PRODUCER COMPENSATION
AND THE IMPACT OF VESTING AND OWNERSHIP
by Carol Hammes
There are probably no two hotter topics for insurance agency principals than producer compensation and agency value. Although they may appear to be separate issues, the questions 'What should I pay my salespeople?' and 'How much is my agency worth?' are closely connected. A producer compensation program that's too rich will detract from the bottom line and may reduce the agency's value significantly. Conversely, if the salespeople are not paid enough to be motivated, the agency's future growth will be adversely affected-another factor that detracts from the value of the firm. Furthermore, a program that gives the producers deferred compensation rights in addition to high current commission levels can make a serious dent in the internal and external selling prices of the agency.
Developing and implementing an effective, affordable producer compensation program can be one of the most difficult challenges faced by the agency management team. So many decisions must be made relating to other aspects of the agency operation and the owners' management philosophy that it's impossible simply to take what other agencies have done and apply it carte blanche to your own situation. What you pay must be based on what the agency expects from the salespeople and what services and other support are being provided to help them perform the job as it has been defined. And once the compensation program has been defined, the principals must be prepared to demonstrate to the producers how they personally will benefit more from this approach than from the seemingly more lucrative plan being offered by another agency in the same marketing area.
Because the producer compensation plan can have such a significant impact on agency value, it's important to involve all of the agency's principals in defining the program's major elements. Once the owners have set the parameters, the details of the plan and its subsequent implementation can be handled by the person assigned to be the Sales Manager.
OWNERS' PRODUCER COMPENSATION QUIZ
Target profit margin. What percentage of revenues are to be targeted as profit-before-owners'-bonuses over the next several years? Most agencies fall into a range of 12% to 20%, but there are many exceptions.
Sales support services. Will the agency provide producers with cold calling and appointment services, claims management, loss control and/or risk management consulting backup, marketing and placement assistance, and so on? What percentage of revenues must go to fund these services? Most agencies will fall into a range of 2% to 5% of revenues.
Sales expense reimbursement. Is the agency going to pay for travel, entertainment, auto, club, or dues expense? Or will some or all of these things be expected to come from the producer's commission split? Most agencies pay 3% to 5% of revenues for selling expenses, either directly or as part of the producer's commissions.
Employee benefits. Will the agency pay payroll taxes and education expenses for the producer, and will the standard group insurance and retirement programs provided for other employees also apply to the producers? Most agencies pay these items directly, before calculating producer commission percentages, at a cost of 8% to 10% of revenues.
Promoting target sales. Should the agency direct producer sales efforts by having different programs for various types and sizes of accounts? Most agencies treat Personal Lines and Life insurance differently than Commercial Property/Casualty and employee benefits. Many are now front-loading for new business over renewal, setting up lower commission scales for smaller Commercial accounts, and enhancing incentives for large accounts.
Piece of the future. Will producers have the opportunity to vest in a deferred compensation program or to trade accrued production credits for agency ownership or phantom stock?Number of programs. Should only one program apply to all producers or can there be variations? Will the same or a different plan apply to the agency principals' compensation?
BASE PRODUCER COMPENSATION PLAN
Depending on the answers provided to these questions, most agencies will find that they can afford to pay producers somewhere between 25% and 45% of the commissions that they bring into the agency. Firms providing a lot of support services and that pay for all employee benefits and sales expenses will be at the lower end of the range. Those that expect producers to do everything for their prospects and accounts and pay all their own expenses will be at the high end. We cannot emphasize it enough that this is a very broad range, with a lot of room for error. Know what you can afford to pay at this point in your agency's history, recognizing that it may vary substantially from what you could pay producers even 10 years ago.
Once all the computations have been made, a general lines agency that provides standard CSR assistance for Commercial Lines producers and pays for their payroll taxes, other benefits, education, and out-of-town travel expenses will often have a target producer commission range of 31% to 33% of the gross Property/Casualty commissions. The following discussion of base producer compensation programs will use that range as a starting point. Again, adjustments must be made to the percentages to reflect the actual expense structure of your particular situation.
In firms where the principals have decided not to differentiate by line of business or type/size of account, the producer compensation plan could simply be 32% of the new and renewal commercial commissions collected, plus a modest car allowance of $300 per month and some legitimate expense reimbursement. A finder's fee of 50% of the first-year Personal Lines commissions might be paid for referrals to that department, and perhaps 15% of the first-year Life commissions for those referrals. In agencies with separate employee benefits producers, the P/C producer will often receive 25% to 50% of the first-year producer commission paid to those producers in return for sending business their way.
Using that same 31% to 33% target level with comparable benefits and expense treatment, this relatively simple program can be converted into hundreds of different options. The program or programs that are right for your agency will depend on the answers to the Owners' Producer Compensation Quiz, possibly modified to reflect your computer system's ability to provide the necessary detailed information to administer the plan properly. If the level of detail that you need means that CSRs or accounting department personnel must spend an inordinate amount of time tracking production results manually, you will be much better off selecting a simpler producer compensation plan.
