Producer Compensation - 2001
Historically, producer compensation was simple. The producer got 50% of the agency commission and the agency retained the other 50% on any transaction. Unfortunately, the longest soft market in our history made that simple formula impossible to continue if the agency wanted to remain profitable. As the market worsened in the late 1980’s, the carriers began reducing commissions and that tendency continues today. The soft market also carried a ten-plus year run of lower premiums, thereby doubling the effect on agency revenue of the commission reductions. A $30,000 premium carrying a 20% commission became a $10,000 premium over a 10-year period carrying a 12%-15% commission. This translates into a $6,000 commission reducing to a $1,200-$1,500 commission for the same account. Not only did the producer lose money (even at 50% of the commission), but also the agency had to provide the same or greater levels of service that it did for $3,000 10 years previously for $600-$750 by the end of the soft market. This is truly a Lose/Lose situation.
The producers found themselves remarketing accounts every year to save them from competitors who were undercutting prices each year. The agency also had to provide greater service for an ever-decreasing commission return. An unsatisfactory condition was developing in which producer and agency alike found that they were working harder for less money each year. The producers were, of course, concerned with their own earnings capacity, so they became disgruntled and dissatisfied with the seemingly poor treatment by their employers. Simultaneously, agents saw their revenues eroding as producers spent all of their time trying to save renewals at lower premiums. While retained accounts paid less to agencies, their overhead costs continued to grow at an average 4% per year. Obviously, profits eroded and agencies that tried to continue to sell, service, and process the same way as they did in 1985 are either merged with other agencies, or are at their wits end trying to meet payroll and expense needs every month. The days of large surpluses and double digit profits seemed to disappear.
The successful agencies changed almost all phases of operations and sales. Since compensation is always an agency’s largest expense, operations had to remain comprehensive to retain customers, but it also had to automate to permit a smaller number of employees to manage a larger book of business. Automation, itself, has been expensive but its returns (in revenue per employee) have been an increase in productivity by 50%. The employees’ responsibilities have expanded to permit management of a larger number of clients by each service employee. The employees have had to become technologically educated to manage clients with decreasing paper files (customer files to drop files to transaction files).
Automation, however, was only part (the easy part) of the operational solution. The major change, now being implemented throughout the United States, was the mind-set change of the owners. For generations, producers were put on the street and told to “Sell Insurance”. Besides doing their own prospecting, they also marketed the accounts to the underwriters, put together their proposals, and, in many cases, were responsible for all after-the-sale service to the clients. Lower margins to the agencies and lower earnings to the producers are forcing a change that is long overdue.
Agency owners now recognize that the skill that they hire in a producer is the knowledge of risk selection and evaluation, and the ability to establish and maintain relationships with prospects and customers that convince them to place their insurance through the agency. If they isolate the producers into that role, they will make the producers more valuable to themselves and to the agency.
As a result, Marketing Departments have been established to oversee outbound marketing plans to interest prospects in meeting with producers, to oversee inbound marketing that takes prospects to the underwriters, and establishes the proposals and pricing that will give the producers the best chance of successful sale. The producers are being trained away from price-driven issues alone and toward identifying and fulfilling customer needs and expectations. The best producers in the country have long established that price is the absolute wrong way to sell to customers with whom you expect to establish a long-standing relationship.
The marketing functions being assumed by the agency come with a price tag that lowers the amount an agency can spend on producer compensation. The lower margins combined with higher costs also diminish the percentage of revenue available for acquisition costs. However, the compensation needs of producers also continue to rise.
The answer is driven by sheer economics. If a producer must prospect, solicit, market, propose, sell, and service, he may sell one or two accounts each MONTH. If, on the other hand, the agency provides qualified leads on the front end and marketing support that returns finished proposals to the producer on the back end, the number of sales can easily change to one to two sales per WEEK. Even if the average sale is only $10,000 premium and $1,500 commission, the difference between producer-generated business and agency-generated business, in which the producer is the sales arm, is the difference between $3,000 of new gross commissions per month and $12,000 of gross commissions per month. In the producer-generated agency (the one in which the producer does everything for 50% of the commission), the producer earns $1,500 of new business commission on two sales per month. In the advanced agencies, producers are paid differently at lower rates, but will earn $4,800 of growth commissions each month.
