Producer compensation: What should you pay?

Compensation for an agency is always the largest expense category. For the typical agency, total compensation (producer and employee compensation plus benefits and taxes) ranges from 50 percent to 75 percent of total revenue. If the compensation is too high, the agency will lose money. If the compensation is too low, then the agency will lose the producers and employees, and service may suffer.

Designing a producer compensation does not need to be a mystery. The bottom line is-pay only what can you afford to pay, but no more. Pay also needs to be high enough to get someone interested in doing the job. It is that simple.

Do the math

The way to calculate what you can afford to pay is to take commission and fee revenue and 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 percent and 20 percent 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 percent to 35 percent commission for renewal business. This assumes that the owners want to realize a 10 percent to 20 percent pre-tax profit. Keep in mind that if the owner is a producer, their producer compensation is the same 25 percent to 35 percent commission and is addition to the profits of the firm.

The range of 25 percent to 35 percent 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 insurance, payroll taxes and retirement plans.

The producer expenses often include some business development expenses, such as travel and entertainment, auto or club dues and cell phones. We typically recommend that producers receive about 2 percent to 5 percent of their book of business for the business development expenses, which are really perquisites for the producer. This percentage actually becomes an expense cap for the year, with monthly expense reports still being submitted.

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 new business. A higher percentage is often paid to encourage producers to write new business, such as 40 percent.

Who’s doing what?

Pay also needs to be based on who is doing the job, the producer or CS?R? Firms are beginning to delegate their “small” accounts to CSRs to sell and service. Because of this trend, 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 makeup and can be defined as those accounts generating $500 to $2,000 in commission or less. Where the agency is located often determines what the dollar amount cut-off is.

The trend in compensation arrangements for commercial lines producers who also sell personal lines accounts is similar to that for small commercial accounts. Pay commercial producers (not personal lines producers) little or no commission on personal lines business, because the CSRs are typically doing all the work.

Compensation for producers for at least the VIP personal lines package policies may be warranted to encourage commercial producers to refer the leads on these good-sized accounts to the Personal Lines Department CSRs. These packages usually generate adequate commissions to have room to pay commissions to producers the first year the account is written.

Salary or commission

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. If salaries are paid (versus paying commissions to producers as accounts are written), then the salaries need to be based on the renewal commission paid for the existing book handled during the previous year. This calculation should take into account attrition of probably 5 percent to 15 percent.

Throughout the year (e.g., monthly or quarterly), salaried producers should be bonused for new business. Often, owners also follow this strategy for setting a salary, especially the more astute firms today. Owners should also be paid for their management duties.

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, to avoid an immediate impact on producer incomes. The new plan can apply to new accounts written as of a certain date.

Compensation for owners and producers is never an easy issue to address. The interesting point is that there is no single solution. Each agency needs to blend the right ingredients for an effective compensation plan to attract and retain good producers.

Topics Talent