Pay for Performance

By and | March 18, 2019

Why Agencies Should Rethink Compensation

The single largest expense in an insurance agency is compensation. Salaries, commissions, payroll taxes and benefits usually total between 50 percent to 75 percent of revenue, with most firms having an expense ratio around 65 percent. What do agency owners and managers do to control this expense? The answer too often is not much. It is just accepted as the way business is done.

When the personnel expenses are broken down, on average, the overall expense ratio for owners and producers is around 30 percent to 35 percent of revenue, office staff around 20 percent to 25 percent and payroll taxes and benefits cost around 12 percent to 16 percent of revenue. Of course, agencies are all structured differently, so these numbers are industry averages and not meant to be how any one specific agency should be managed.

Like it or not, compensation is used as a measure of the worth of the employee to the company. It is also used to motivate employees. Yes, it should not be the only way. Employees need to have “meaningful” work and need to be respected by the owners or their superiors. However, an insurance agency is still a business and compensation should be tied to productivity and overall worth of that person to the company.

The standard compensation model does work for most agencies, but is it always the best approach? If an agency wants to stand out from the crowd, then it will need to do something different. Since personnel expense is about two-thirds of all expenses in an agency, then revising this one area can have the most impact on the success of the firm. Compensation needs to be tied to an employee’s contribution to the agency.

Producers

Producer compensation is one area where agencies show variety and customization. Paying producers on commissions is the most common approach, a fixed salary is the method used by a minority, while others use a combination. It is important to understand the strengths and weakness of the various methods and then synthesize a compensation plan that meets the needs and expectations of the agency and the producers.

Some agencies will often pay higher commission for new business to encourage sales, while others pay the same whether the account is new or renewal. Some pay no commissions for small accounts or certain types of business (such as personal lines), while others pay commissions for all accounts and lines. Some agencies have compensation plans that pay more commission or bonuses too, if the producer exceeds their goal, while others might reduce commissions if the goal is not reached.

For agencies that pay producers on commission, the industry average is around 40 percent for new business and 30 percent for renewal. Independent contractors can earn another 10 percent in commission

points since the agency does not pay for payroll taxes and benefits. Producer compensation for writing employee benefits coverages tends to be similar to commercial lines.

The standard compensation model does work for most agencies, but is it always the best approach?

Who Makes the Best Salesperson?

The typical personality type for good sales people is that they see the connection between risk and reward. They like getting paid when they have wins. That is why paying most producers on a commission basis makes sense. However, there are situations when a commission-based compensation plan is not the best approach.

Salaries are often used for new producers. This allows time to build a book of business while still earning a living. Typically, the salary is reduced over time as the producer generates enough in sales to replace the salary with commissions. Small personal lines agencies often have the role of an agent that does both sales and service. Many of these agencies pay the agent a salary and then pay either a commission or fixed dollar amount for new business sales. A creative method some agencies use is to establish a monthly “salary” for the producers based on a percentage of their book of business so the producer gets a steady income. The salary is then trued up periodically (monthly, quarterly or annually) to match current production. This is a nice hybrid approach, providing the producer with a known monthly income while still based on performance (a commission percentage of their book of business). It also gives them regular rewards for new business over their draw. Agency owners and managers need to explore their options for a good producer compensation plan. The personality of the producers and the goals of the agency will determine the best approach.

Service Staff

Customer service reps, account managers, claims and administrative staff are paid on a fixed salary in the majority of agencies. Some firms will add a small commission or flat dollar bonus if the staff member helps generate new business. Some agencies will pay bonuses or offer perks to the office staff if the agency or department hits goals, such as new sales or account retention. This general type of compensation plan works but can limit the agency to fall into the realm of an “average” agency.

What happens too often with people on a fixed salary is they don’t see the connection between their performance and their compensation. This is because there really is no connection other than they can get fired for bad performance. A better approach is to create a system that ties a portion of the employee’s salary to their performance results. Paying commission for new business might seem like it falls in this category, but employees see the occasional commissions as a bonus rather than a part of their regular compensation.

The stereotypical personality that works in customer service prefers a fixed salary to a risky one, such as commission expense. So, it is important to keep this in mind when designing a new compensation plan. A more robust performance-based compensation plan would tie 10 percent to 20 percent of their salary to a set of metrics that are meaningful to the position and to the overall agency results.

The approach is that if the employee does a certain set of tasks, then their overall job will be done properly, and the business will be going in the right direction. This business model requires the designing and tracking of certain Key Performance Indicators (KPIs), which eventually indicate the overall health and direction of the firm. What gets measured gets done.

A benchmark is set for these KPIs with an allocation of the compensation the employee can earn. In many cases, it is best to have a sliding scale and not an “all or nothing” approach. This way, the employee can still earn decent compensation even if they miss the mark in an area or two, like getting only 85 percent of their quotes done on time.

Tracking employee performance will add some complexity to handling the payroll. Depending on the KPI, it might be calculated from the agency management system, an Excel spreadsheet or even can be self-reported. The upside of regularly tracking employee performance is it also tracks the key measurements that drive the business, which helps management make better decisions.

Tom Baker from Catalyst Insurance Systems has created a software system called Symphony where employees enter their KPI results and the system compiles the data and then calculates employee compensation. Once it is set up, management just monitors the overall results.

Compensation needs to become a tool to drive productivity and agency performance.

Owners

Agency owners need to look at their role as having two positions — one as an employee and one as an investor in the business. From this perspective, there should be two compensation plans. First, the owner should pay themselves as a producer and also as a business manager. The producer compensation should be the same as the other producers in the agency. Next, the agency should set aside a management fee that can be split amongst the agency owners that handle the management of the various aspects of the firm. This fee amount can typically range between 3 percent and 7 percent of revenues. It caps at about $250,000, as the the larger agency likely has a good middle management team.

Second, as an owner, there should be a return on investment or a dividend. If the owner sets up their monthly compensation as an employee (i.e. producer and manager), then, assuming the agency is in good shape financially, there should be a profit margin of around 15 percent to 25 percent. This can be paid out to the owners annually or semi-annually. The profits can also be allocated based on criteria such as sales, book of business, management and equity.

This sort of owner compensation plan will pay owners for their contribution to the business. Owners that are Retired In Place (RIP) will see their compensation diminish, while those active in sales and management will be appropriately rewarded.

Oak & Associates has developed a worksheet that helps in the creation of such a compensation plan for the owners, which we sell for a nominal fee. Contact us if you would like to re-design your compensation plan for the owners, producers or staff.

Summary

The old business model treats employees as an expense on the P&L statement. Compensation needs to become a tool to drive productivity and agency performance. It is time to explore new options for compensation and develop a new model that moves the agency in the direction of the vision set by management. This includes creating a compensation system that aligns the employees’ performance and goals along with those of the business.

Performance-based compensation systems will create a new culture for the business. Employees will gain a new sense of control and empowerment, as they can directly see how their work impacts the success of the business and their fellow workers.

Was this article valuable?

Here are more articles you may enjoy.

From This Issue

Insurance Journal West March 18, 2019
March 18, 2019
Insurance Journal West Magazine

Manufacturing; Markets: Restaurants & Bars; Corporate Profiles – Spring Edition