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The PIPELINE

A national monthly newsletter for agency principals dedicated to agency management topic

When Does Incentive Compensation Make Sense

Frequently Asked Questions

Incentive Compensation defines a change in compensation method in which employees achieve increased compensation (raises) for increased productivity. It acts on Operating Income (commissions and fees) only to eliminate contingency income and any non-recurring income from productivity consideration. It takes compensation decisions out of the hands of managers and agency owners but leaves evaluation and retention decisions with the employees’ direct managers. It teaches employees the shocking truth about growth and profitability -- we can only afford to keep paying more to employees if we grow and are profitable (without taking money from agency owners’ pockets).

Why should increased productivity be a basis for pay raises?

It sounds like simple reason to say that the more productive an employee, the more he (I will use the masculine term but, of course, it applies to both male and female employees) is worth. But that is a truism, all other things remaining equal.

What is “productivity”?

In the simplest terms (easiest for employees to measure), productivity is Revenue per Employee growth. For managers and owners, productivity is measured in Revenue per Employee, Compensation per Employee and Spread (the difference between Revenue and Compensation per Employee), the measure of non-compensation revenue per employee available to pay overhead and to contribute to profit.

Aren’t there many qualities of an employee besides productivity?

Absolutely. Loyalty and Work Ethic pop to mind immediately. They are great reasons to keep employees and to evaluate them highly. But when your commission rates are being “adjusted” by carriers and the Contingency payments are being reviewed, the future of your business depends on how you can manage growth of clients and revenues without increasing the number of employees (loyal or not; hard-working or not). So while I will certainly fight to retain loyal, hard working employees before the lackadaisical employees who put their running shoes on five minutes before quitting time and refuse further phone calls, I will PAY more for employees who can handle an ever-increasing customer or revenue base by working smarter and learning the automation short-cuts that we have (but rarely use). Happily, these are often my most loyal and hard-working employees, as well.

What if productivity grows substantially? Won’t I be giving raises that I can only afford in “good years”?

Let’s say you pay 20% of your income to office employee compensation (excl owners and producers) and that amounts to $300,000 on $1.5 Million of revenue. If you were to offer straight growth raises (only one part of the productivity raise formula) to your employees and the book of business grew to $1.7 Million, you would be granting $39,000 of raises (13.3% growth = $200,000 on $1.5 Million. Multiply that 13.3% times $300,000 existing compensation). The new compensation would be $339,000 on $1.7 Million, or 19.9%. Many agents retain the first few percentage of growth before incentive compensation kicks in, thereby lowering compensation as a percentage of revenue regardless of how much growth is involved. It is a “hedge” against the agency owner putting himself in harms way by paying his employees for real productivity.

Finally, in the long term, growth is only one part of the formula. A full raise is based on growth but is contingent upon agency profitability (and department profitability).

I’ve given bonuses when I can afford them. Doesn’t this still incent employees but keep my salary costs down?

YES --- BUT ... your employees live on their weekly or monthly take home pay. Very few of them are capable of banking bonuses and living off them in lean months. Their living costs increase just like yours and mine. If they receive the same pay year after year with occasional bonuses (that they can’t really count on in case of bad years) they are going backwards compared to the industry and to other wage-earners in the area. Would you boast that you pay as little as you can to your good employees? Why not, if that’s the case? The answer, of course, is that you know that the good employees probably deserve more and the marginal employees deserve less than you’re paying them. But you haven’t known (until now) how to incent your strong employees and dis-incent your poor employees without the chance of hurting your bottom line in the long run.

Isn’t it overly complicated to consider Operating Revenue only when calculating Incentive Compensation – shouldn’t I be sharing contingency income when the agency does well in that category?

Incentive Compensation acts only on the revenue base that is somewhat controllable by the employees being compensated. Everyone in the agency (not just CSRs) affect how customers feel about the agency. The receptionist scores points with customers who she remembers. The Claims Rep scores points when she doesn’t wait for a customer to complain before checking the status of a claim and communicating with the client. The accounting rep scores points when she is cooperative and understanding with carriers instead of treating them as adversaries. And, of course, no one denies the affect on retention of business by the customer service staff.

The simplistic answer to the second part of this question is a resounding NO!!! It is a part of the job of the producers and customer service departments to underwrite good business for the agency and its carriers. If strong growth or profits arise, the contingency income derived from them should accrue to the agency as “found money”, not as operating income (a failure in many agencies). This is the source of funding for growth that so many agents ask me about. As long as we are capitalist society and have private ownership of companies, we deserve the gains achieved in our companies. Sharing the gains only makes sense if the employees are willing to share the losses and the investment in the agency that owners have to make from time to time. The retention of contingency income is also another “hedge” for owners to comfort them that they are not overspending their budgets when giving incentive compensation raises.

Why would I want to take compensation decisions away from my managers? Maybe I don’t “have” to pay more to get more productivity...

This is short-term thinking. Most principals who don’t think of paying more to productive employees will eventually lose them or dis-incent them into becoming marginal employees. Unfortunately, we cause many of our own personnel problems by not acknowledging and paying our best employees more than our marginal employees.

I don’t want to personally lose control over the pay raises given to my employees. Is that wrong?

A large percentage of agency owners fall into the category of benevolent dictators. They want the best for their employees and intend to do well by them, but only on the employer’s terms. This most often translates into common raises (similar for both strong and weak employees) and controlling influence. Employers actually believe that the employees will work harder if they think the employer is holding their purse strings. In fact, the simplicity of working harder and getting paid more for greater productivity becomes very apparent once the employees learn the objectivity of this compensation program. And, believe me, they work for you because they like you, not because you might pay them more someday.

Evaluations have always been informal and only done occasionally in my agency. Why are they important, especially if raises are productivity based?

Even if the employee knows that increased productivity means increased pay, they want and need positive communications from their manager and agency owner to reinforce their pride in their work efforts. If we act like our European ancestors our attitude is, “They should work hard and are expected to do it right. I shouldn’t have to commend them for doing their jobs. My job is to criticize and correct them for doing it wrong.” Unfortunately, that attitude tears down more employees than it builds. Evaluations are the formal methods of reinforcing positive actions and correcting weaknesses in a non-threatening manner.

A second, important reason for evaluations once or twice a year is that productivity alone may be an insufficient reason to retain an employee. If an employee does not get along with you, with other employees and with customers, productivity becomes a secondary factor. The evaluation is the time to correct weak behavior as well as commend strong behavior.

Finally, we recommend that Continuous Improvement be a part of every job description. This requires a Development Plan at every evaluation to assure that an employee does not stagnate and improves him or herself every year (either within the job they have or in preparation for their development into more valuable positions).

I’ve always considered retention of employees an “accident of economic timing”. How can I affect employee retention?

Employee retention is a combination of fair compensation and a feeling of job satisfaction. That job satisfaction is a direct reflection of the employee’s feeling of appreciation by their manager and/or agency owners. We have seen employees whose pay does not match their qualifications and experience stay with an employer who they feel truly loves and appreciates their efforts. We have also seen highly paid employees leave an agency for a pittance because of their feeling that they have been disrespected. While some employee loss is due to “accidents of economic timing”, much is not – but the employee will not burn his bridges and tell you the real reason he is leaving. He just leaves.