Account Size Option
Because the cost of handling certain sizes of accounts is different, many agencies are now going to a producer compensation program that pays producers differently, based on the commissions generated by the account. Assuming that the support staff can handle more of the renewal processing on the smaller accounts, there's also a front-end load for new business. Using the 32% overall target, here is a sample of one such plan. Note that the definition of the smallest group of accounts will vary, depending on the agency's marketplace. In metropolitan areas, the commission threshold may be $2,000 in commissions rather than the $500 shown here:
| Account Size | New | Renewal |
| Commissions under $500 | 30% | 10% |
| Commissions $500 - $2,500 | 35% | 15% |
| Commissions $2,500 - $10,000 | 40% | 25% |
| Commissions over $10,000 | 45% | 40% |
Book Size Option
In some situations, the agency's cost factor is determined more by the size of the book of business that the producer is handling than by the actual size of the individual accounts. To encourage the sales people to develop larger books of business, the commission rate can be adjusted based on the size of the total book of business, or a bonus can be paid on all commissions above a certain threshold. As an additional incentive, the auto or expense allowance can also be increased as the producer develops more business. Here are several examples:
| Total Size of Book | New/Ren | Auto/Mo. |
| Commissions under $100,000 | 30% | $250 |
| Commissions $100,000-$250,000 | 32% | $350 |
| Commissions $250,000-$400,000 | 35% | $450 |
| Commissions over $400,000 | 40% | $550 |
| Base commission 30% new and renewal plus extra points on new if: | Extra Points |
| Total Commissions over $150,000 | 5 points |
| Total Commissions over $250,000 | 10 points |
| Total Commissions over $400,000 | 15 points |
Here's an illustration of how this second option would work: The producer starts the year with $350,000 in commissions, upon which he or she receives 30%, or $105,000. Any new commissions for the year would be paid at 40% on the first $50,000 and $45% in excess of that $50,000. If new commissions for the year are $60,000, the total compensation would be $105,000 plus 40% of $50,000 ($20,000) plus 45% of $10,000 ($4,500) -- for a total of $129,500.
There's virtually no end to the possible number of options or combinations thereof. Accounts from a special marketing program could be treated differently. Extra points could be awarded on accounts for which the producer has provided leads that have resulted in employee benefits or Life sales. Instead of extra points, a dollar bonus could be paid if producers reach the desired thresholds. Some agencies allow the producer who achieves certain production levels to 'earn' a dedicated CSR or a title and more perks.
In about 80% of the agencies that use production results as the basis for sales compensation, the producers are paid a draw or a salary to smooth out the ups and downs associated with monthly straight commission calculations. This base amount should be applied against the total producer commissions as produced by the selected formula. In other words, a producer who has a book of $100,000 in commissions should not be paid a $30,000 salary and then also receive 32% ($32,000) on top of that. The total salary plus bonus would be $32,000. For seasoned producers, it's advisable to set the next year's draw or salary at 75% of what the formula produced the prior year, adjusted by a bonus once or twice a year.
With producers who have not yet validated, the draw should be set at the formula as it would be applied against the anticipated third-year production. If the producer's goal is to be at $125,000 in commissions by the end of the third year and the agency pays a straight 32%, the starting salary should be 75% of 32% times $150,000, or $36,000. To the extent that producers sell in excess of $112,500 in commissions in any of the first three years, they would get a bonus to make up the difference between the salary and the 32% formula value.
If the agency principals have decided that they'd like to offer either a deferred-compensation program or agency ownership to producers, a number of additional decisions must be made regarding the nature of that program. And the base compensation must be adjusted to take into account the approximate future value of the payments to be made. Only a finite amount of money is available. If the agency is paying the maximum amount that it can afford to producers as the business is written, it can't also fund a deferred-compensation program without sacrificing the target agency profit percent and the value of current and future ownership interest.
DETERMINING FUTURE VALUE ADJUSTMENTS
Nature of equity interest. Will the producers be earning deferred compensation rights in their own book of business, a portion of the actual agency ownership, or phantom stock? Will there be an option to convert the deferred compensation into ownership at a later date?
Commissions to be included. Is the formula to be based on new commissions produced after the date of employment, commissions that the producer brought initially to the agency, commissions given to the producer to handle, or a combination? Is this to be only Property/Casualty business, or are employee benefits and Life insurance also included?
Initiation. When will vesting begin? Some agencies start this at the date of employment, but most delay it for two or three years.
Length of vesting period. Vesting generally accrues over a five- to 10-year period, with many agencies selecting a maximum vesting of seven years.
Percentage of vesting each year. Annual vesting is usually from 5% to 20% with 10% the most common.
Maximum amount of vesting. Vesting is generally 50%, but some agencies allow up to 100%.
Value of deferred compensation/ownership. The formula to be applied against the book of commissions generally runs from .75 times to 1.5 times. Some plans offer a higher value if the producer stays until retirement, dies, or becomes disabled, as opposed to just leaving the agency.
Timing and method of payment. The price can be fixed based on the last year's commissions and paid out all at once or over a number of years with or without interest. Most plans are now set up on a retention basis with a certain percentage of renewed commissions paid over a three- to five-year period.
Buy-back provisions. Will the producer be able to buy the right to take the business by paying for the unvested portion? If so, at what price?
Conversion privileges. Can the deferred compensation be converted into agency stock or phantom stock? Is this conversion option guaranteed, or is it based on reaching production goals and/or agreement of current agency principals? What is the conversion value?
To make the adjustments to base producer commission levels necessary to accommodate the future value agreements, you must come up with an approximate value of the deferred compensation. To do this, start with the book of commissions that you think a producer will have at full vesting and apply the formula. For example, a book of $400,000 in commissions at the end of the seventh and final year of vesting with total vesting at 50% and the value of the book at one times would produce an approximate value of deferred compensation of $200,000. Because this amount is not guaranteed and will be paid sometime in the future, we recommend that you use a discount of 50% of the maximum value, or $100,000, for these calculations. This $100,000 current value bonus relates to the total commissions in the book of $400,000 at 25% ($100,000/$400,000). If the payments are to be made over five years, the deferred compensation is therefore worth 5% per year (25%/5). The appropriate adjustment to the current renewal commission percentage would therefore be five points.
Referring back to the example on the table above, if the producer is being given a vesting agreement comparable to the one used here, the renewal percentage for the base producer compensation should be decreased by five points, with the resulting renewal commission percentages as follows:
| Account Size | New | Renewal |
| Commissions under $500 | 30% |
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