Defensive Agency Management

by Carol Hammes

Even in the best of times, managing an insurance agency isn't easy. The past decade has brought about rapid changes in technology, created more sales opportunities, and presented new operational challenges.

In this article, we'll look at how new trends are affecting management, relationships, distinctions between exempt and nonexempt employees, agency trust requirements, and procedures.

Opportunities to join mergers or networks pop up almost weekly, further confusing already murky business plans. As if direct writing companies, banks, the Internet and mega-brokers aren't enough, accountants are getting commissions for Life insurance sales and they may begin selling other lines.

The American Bar Association (ABA) is considering a proposal to allow lawyers to work more directly with accountants, insurance agents, and financial planners. There are more than 160,000 CPAs and almost a million ABA members in the United States. Compare that to about 35,000 independent insurance agencies with an average of 3.8 producers each.

With all the changes in the insurance market, agency principals are spending more time than ever managing, and they're getting a lot less satisfaction from it. That's why a number of principals are hiring managers.

Usually, an agency with fewer than 15 employees hires an office manager; one with 15-30 employees usually hires an operations manager or CEO; and one with more than 40 employees and more than $4 million in revenue usually hires a CEO/president. If an outsider is hired, it's customary to allow them to participate in ownership after they prove themselves.

Most management consultants agree that 5%-7% of revenues should be earmarked for top management duties. Smaller agencies usually pay higher percentages. Between 1%-2% is usually divided among top managers, which often includes the entire group of principals.

An agency with $2 million in revenues might pay principals $20,000 or 1% as a group. This may not sound like a lot of compensation, but non-manager owners also get sales compensation. If everything goes as planned, they'll have a bigger profit to divide up now that they have the time to go out and sell.

The other 4% of revenues (around $80,000) go to managers, who may also be principals, for helping increase productivity and profitability.

For a management handoff to work, principals must delegate enough responsibility and authority to let the managers actually manage. This isn't easy for most agency owners, especially those who founded their firms.

Practicing defensive agency management is crucial in today's litigious environment. One way to avoid legal and regulatory pitfalls is to give managers operating guidelines. Agency battles cost a lot in professional fees and hurt morale tremendously.

Over the past 10 years, the Internal Revenue Service (IRS) has spent hundreds of millions of dollars recasting independent contractor agreements into employer/employee relationships.

Your salespeople are not automatically considered independent contractors even if they're paid under 1099 arrangements and they're responsible for their own Social Security taxes. For that classification, the relationship must meet more than 20 strict requirements, most of which, probably aren't conducive to your agency's management needs or to consistency in underwriting and processing. When in doubt, treat the producer as an employee.

The Common Law test for an independent contractor classification includes the following problematic requirements. The contractor:

• Must be able to work for several agencies at once and make services available to the general public.
• Makes a significant investment in the facilities used in performing the services.
• Doesn't have to comply with instructions on how or when to work.
• Can't be trained or supervised by anyone in the agency. The agency can't set annual production goals or take any action if the contractor doesn't follow agency procedures.
• Must be in a position to realize a profit or suffer a loss as a result of the services provided.
• Can't be discharged as long as the contractual obligation is fulfilled.
• Can't terminate the relationship with the agency at will.

Your agency has about a 10% chance of facing an IRS audit. If you're one of the unlucky few to get audited, you'll probably be dealing with the implications of the Federal Insurance Contributions Act, the Federal Unemployment Tax Act, income tax withholding, tax penalties, and Workers Compensation.

A departing producer or customer service representative (CSR) can hurt your agency's revenue stream significantly if they take accounts or other employees with them. An employment agreement won't guarantee protection, but legal fees can be enough of a deterrent for an employee to think twice about breaching the contract.

An employment agreement must take into account local labor laws. Don't draft contracts yourself; get the necessary legal advice. In most parts of the country, you can get a two-year or three-year non-piracy restriction to stick, but not everywhere and not under all circumstances.

