Deferred Compensation and Shadow Stock

Producers, experienced or new, who are talented enough to help agencies develop, are the goals of every agency owner that is focused on growth and perpetuation.

No one strives to be a maintenance owner, servicing a declining agency client base. Yet many agencies find themselves in that very position. They only grow when rates or the market drives premiums higher. And they pay no attention to the key element of agency success growth of client base. So their client base silently and slowly erodes until the pressures on cash and profit drives the agency to sell or merge to maintain some value to the asset.

The answer for insurance agency owners is to recruit producers who will both grow the agency in support of their compensation needs AND become the agency owners’ successors.

Finding producers that fit into the successor category is excruciating. Most of the experienced insurance agency producers who are available are only available because they are not supporting themselves or their current agency. There are considered Journeymen Producers. They work in the field for five or ten years to attain a large enough client base to support their compensation needs and then move from agency to agency, taking their clients with them, until the agency realizes that it bears little profit or growth from the producer after the initial rollover of clients. The producer has Retired In Place and is taking producer compensation (usually higher than service compensation) to become a service representative for the same group of clients that they have had for years.

However, every year there are some experienced producers who realize that they will never achieve their earnings potential or agency ownership with their current employer. While they may have non-competition periods that require an investment by a new agency, their motivation is exactly what most agents are seeking – someone willing to work consistently, grow a book of business for which they expect fair compensation AND some form of equity to support themselves and their families in retirement.

Two simple methods exist for those producers, Deferred Compensation and Shadow Stock. Both can be used to sponsor and retain good producers, whether new to the industry or experienced, without giving them real agency ownership until they have proven their value over a long period of time.

The first rule is never give ownership or equity of a book of business or the agency to a producer who is new to the agency and hasn’t shown evidence of his/her long term value.

We have had countless experience as Expert Witnesses in cases which an optimistic owner granted either equity in a producer’s book of business or even agency ownership as an enticement to acquiring a producer the owner hoped would be the agency’s salvation and perpetuation – only to find that the promises weren’t kept and the equity position remained.

In the rare occasions that ownership is appropriate for a new entrant to an agency, a contract of at least two years in duration that provides some ownership interest to the producer IF the growth expectation is actually achieved. The participant should have no concern that the ownership potential may not be forthcoming because of the contractual relationship. But the agency owner no longer need be concerned about being the only participant at risk if the situation does not mature as expected.

Regardless, we NEVER recommend equity in only the book of business generated by the producer for the agency. It is ALWAYS our position that the business brought to an agency through the efforts of an employed producer belongs to the agency. By agreeing to an equity position for a producer, you are yielding the possibility that the producer’s efforts could be separated from the agency’s owned business. No one has ever suggested that the future purchases of an appliance store client belong to the salesman who first sold them a refrigerator. Future purchases BELONG to the store and the commissions for those purchases belong to the salesperson who sells the products to the store customer. The customer is the store’s customer, not the salesman’s customer. If all agencies treated their books of business in that way there would be little need for litigation if a producer leaves and tries to steal customers and the confidential data produced on those customers by the agency.

The second reason we don’t recommend granting equity in a producer’s book of business is that you are trying to get everyone in the agency concerned with the growth, retention and profitability of the agency. Equity in a book of business naturally inclines the producer to be concerned first (and sometimes ONLY) with the book of business in which the producer has an equity position. They will certainly use the agency’s assets to support them and their customers, but will assume the customers to be “theirs”.

However, the trail to agency ownership and success often lies with young or experienced producers who first build a substantial book of business for the agency and then become more valuable to the agency in its growth and progression than simply through their sales.

The Second Rule is to make sure a producer validates sufficiently to support himself before ANY consideration of extending long term compensation and other benefits to him/her. The validation level must be at the discretion of the agency owner. Some agencies are satisfied with producers who have achieved $100,000 or $200,000 of agency revenue before they are considered sufficiently valuable to be giving retention incentives. Others look for producers to break into six digit earnings (taking commission compensation above $100,000) before being considered valuable enough to warrant retention programs.

Deferred Compensation – the first level of retention program.

In a deferred compensation program, the producer is told that for every dollar generated by him, a percentage will become a deferred liability to the agency, payable to the producer upon retirement (from the business of insurance), death or disability, or, minimally, upon achievement of a time period in the agency (usually at least ten years). At the triggering event payments will begin over a stated period of time to add to the producer’s other benefits.

This program is good for pure producers and for producers who are pretty much concerned only with their task of selling insurance. There are many producers who are good at what they do and will never have (nor want) ownership or management involvement. The deferred compensation program is designed for them because they know that they are working toward retirement and this builds their value.

The key to a deferred compensation program is to specifically indicate that this only applies if they remain employed by the agency through the triggering event. If they leave early for any reason, the deferred compensation agreement terminates without benefit. As you can imagine, the longer the producer is in place and the more successful (s) he becomes, the greater the loss if they leave early.

Shadow Stock – on the path to ownership

The second level of Retention Program is Shadow Stock, a side agreement between the agency and a producers that promises the producer an equivalent value to a percentage of ownership if the producer dies, becomes disabled or retires from the business of insurance – or if the agency is sold before another triggering event. The appropriate time to use this retention tool is when a producer becomes sufficiently successful to have an impact on agency value if (s) he leaves. Shadow Stock has no impact on agency ownership since it is a side agreement, not a real ownership position. However, it is used to create a sense of ownership and to determine whether that producer can be as concerned with overall agency growth, retention, profitability and value as the producer has been concerned about personal production.

The third level of Retention is actual granting of stock through stock sales or stock options for producers who have evidenced the desire and capability of becoming the next agency owners.

Each level of Retention Program, Deferred Compensation, Shadow Stock can be upgraded for the lucky producer who comes into an agency, builds a strong book of business on behalf of the agency, becomes a valued asset whose loss would impact agency value and, finally, becomes worthy of being a part of the agency’s ownership and succession plan.

Please call Agency Consulting Group, Inc. (856 779 2430) to discuss how to establish one or more of these retention programs within your agency to attract new producers, to motivate continued growth of existing producers and to retain successful producers and agency perpetuators who will be constantly accosted by your competitors with offers of “greener pastures.”