What makes a good and motivating producer compensation model does not need to be rocket science. The key is to pay what the agency can afford to pay and for what the firm is providing the producers. Lastly, the plan needs to 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% to 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.
What Can the Agency Pay?
The way to calculate what you can afford to pay producers is to take total gross agency commission and fee revenue. Then, subtract all necessary ongoing 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% to 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% to 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% to 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.
How to Pay Expenses
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 done by high-performing firms today is to give them about 2% to 4% of their book of business for these expenses. These expenses are perquisites for the producer. This percentage becomes an expense cap for the year, with monthly expense reports still being submitted up to the cap.
Pay More for New Business
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. These are often higher due to the time of staff involved.
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.
Particularly in agencies that want to grow, a higher percentage is often paid to encourage commercial lines and employee benefits producers to write new business, such as 40% up to 50%. The latter is usually if the agency pays 25% on renewal.
This would assume that the owners are giving up some of their profit in the first year, as what is available is closer to 30%.
Some 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 $75,000 to $150,000 in new commission per year. This depends on the size of their current book, where the agency is located, etc. If the producer exceeds their goal, the agency may provide an additional bonus of up to 5% commission. This can even become 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 certain job tasks performed by various employees. For example, who should do policy checking? In some agencies, this function is performed by the producer, but in others, this function is that of the account manager/CSR. Still, in others, it is the marketing department if one exists.
Today, many firms are delegating their small accounts to AMs/CSRs to sell and service. Thus, many firms pay producers less commission or even zero for small commercial accounts. Or, there can be a high first year commission, such as 40% to 50%, and nothing on renewal if the account goes to a “Select” or “Small Accounts” person or department.
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 is usually defined as those accounts generating $1,000 to $2,500 in commission or less in most independent agencies.
Where the agency is located and what is available to write in the area can often determine what is the dollar amount cut-off. Larger agencies and national firms often do not pay producers for commercial lines or group benefits accounts under $5,000 in commission.
How is Personal Lines Compensated?
The trend today is to not pay commercial lines producers who also refer personal lines accounts to the personal lines department because the account managers/CSRs are typically doing all of the work. A first-year commission for commercial lines producers for a VIP personal lines package policy may be warranted to encourage them to generate the leads on these much larger personal lines accounts and often do an introduction. Then, the account is handed off to the service staff in the future.
The method of paying producers should not make a difference in determining what is a fair amount for compensation. Paying the producers their earned commissions each month is typical. 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 a renewal commission rate because of probable attrition.
For example, a producer that handles a $300,000 commission book of business could receive a fixed monthly draw of $5,000. This is based on $300,000 times 25% commission times 80% retention divided by 12 months. The producer’s compensation would periodically get “trued-up” the following month based on actual renewals and new business generated during the previous month. This allows the producer to have a budget for their income, while keeping them motivated to write new business. Salespeople need these carrots to keep motivated and to feel rewarded.
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. This is also true when an agency is acquired. It is best to keep the existing plan in place and introduce the new plan on new business.
Compensation for owners and producers is not a simple, straightforward measure. There is no single solution. Business goals, owner philosophy and the drivers that motivate individual producers will vary. 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 today.
Oak is the founder of the consulting firm, Oak & Associates, based in Northern California and Central Oregon. Schoeffler is an associate of the firm. Oak & Associates specializes in financial and management consulting for independent insurance agencies, including valuations, mergers acquisitions, sales and marketing planning as well as perpetuation planning. Phone: 707-935-6565. Email: firstname.lastname@example.org.