Al Diamond’s Incentive Compensation Programs (ICP) are blossoming and creating more productive employees who understand that growth and profit, not simple hard work, define the value of employee performance in an agency.
Incentive-based compensation differs from performance-based compensation because it measures results. Performance-based programs count on agency managers or principals to judge each employee’s performance based on job descriptions or responsibilities. Raises are subjective and often inequitable. Principals and managers find it difficult to differentiate employees by their contribution and value to the agency. Too often, regardless of the strengths and weaknesses of individual performers, pay raises are so similar that no real difference appears between excellent performers and mediocre performers.
ICP addresses this issue directly because: (1) only productivity and profitability gains define pay raises; and (2) employees measure their own success every month until it’s time for a pay change. Evaluations are still conducted, but they’re concentrated on strengthening the employee in the period before the next evaluation. If the employee is good enough for the agency to keep, they will determine their own raise by virtue of performance.
ICP should be implemented gradually. Employees have become so accustomed to subjective pay raises that they become very nervous if you tell them that their pay will depend only on their productivity and profitability to the agency. To make the ICP a smooth transition, you need to teach your employees that their success depends on the success of the agency. You can do this by introducing the program in two or three annual stages.
STAGE ONE: GROWTH
When introducing ICP in an agency, the easiest way to explain the process to employees is to link their raise to growth. The more the agency (or their department) grows, the greater their raise. If the group (agency or department) grows by 8%, their salaries will grow by 8%.
The basic principle is that non-compensation overhead is generally, and relatively, fixed. If your revenue is $1 million, personnel costs are $500,000, and all other expenses are $400,000, you’re earning a 10% profit. If you grow the agency naturally (through sales and retention rather than acquisition) by 8%, it probably won’t cost you 10% more in non-compensation overhead to manage the agency. And, in most agencies, you won’t even have to add employees. That extra $80,000 income in the following year is available to cover some minor increases in costs, pay staff, and contribute to profits. If you pay a raise based on the percentage of growth (8%), your compensation costs will increase from $500,000 to $540,000 (your personnel costs are frozen at 50% of revenue) and you have $40,000 to pay extra expenses or additional profits.
Granted, this growth can come at an additional expense sufficient to cause the agency to lose money. If the agency’s growth from $1 million to $1,080,000 (8%) requires the addition of two $50,000 employees, the $80,000 growth has resulted in a net $20,000 loss to the agency (in this year only). However, budgetary realities ameliorate this risk to some degree. Most agencies can support relatively substantial growth without adding similarly substantial expenses. And since every ICP is customized to the individual agency, if you know that expenses must rise when growth occurs, you don’t give raises on first-dollar growth, but on growth beyond expected expense add-ons. This means that if you know that your agency will need more people or higher overhead, or personnel costs will be too high to support appropriate profitability, you’ll pay for growth above a specific percentage of current income (sufficient to pay the additional overhead, for any additional staff needed or to lower the percentage of compensation to revenue) instead of from first-dollar growth.
This system also permits you to gear down total compensation increases if you’re overpaying relative to the industry (or to your profit target). In the example above, if you eventually need to come down to allocating 45% of revenue to compensation, in each year of the ICP the growth will reflect a 1% or 2% decrease in compensation increases. This means that people will still get raises for growth, but their compensation increase as a percentage of revenue will fall to desired levels over time.
STAGE TWO: GROWTH AND PROFITABILITY
In the second year of the program, growth still determines the raise percentage, but the department or agency also sets a profit goal. If this goal is met, the full growth percentage raise is given. If not, the raise percentage becomes a pro-rata portion of the growth defined by the ratio of the profit achieved to the goal set. For example, if the profit goal were 10% and 8% is achieved, as well as 8% growth, the employees would earn 80% (the 8% actual profit vs. the 10% target) of the 8% growth — or a 6.4% raise.
STAGE THREE: PRODUCTIVITY GROWTH AND PROFITABILITY
Although group raise targets are appropriate in some agencies, many have employees managing significant books of business or alpha splits. Because individual employees work at different performance levels, you should permit your most productive employees to earn higher compensation. In agencies that assign employees books of business or measurable responsibilities, the third state of the ICP will allow you to differentiate employees by productivity.
In this stage, productivity measures (usually revenue per employee) trigger compensation growth. If an employee handles a $300,000 book of business and can increase it (by cross-selling, higher premiums, or more clients) to $330,000 in the following year without additional staffing requirements, that employee deserves a raise based on the ratio of the department or agency profit increase to the goal set (as in the example above).
This final phase will assure that the most productive employees are paid at the highest levels and that all employees will see growth in their books of business as a vehicle for higher compensation instead of simply greater workloads. It also redefines the desire of employees to use systems and procedure enhancements (such as scanning and agency management systems) to their fullest in order to maximize productivity before staff additions are needed.
CONCLUSION
The ICP forms one of the keys to the growth and success of motivated agencies. If you’d like more information about this program or schedule a consultation to get an ICP started in your agency, please call us at (800) 779-2430.