Consideration for Termination
Basic Compensation Model Changes
Most agencies pay their producers just like previous generations have paid, a high front-end for the generation of new accounts and a lower, but stable back-end commission for the maintenance of and renewal of the accounts. We already know that paying on-going commission on Personal Lines is one of the common aspects of agencies who do NOT earn profits from personal lines. Agencies that pay no commission on personal lines (or first year finders’ fees only to commissioned producers on personal lines) consistently earn strong profits on this line of business.
A few decades ago, we introduced the concept of Base and Growth compensation to replace New and Renewal compensation on Commercial Lines because we noticed that most producers have a natural tendency to concentrate on the more exciting, higher compensation targets of New Business and, if it meant the loss of some existing accounts, they didn’t suffer as much since they would be generating higher NB commissions as the outcome. We also found that renewals that generally automatically renewed in prior agency generations is now taking as much agency time and effort as NB with less return. Finally, in the never-ending soft market that we had a decade or more ago, agencies were actually shrinking in size as both account losses and lowered rates affected revenues while producers were still growing their income through the generation of higher commissioned NB.
If we grandfathered all existing accounts at their standard commission rates and installed a Base and Growth commission structure for all new business from a specified point, the producers would not be negatively affected by any change in compensation for existing business but would have to make up the revenues lost through account termination or rate affect BEFORE breaking into the “growth” commissions (which was equivalent to the NB commission earned previously).
For instance, the standard CL commission structure for basic producers was 40% NB and 25% renewals. From a specified point in time, we converted all new production to 25% Base (the revenue generated by that book of business in the prior year) and 40% for Growth of the book of business beyond that of the prior year. The producers were easy to convince since, in the first year, all business written was new to their new producer code and was, therefore, rewarded at 40%. Their prior book of business was grandfathered at their prior renewal commission rate, so it wasn’t affected by the change. After the first year of the new Base/Growth compensation schedule, the book of business that they generated (at 40%) in the prior year became their base, payable at 25%, while growth beyond the base was rewarded at 40%, regardless of whether the account was new or renewal.
If business was lost or if the market was soft and rates, premiums and commissions were reduced to below the level of the base, the producer had to produce additional business (within the 25% base rate) until the prior year book of business level was achieved before breaking into the Growth commission level. In a hard market, the producer may break into the Growth commission level simply by renewing all of the accounts at much higher premiums and commissions.
Example – Prior Book of Business = 250,000 continue to be payable @ 25% renewal commission (as previously in the 40% NB, 25% Ren model).
1st Year of new producer code = 65,000 payable at 40% (since all revenue in that code is considered “growth”
2nd Year renewals (including lost business and rate affect) = 60,000, NB = 70,000. Producer is paid 25% on the total pre-existing book of business (whatever it may yield) + 25% on the first 65,000 generated in the new producer code and 40% thereafter.
In the long term this process will require the producer to make up any lost business at the Base commission rate before breaking into the greater “growth” commission each year.
Tiered Compensation for Larger Producers
There is not doubt that producers with bigger books of business are more valuable to the agency. It is difficult to motivate producers once they reach a level of compensation that achieves a comfort level. So we installed a trigger to the compensation model that would assure continued motivation for producers who were basically money-motivated.
Within the new compensation model we found that economies of scale permits the agency to compensate producers differently as they grow beyond levels of production that make sense to the agency’s bottom line. So we added a TIERING feature to the Base/Growth Compensation Model that rewards producers 5% higher commission (from the first dollar of production) for achieving targeted sizes in their commission books of business. In other words, if a producer reached the first Tier Break-Point, (s)he would receive 30% Base and 45% Growth for the entire book of business. You can imagine how motivated the producer becomes as (s)he nears the Tier Break-Point since the compensation change affects every dollar of commission generated, not just commissions beyond the target level.
We then constructed several tiers that would assure continued agency profit even at higher commission levels because of the economies of scale presented by the larger producers for every agency.
We create the Base and Growth commission levels and the Break-Points for Tiering individually for every agency because the compensation program must respond to each agency’s type and book of business and its expense ratios. While one agency may find a Tiering Break-Point at $250,000, another agency may not achieve the first Tier until $300,000, $400,000 or more. If you are constructing a tiered program for yourself, the key determination is at what point the producer’s revenue requires more primary agency expense (more people) and what percentage of the growth income will be eaten up by the additional expensing. Knowing that, you are equipped to determine at what point to institute the first and additional tiers of compensation while still rewarding the agency in both top-line (revenue growth) and bottom-line (profit) income.
