produced by taking 6% of $1.5 million) before the balance is allocated to the principals for handling other management duties. Only pure top-management salaries should be used in this computation. If a lead CSR is also assigned some supervisory duties, or if a bookkeeper manages the receptionist and file clerk, they are not really handling top management duties and their compensation should not be included in the management allocation.

When there is more than one owner, the allocated management compensation amount has to be divided up. The easiest and probably most fair way to do this is to determine the amount of time that each principal spends on each function and to split up the pie accordingly. Estimates can be made, or you can keep detailed records for a month or two if it will make you more comfortable. It is also a good idea to double check the percentages every year to make sure that the time allocations have not changed materially. Often, one of the principals will evolve into handling more of the management duties as the agency grows and will consequently be spending less time on sales. If you try to operate with outdated time allotments, the management compensation for that person will not be increasing as his or her sales compensation is decreasing and may become unfair. The following chart is an example of how the allocations might work out:

If the agency has $1 million in total revenues, the top management compensation should be around $60,000 (6% of $1 million). The principals in this agency together spent 1,500 hours on management, so they should each be paid a salary of $40 per hour for that time. Owner A would get a salary of $12,000 for being the part time Sales Manager, Owner B would receive $16,000 for managing company relations and the commercial client services people, and Owner C would get $32,000 for managing the finances and the personal lines CSRs. The total management compensation pie would be divided up at 20%, 27%, and 53% regardless of the percentages of ownership held by each of them.

The third component of ownership compensation is to divide up the profits each year. This is the only part of the compensation computation that should be based on ownership percentages. A well-managed agency should have tangible net worth equal to at least two months' worth of operating expenses, so, to the extent that the firm is not yet at that threshold, it may be necessary to retain some earnings in the business. We often see reported profits of around $50,000 in regular 'C' corporations because that is the level at which you can maximize the surtax exemption and receive the lowest possible tax rate on those retained earnings. Once the amount of profits to be retained is determined, the balance can be paid to the owners. In a partnership or a Sub-S corporation, the distribution can be based on ownership percentages. In a regular corporation, there may be major tax implications if the IRS thinks that profits are being distributed to owners as W-2 income when they should be considered as after-tax dividends. In these situations, it is necessary to be a little more creative with the distribution.

One of the best ways to avoid tax problems is to set up a bonus formula at the beginning of the year that makes it difficult to trace the distributions to actual ownership percentages. This bonus could be based on a combination of revenue growth and expense reduction or perhaps on contingent income. If the agency's profit margin is consistently about equal to the contingents received, set up the bonus based on the amount of company profit-sharing income the agency is expected to get that year. Another approach to distributing some profits is to give the owners expense allocations for automobiles and entertainment items that might be higher than the allocations provided for non-owner producers. The justification for this variance could be made based upon seniority in position/title, longevity, size of book of business handled, or anything else that gives you the results you want.

To illustrate the three components of ownership compensation, let's use an agency with $1.2 million in revenues, a 15% pre-bonus profit margin ($180,000), and three equal owners. Producers are paid 30% new and renewal, and management compensation is 6% of revenues. The owners decide to leave $60,000 of profits in the business. Performance of each owner is:

Owner A -- $500,000 in commissions/10% of management

Owner B -- $200,000 in commissions/70% of management

Owner C -- $200,000 in commissions/20% of management

The ultimate reward for taking on the responsibilities of agency ownership is to build up equity at a rate of return on the initial investment that is greater than if the owner had been a passive investor in some other less risky stock. If all of the profits are removed from the agency each year, and the owners are all making more than they would be making in the business than if they were non-owner employees handling the same jobs, they must look at the excess amount as an annual return, or yield, even if it is not actually declared as a dividend. To a certain extent, these owners are selling the agency to themselves each year rather than putting the profits back into the operation to fund growth, ownership perpetuation programs, and future value. There is nothing wrong with this approach as long as the owners recognize that they cannot have their cake and eat it too. An agency that has been stripped each year will generally not command as high a price as one that has seen consistent re-investment in facilities, personnel, and acquisitions.

Even in these situations, however, the eventual monetary return for agency principals can be quite impressive. If you had the opportunity to purchase 10% of a $500,000 commission agency worth 1.5 times in 1985 (note: a multiple is not recommended for actual valuation and is used only as an example), that $75,000 investment could be worth more