AGENCY FINANCIAL MANAGEMENT
By Paul J. Di Stefano, CPA, CPCU, Thomas Pepe and William E. Ryan, CPA
To assess the effectiveness of an agency's producer compensation program, an annual producer profitability model should be generated.
Insurance agencies are by definition sales and marketing organizations, and it goes without saying that producers are typically the backbone of the organization. It is not surprising that managing producer productivity can be paramount to the level of financial success that an agency experiences over time.
Producer compensation is obviously a key component of producer productivity. Although there have been many articles written on this subject, the topic of producer compensation remains a constant source of conversation among agency owners. In a perfect world, ignoring competition and prior commitments, commercial producers' compensation should effectively average 25% on new and renewal business. In many cases that average may seem low; however, it takes into consideration that the producer is not actively servicing certain elements of his book of business such as monoline workers compensation, which may have been left with the agency after the loss of other related lines. If a producer is being paid 25%, the agency has room to offer producers an additional 5% to 10% of commissions on new business to encourage production in certain areas.
Harbor Capital's clients have routinely adopted the strategy of growing their agencies by focusing on new programs. In order to assure the success of these programs, these clients have implemented special producer compensation plans that call for commissions of an additional 5% to 10% on new business. The rationale for the additional commissions on new business is to encourage producers to promote newly targeted niches or programs generated by the agency with certain carriers where attractive profit-sharing agreements can be taken advantage of.
Another example of a very effective use of a higher commission strategy is the allocation of additional new business commissions to a bonus pool for a marketing manager who contributes a great deal to the closing of the sale. The remaining 5% can be used for the investment in automation and marketing which should aid producers in reaching their production goals.
Realizing that we do not live in a perfect world and in order to maintain reasonable operating margins, the agency should avoid producer compensation deals on commercial business that exceeds 30% on new or renewal business. Agency principals must also keep in mind the ancillary costs of supporting the producer--CSR support, marketing, telemarketing and T&E expenses--accumulate and are part of the support component of compensation.
While commercial lines producer compensation is a critical issue, personal lines and group producer commissions also should be addressed. A reasonable commission rate for personal lines producers is a one-time 30% to 50% commission payment when received from the insurance carrier. Renewal commissions on personal lines generally are inappropriate because the producer usually is not involved in servicing these accounts and agencies cannot afford to pay two sets of servicing costs.
Group business does not have similarities to P&C business with regard to cost to service. It is more expensive due to continuous remarketing. We recommend that group commission splits not exceed 25%. The agency's group health producers should agree on an up-front split commission with proper notification to the accounting department.
Agency principals must keep in mind that while the above guidelines are generally valid, individual agencies should always perform the appropriate operational and financial analysis prior to attempting to implement any changes. To assess the effectiveness of an agency's producer compensation program, an annual producer profitability model should be generated. This model is in effect a profit or loss statement on producer activities or, if you will, a report card. It should be shared with the producer and become a part of his or her prospective plan. Harbor Capital routinely assists in developing this model which over time has proved its ability to improve agency profitability.
In addition to compensation, the following are other management tools that should be considered as part of an overall producer productivity management strategy:
* Producers should construct a formal annual production plan showing the where and how of new business generation including anticipated retention rates.
* Periodic meetings with individual producers to assess periodic progress on attaining new business and retention goals.
* Weekly meetings with production personnel to discuss sales problems, market opportunities, and overall agency issues.
* Detailed periodic revenue reports prepared by the accounting department analyzing renewal revenue, price changes and new business by producer.
* Producer accountability for past-due accounts receivables.
In summary, producer productivity is directly related to the future growth and profitability of an agency. In general, however, producer compensation, including benefits, payroll taxes, travel and entertainment expenses, should be in the range of 35% to 40% of the producer's book of business. While we realize that some agencies pay up to 50% on new and renewal business, it is difficult to come up with a rational financial scenario which could justify such levels of producer compensation. Harbor Capital has consulted on numerous assignments to improve producer accountability and corresponding agency profitability. We have found that when producers are educated in the costs to support their activities, they understand the rationale for the aforementioned compensation percentages.
However, in setting up producer compensation control guidelines, agency principals should think twice before delegating this responsibility to a sales manager or other trusted employee. A consulting organization--such as Harbor Capital--can provide independent advice and implementation of agency compensation guidelines. Harbor Capital Advisors, Inc., can be reached in New York at (800) 858-2732. *
The authors
Paul J. Di Stefano, CPA, CPCU, is the managing director of Harbor Capital Advisors, Inc., a national financial and management consulting firm which offers services to the insurance industry. Services include agency appraisals, merger & acquisition representation, strategic and management consulting.
Thomas Pepe is an associate director for Harbor Capital and was previously president of A.J. Gallagher of New Jersey. Tom was a partner at the time of the sale of his agency to A.J. Gallagher and spent six years with A.J. Gallagher.
William E. Ryan, CPA, is an associate director for Harbor Capital and was previously head of finance for an insurance agency consolidator. Bill has 20 years of experience in valuing agencies and managing agency acquisitions.