By: Catherine Oak
Designing a good and motivating producer compensation does not need to be a mystery. The bottom line is – pay what can you afford to pay, for what you are providing the producers and be in line with the important competition.
Total compensation for any agency is always the largest expense category. For the typical agency, total compensation (producer and employee compensation—plus benefits and taxes) ranges from 50-75% of total revenue. If the compensation is too high, the agency will lose money. If the compensation is too low, then the agency could lose the producers and employees, and service may suffer.
How to Calculate
The way to calculate what you can afford to pay is to take total gross agency commission and fee revenue. Then subtract all necessary on-going expenses except producer compensation and any owner compensation or bonuses. It is not recommended to include contingents, since these should be considered bonus income.
The next step is to take out an expected fair rate of return on the business for the owners. This typically ranges between 10-20% of revenue. This “expense” is the cushion for affordability of producers. If the agency really needs a producer, then the owners might need to dip into their profits to make it happen—at least until they validate.
Today, an average firm that properly manages expenses can typically afford to pay commercial lines producers 25-35% commission for renewal business. This assumes that the owners want to realize a 10% to 20% pre-tax profit. Keep in mind that if the owner is a producer, their producer compensation is the same 25% to 35% commission and is in addition to the profits of the firm. Owners should also receive management compensation, if they are performing that role.
The range of 25-35% varies based on whether (and how much) the employer pays for certain expenses, resulting from the producer’s employment and activities. These expenses include employee benefits such as health and related insurances, payroll taxes and retirement plans.
Producer Expense Caps
The producer expenses often include business development expenses such as travel and entertainment, auto and club dues, and cell phones. The best way to properly manage and reward producer business development expenses is to give them about 3-4% of their book of business for these expenses (which are actually perquisites for the producer). This percentage actually becomes an expense cap for the year, with monthly expense reports still being submitted.
Pay More for New to Grow
New business can be paid at a higher rate, since the calculations assume expenses are mostly paid out of renewal income. Of course, there are expenses associated with writing new business related to marketing and staff time putting the new account together.
Particularly in agencies that want to grow, a higher percentage is often paid to encourage producers to write new business such as 40% to 50%. This would assume that the owners are giving up some of their profit the first year!
Some real aggressive agencies are paying an additional incentive to those producers that exceed their new business growth goals. Some firms today will expect experienced producers to write between $50,000 to $100,000 in new commission per year. This depends on the size of their current book, where the agency is located, etc. If the producer exceeds whatever his or her goal is, the agency may provide an additional bonus of maybe 5% commission. This becomes retroactive on all of the new business written for the year!
Who is Doing the Work?
Another key compensation concept is to, “Pay based on who is doing the job!” Agencies do differ on whose job things should be. For example, who should do policy checking? In some agencies, who does this role would be that of the producer, in others the role is that of the CSR and in others the marketing department, if one exists.
Today many firms are delegating their “small” accounts to CSRs to sell and service. Thus, many firms pay producers less commission or even zero for “small” commercial accounts. Small is usually defined as those accounts that are Business Owner Package policies or small monoline accounts.
However, the definition of “small” also depends on the firm’s book of business and are usually defined as those accounts generating $500 to $2,500 in commission or less. Where the agency is located and what is available to write in the area, can often determine what is the dollar amount cut-off.
What about Personal Lines?
The trend today is to not pay commercial lines producers who also refer personal lines accounts to the PL department, because the CSRs are typically doing all the work. A first year commission for CL producers for at VIP personal lines package policies may be warranted to encourage them to generate the leads on these much larger PL accounts.
The method of paying producers should not make a difference in determining what is a fair amount for compensation. Salaries or draws against commission should be considered only as a convenience for producers, since the timing of renewals can produce some lean months. They should be set based on the firm’s renewal commission and use a book that is somewhat smaller, because of possible attrition. Once the draw or salary is met, new commissions should be paid to the producer at least quarterly, to keep them motivated to write new business.
Grandfathering the existing compensation plan for a period of time (or indefinitely) for accounts already on the books, is one way to introduce a new compensation plan and to avoid an immediate impact on producer incomes.
Compensation for owners and producers is never an easy issue to address. There is no single solution. Each agency needs to blend the right ingredients for an effective compensation plan to attract and retain good producers. Being creative and trying new things (which may include some of the ideas in this article) may be the healthy change the agency needs to be competitive and become more profitable.