Using an example like this, it becomes obvious that it isn’t the percentage paid to producers that makes a difference to the individuals and to the agency’s profit – it is the amount of money that can be earned by both the producer and the agency.
Base And Growth Commission
One of the hard lessons learned by agencies during the soft market who paid a high level of commission for new business and a lower level to maintain renewals was that many customers would be sold based on achieving a lower price than the incumbent agency. A higher commission would be paid to the producer in the first year, while the agency also had to expend higher expenses to market, underwrite, and issue the new business. An ever-increasing number of these new business accounts did not renew after their first year
because the old incumbent (or another agent) offered to undercut the new agent, thereby taking the business away again. Agencies recognized that paying a high first year commission made the account unprofitable until at least the second (and often the third) renewal. Accounts lost in this way after their first year gave the agency the opportunity to both lose money and pay higher commissions to their producers for putting one-year accounts on the books.
Obviously, this was a losing proposition. So agencies began paying producers a level commission based on BASE commission (that level of agency commission developed by the producer’s book of business in the prior year) and a bonus commission on GROWTH commissions (every commission dollar generated by the producer in the current year above that written in the prior year). The most common Base and Growth commissions are 25% on Base and 40% on Growth.
Imagine a producer who has a $200,000 book of business at the end of the year. He will receive 25% of every commission dollar generated by his book of business (new or renewal) up to $200,000 in the following year and 40% of every commission dollar generated in excess of $200,000. At the end of that year, the Base becomes his year-end gross commission book of business and the cycle continues.
This process works best in agencies in which the agency, not the producer, markets to attract prospects to the agency, and services the account using agency personnel, not producers, after the sale. The producer simply concentrates on replacing any lost accounts (and decreases in commission in a soft market) to attain his bonus commissions, and, if the service levels are high, the book of business will grow every year (especially in a hard market when price levels take care of any retention losses).
In addition to Base and Growth commission compensation, agencies have found that a producer generating $400,000 of annual commissions was certainly profiting the agency more than a producer earning $200,000 or $100,000 of commissions. Agencies who are financially grounded aim at a fair and established profit each year. They understand that greed usually loses employees, so they determined that at various sizes of books of ``business, an increase in both the Base and Growth commissions ceded to the producer are warranted. The number of tiers and the commission percentage difference between the tiers are simply determined by budgetary and profit needs. It is not unusual to see three tiers, 5% apart to reward the most productive salespeople for their roles.
Success tiers can be used as golden handcuffs with producers who are successful in an agency. At the higher tier levels, a producer would find it difficult to leave the agency to go off on his own or to join another firm. This is especially true when Employment Agreements with tight non-competes are in use. However, it is acknowledged that even in agencies with no agreements, if an agency actively pursues a departed producer’s book of business with replacement Account Managers, the agency will retain over 50% of the book of business (often over 80%). Every producer believes that their clients will follow them from one agency to the next, but this is rarely the case.
We have never espoused offering equity positions in a producer’s book of business as a reward for success (or as a means for tightening a non-compete agreement). If an agency encounters a truly successful producer who adds value to the agency through his/her steady and increasing production, however, it is quite advantageous to bring that producer into an agency ownership position (albeit a minority interest) as a way of cementing the relationship between agency and producer and providing an additional source of funding for the producer’s retirement. It also provides a logical succession and perpetuation plan using the producers who add the most value to the agency as its next generation. Stock options and beneficial stock prices based on achievement of milestone commission positions is the best way of handling this issue.
Giving agency equity instead of equity in the producer’s book of business is a tacit acceptance by the producer that his book of business is an integral part of the agency-owned business (avoiding ownership issues in the future). It also makes the producer very interested in the success of the entire agency, not just in the growth of his own book of business, since his interest rises and falls with the stock price of the agency.
Just as NASA would be foolish to take a highly trained astronaut and charge him with building the rocket and maintaining it as well as operating the controls, changing the way an agency operates to isolate producers into their most productive roles also makes sense. Paying affordable commissions in such a way that acquisition costs are only paid for once as a book of business grows is also a common sense approach to making an agency profitable. Using tiers and equity to motivate and hold your most productive salespeople is the final ingredient in Producer Compensation in the 21st Century.