Protecting the Agency
Agencies must have contracts with every producer, whether an employee (W-2) or a contractor (1099), whether paying the producer on salary, draw or straight commission. The principal is that if the producer is primarily generating insurance accounts on behalf of your agency, they should set goals for their activity to support the administration of their business and devote dollars to agency profits.
If you don’t contract your producers a number of risks arise. Your agency value decreases because you have no agreement by the producer that the accounts produced belong to the agency. No one will buy an agency if each producer has an implicit or explicit ownership of their books of business. Sure, there is a flow of revenue to the agency, but it’s like selling a ranch full of free-range cattle that can go wherever they want whenever they want. We’re not suggesting that insurance clients don’t always have the right to determine who their agent will be. But if the client is relatively satisfied with the service and products provided and if the producer is the primary (or only) contact the client has with the agency, the agency must have some protection against loss of the accounts if the producer leaves and solicits the accounts away from the agency.
A contract with both Non-Compete and Non-Piracy clauses provides an agreement between the agency and the producer that the business generated by the producer on behalf of the agency during the producer’s employment is owned by the agency. The producer achieves a compensation for the production and maintenance of the accounts written on behalf of the agency but this does not give the producer the right or ability to strip the agency of those accounts should the producer decide to leave for any reason.
A Non-Compete Clause is specifically for accounts written by the producer and/or assigned to that producer by the agency. These are accounts either written by or controlled by the producer during the producer’s tenure with the agency.
A Non-Piracy Clause is generically for all other accounts of the agency about which the producer might have access to confidential information that would give the producer an unfair advantage if the producer left and solicited those accounts on behalf of another agency.
Vesting in Shadow Stock Strengthens Contracts
Regardless of the terms of any producer agreement, there always exist questions in the mind of a judge or jury regarding the desire of an agency to restrict a departed producer from contacting the clients that (s)he handled, controlled, wrote or to which (s)he had access (beyond what is available in the public domain).
If you have an explicit agreement with your producers that the accounts that they generate, control or manage on behalf of the agency belong to the agency, one way of further strengthening that ownership is by the agency providing “consideration” to the producer upon the producer’s departure in sponsorship of the agreement that all accounts belong to the agency. Consideration is defined as monetary payments. In other words, the producer agrees to take an amount of money from the agency (at once or over time) in sponsorship of the non-compete and non-piracy clauses of the agreement.
We act as Expert Witness on many agency disputes in federal and state courts and have found that a device known as “Shadow Stock” is a better way to provide supporting consideration than any value or vesting in the producer’s generated or controlled book of business. WHY?
If a court notes that you have segregated the “producer’s book of business” as different or unique from the agency’s total book of business and have assigned a value to it, many courts have used that fact to assume that the book of business has a life and ownership different from the agency’s other book of business.
The same protection can be accomplished by identifying a combination of size of book of business being managed and producer longevity with the agency to construct a device to reward the producer with an equivalence to the value of some shares of stock in the agency. Since it is an equivalence, not actual stock, the producer does not achieve voting rights or ownership (unless you choose to permit the producer to exchange the Shadow Stock for real stock as a way of rewarding and tying the producer to the agency as an owner).
For instance, you may say that once a producer is with you for at least three years, (s)he will earn a specific number of shares of Shadow Stock in the agency for every $100,000 of revenue generated or managed by the producer. The shadow stock is a “pocket agreement” that he is due the equivalent of the value of that number of shares of stock and would be vested over the next five years (giving him 20% more of the value of that shadow stock each year over the next five years – and further tying him to you for an extended period of time). Of course, the producer’s death, disability or full retirement from the business of insurance would immediately vest any unvested portion of a vesting program. Every time the producer achieves the target revenue, a new shadow stock letter is issued.
The primary purpose of the Shadow Stock is to provide a further retirement reward for producers to stay with the agency and continue to grow their book of business. However, the main benefit is to pay producers who leave the agency – shadow stock can be paid off over an extended period (i.e. 60 months) – and need an incentive NOT to compete against the agency’s accounts. Most courts view compensation in support of Non-Compete and Non-Piracy clauses a strong additional argument for the ownership of accounts by the agency. And, certainly, the agency can and should stop payments for shadow stock at the instance that a departed producer attempts to solicit agency business with a sponsored non-compete/non-piracy agreement in place.