Unless you're buying the agency or the book of business from the employee, don't use the words 'noncompete' or 'noncompetition' anywhere in the employment agreement, including paragraph headings. Instead, refer specifically to everything the employee is restricted from taking, such as accounts, prospects, trade secrets, templates, computer programs and other employees. Define each term carefully. In most jurisdictions, judges determine that former employees should be allowed to continue working in the same industry after leaving an employer.

Don't mention geographic boundaries in the contract, since nonpiracy (or nonsolicitation) applies to specific customers. The contract could be nullified if restricted accounts are located outside stated boundaries.

Include provisions for injunctive relief in the event of a breach, and specify a specific dollar amount or a well-defined formula for liquidated damages. If the agreement allows the producer to receive deferred compensation related to the book of business, tie non-piracy to that clause. Consider an option for the producer to buy all or part of the book instead of receiving the deferred compensation.

Classifying employees as exempt from overtime pay has become an interesting challenge. An employee doesn't have an exempt status just because you pay them on a salaried basis instead of on an hourly basis.

Thirty years ago, most nonproducer employees were secretaries. They commonly handled only clerical tasks and were paid on an hourly basis. Today, the lines of responsibility have blurred. Administrative staff require more training and education. Some administrative staff members are licensed to make policy changes. With the advent of total agency automation, producers type their own letters.

Producers and department managers work as many hours as necessary to get the job done, which generally puts them in the exempt category. But what about the licensed CSR with an assigned book of business? They often work late too. Are they exempt, or does the agency have to pay them overtime?

The Fair Labor Standards Act of 1938 requires time and a half pay for any time above 40 hours a week that nonexempt employees work. Penalties for an employer's noncompliance can reach $10,000. Also, employees can sue for double the unpaid overtime wages over the entire period of their job tenure.

In general, exempt employees must supervise two or more employees. They must also spend half of their time or more performing work that requires teaching or specialized study, and less than 20% of their time on routine tasks. Most Personal lines service reps and Commercial assistants are probably nonexempt.

Senior level Commercial personnel are probably exempt unless the agency watches their hours and docks them for coming in late. In that case, a precedent has probably been set for nonexempt status. Some states insist that the employee's salary be more than $20,000 a year to be considered exempt. It's advisable to treat CSRs as nonexempt and keep accurate records of their hours. In addition to checking federal employment laws, be sure to check the laws in your state

At one time or another during the year, more than half of the country's insurance agencies use premiums to help fund agency operations. In some states it's illegal for agents to be out of trust. In others it's grounds for losing a license.

If your state doesn't have separate trust requirements, you may assume you're in the clear until an insurance company asks to see your balance sheets. Many companies will pull a contract or refuse to plant with an agency that's not taking its fiduciary responsibilities seriously. Many company contracts now require the agency to maintain a separate trust account.

A number of agency owners don't see a problem in operating with a ratio below 100% as long as they can make their payments every month, even if they have to tap into their line of credit a couple of times a year. It's possible to keep all the balls in the air for several years, but they'll come crashing down with the loss of a single major account, or a shift to installments or direct billing on a significant portion of your agency's premiums. If that happens, your agency could be taken over by an insurance company or sold to a competitor for as little as 50 cents on the dollar.

Some states have complex formulas to uncover trust problems, but there's a much simpler way to get a handle on the situation. At the end of each month, add available cash and liquid investments to accounts receivable (less an adjustment for accounts that are doubtful) and compare the total to the accounts payable due to insurance companies, including pre-bill and suspense items. The result should be at least 110% and preferably 120%.

Automation has increased the number of clients that an agency CSR can handle and improved the quality of service. Receiving and sending e-mail to carriers and insureds is revolutionizing policy processing. But there's a downside. Attorneys can subpoena your entire e-mail system. Computer specialists can even retrieve deleted messages.

By imposing strict e-mail guidelines and other procedures, you'll make your agency better organized, more profitable, and in a better position to defend lawsuits. Remember that most E&O claims are the result of poor agency management.

Your agency should have very specific e-mail guidelines explaining what kinds of comments are off limits. Employees need to know that management will review e-mail transmissions and will enforce the rules. Make sure that your employees know that the procedures protect them as well as the agency.