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Producer Equity...Good Idea or Bad?

NEVER offer equity in a producer's created book of business. Well, 'NEVER' may be too absolute. Let me put it this way. Never offer equity only in a producer's book of business if the goal is to reward a producer for success or to cement the relationship between producer and agency. The forced "acquisition" of a producer's equity can eliminate the profit for each account for as much as TEN YEARS! Here's why....

It is hard enough to convince producers that when you hire them, compensate them for their time and efforts, support their sales efforts with advertising to gain the public's attention, prospecting to gain sales opportunities, and marketing to the carriers, then support the customers for which they continue to achieve renewal commissions with internal administration and servicing, that the business 'belongs' to the agency, not to the producer.

The producer is a part of the team that drives business to the agency, convinces the prospect to buy from the agency, convinces the carriers to provide the right product at the right price to facilitate the customer's buying decision, and satisfies the client after the sale to maintain his business for many years.

The producer is an integral part of the team, as is the marketing representative who develops the product and places it with the carrier, the service representative who maintains primary communications between the agency and the client to assure customer satisfaction, and the claims representative who assures that the claim service provided to the customer by the agency lives up to the customer's expectation of claim management (not just a reporting facility for the carrier).

When you proffer any level of "ownership" in the book of business that the producer develops, a number of things happen:

1. The producer will pay more attention to the business in which he has ownership than to other agency business. While you want a producer to pay attention to the customers to whom (s)he sells (that's why we pay renewal commission), you also want that producer to pay attention and assist ANY agency customers with equal vigor and care.

2. If the producer is not successful (builds a smaller book of business than expected or projected), the equity provided to the producer is a waste. If you ever have to get rid of the producer, the agency must either pay for the book of business again through the buy-out or it will not re-coup its expenses with the income if the producer buys the book from the agency.

3. Successful producers may consider their equity to be a savings account that builds until (s)he can take their book of business and either strike out on their own or leverage it to make a better deal with you (or with a competitor). We have seen many cases in which a new agency sponsors the buy-out of the balance of a producer's book of business in order to accommodate a new producer, bring him on with a pre-existing cash flow for the agency, and entice the producer with other incentives as a result of the accommodation.

4. Regardless of success, the producer will consider that book of business his (or hers) and will expect the ability to buy that book from you (or sell it to you) if your relationship with the producer ever sours. Considering that average agency acquisition costs do not permit an account to become profitable until the second or third year (at earliest), and that service costs, combined with continued payment of renewal commissions, only provide a 10% to 20% profit per normal account (when profit levels can be achieved), the forced "acquisition" of a producer's equity can eliminate the profit for each account for as much as TEN YEARS!

If the producer wants to buy out your portion of the equity in 'his(her)' book of business, the return that you achieve will likely not return as much as you have spent in acquisition and service costs to acquire and maintain the account (unless you have had it for more than five years).

For instance, if an account is written that generates $1,000 of commission, the combined acquisition cost (including advertising, the cost of marketing to unsuccessful prospects, the cost of marketing to the carriers, and the commission to the producer on the sale) can easily cost $2,000 (Agency Consulting Group, Inc. Acquisition Study). Based on a 5% per year premium growth, the agency will net a 7% profit at the end of the third policy year.

If the owner achieves a 50% equity position and the agreement of value is simply twice the commission payable over 3 years, if the producer leaves and buys the business after the third year, the agency will NET $1,319 over six years, a 7% return for it's cost basis. If the agency is asked to buy out the producer, the combined acquisition costs will take five years to re-coup (assuming another producer is assigned to maintain and retain the account and earns renewal commissions).

Equity relationships with a producer CAN work under very specific guidelines:

1. Set goals. Equity is an issue only if on-going goals are met. Make sure those goals are aggressive, but achievable. They should provide adequate growth and profit for the agency to permit equity sharing while still increasing the owner's value in the agency as well. Remember, even if the producer doesn't pay attention when the equity offer is made, it will become readily apparent if the goals set in order to gain equity are unachievable.

2. Make the equity position one of equity in the agency, not in a book of business. That way, the success of the agency, not of a few accounts, is of prime importance to the equity-sharer. S(he) will pay attention to the value of the business and to all of the accounts, not just to the ones that he produced.

3. Vest the equity over five years. In that way, a long-term relationship must develop before the producer achieves full vesting in the equity.

4. Equity should not be a one-time, percentage (or stock shares) event. If equity is a reward for continued success, permit the evolution of additional equity in each year in which goals are met.

5. Protect the owner. Limit the equity potential to assure control still lies with the agency principal until and unless the equity relationship has developed into a succession and perpetuation-planning tool.

6. Either set substantial enough goals to compensate the agency for the equity being offered - or - make the equity an option to be offered to the producer at a beneficial price. That which is earned or paid for is always more valued than that which is gifted or given.

We support producer (and other management) equity within insurance agencies for two reasons:

1. Successful producers should be groomed for ownership succession. You will not live forever, nor should you stay with your own agency once you are no longer a productive, profit-generating part of it. When that time comes, you should have another generation to whom to sell the rest of your equity. A producer should not go from sales to management overnight. Equity relationships can permit a maturing of producers into management roles.

2. Successful producers are sought after and given opportunity after opportunity during their careers. Two things will keep a successful producer with you - appreciation for their efforts and success and a stake in the future of the agency that translates into growth and retirement benefits for the producer. Equity provides both forms of 'stroking.'

We recommend that you create equity opportunities for both existing successful producers and as incentives to get new producers. Of course the equity incentives for new producers will only be achieved after a number of years of successful goal attainment, but that opportunity for equity may be exactly what differentiates you from the agency in which the producer already resides.

If you have any questions about producer compensation, please contact us at acg@mail.com or visit our web site at www.agencyconsulting.com.