INCENTIVE COMPENSATION PROGRAMS
Agency Consulting Group, Inc. has been assisting agencies in establishing and managing compensation programs for 15 years. During the last eight years, we have developed and matured numerous incentive based compensation programs. The Incentive Compensation Program (ICP) is, by far, fairer to employees and to the business, and more objective and easier to manage (once the management tools are in place) than predecessor compensation programs that have been based on subjective evaluations and management discretion. We would like to explain the process of establishing an ICP to permit agency owners to determine if this would benefit their companies.
What is “Incentive” based compensation?
The “incentive” in Incentive Compensation refers to tying compensation gains by the employee to productivity and profit gains by the company. The “Merit” raise systems in effect in most agencies are supposed to respond to the same principals. However, most companies readily admit that they do not properly measure results, even if evaluations are based on rating performance, and that raises are often a single percentage given to everyone (that management believes is doing a good job). Managers and owners are always uncomfortable performing evaluations because the employees are deaf to everything in the evaluation until the subject of their raise arises, and most evaluations are based on ‘gut feel’, manager’s impressions, or the number of mistakes or complaints received about an employee.
But how does the company know whether the efforts of the employee has enhanced retention or accelerated customer loss? Is the employee profiting the agency from his/her actions or causing losses?
Aren’t these questions most appropriate to determine the degree (if at all) of compensation gain deserved by the employee?
An ICP is based on the growth of the productivity (in terms of revenue managed or handled) and the profitability of the employee during the period measured. The principal on which ICP is based is that employees that are more productive and more profitable to the company are worth more than employees (in the same jobs) who are less productive and/or less profitable. While productivity is a good measure of performance, it is always second to profitability. Frankly, an employee’s profitability to a company should dictate his/her value to the company. However, there are many more factors in profitability than in productivity, and productivity is more directly and easily controlled by the employee, him(or her)self.
Why is it better for the company?
An ICP is directly controlled by the agency’s budget. Rather than permitting compensation (always an agency’s largest expense) to control profit, budgeting permits the agency to assign the percentage of expected revenue that will be allocated to compensation to permit the desired level of profits to be reached. Of course, historical performance is a limiting factor. If compensation has been 50% of revenue and profits have been nil, you cannot simply decide to lower compensation to 40% to drive a 10% profit (unless you have some very aggressive growth goals implemented). However, if compensation levels at the current percentage (last fiscal year) permit you to enjoy a profit level that you find satisfactory, you can easily determine next year’s compensation expectation by multiplying the current percentage and the expected revenue level for next year. This result is your new compensation cap as long as your revenues do not outperform your expectations. Of course, if you generate more income than you expect, compensation will increase, as well. The expectation is that even if compensation is 50% of the revenue dollar, additional dollars over Plan will add to profit, even if 50% of each dollar is spent in compensation, since other overhead will not rise to consume the remaining 50%.
If revenue does not achieve your expected goals, compensation will be somewhat above budget this year since it is fixed, but can (and should) be adjusted in the following year.
A business that tracks its historical Operating (P&L) Statements already knows what percentage of income (net income is total agency income less commissions paid to brokers) is represented by total compensation and, with a little analysis, by department and by each individual. Agency Consulting Group, Inc.’s annual Composite Groups of Agency Operations, used by thousands of agencies to benchmark their own performance, indicates that the current percentage of revenue devoted to direct payroll is between 50.9% and 54.1%. Office Compensation (excluding executives, sales, and management) ranges between 20.3% and 22% of Net Revenue. Many agents also calculate compensation as a percentage of revenue for each operating department (i.e. PL, CL, Life & Health, etc.). If a service employee in the CL department earns $35,000 and services a book of business that generates $400,000 of income in a department that generates a total commission income of $1,200,000 in an agency that generates $2,500,000 total Net Income, she earns 8.75% of her book of business, 2.9% of the department income, and 1.4% of agency income. Since the CSR is in greatest control of her own serviced book of business, her salary for the following year will initially be determined by multiplying her serviced book of business at the end of the year by the 8.75% that represents her performance in the current year. If the serviced book of business rises, so does her salary. If it falls, her salary is frozen until her serviced book of business rises above its previous high annual point.
Why is it fairer for the employees?
An ICP treats each employee differently based on that employee’s performance and contribution to the agency’s productivity and profitability. While the example, above, considers service employees, every employee in the agency (except producers who are paid on commission) has a productivity factor, whether size of the serviced book for service employees, or annual number of telephone calls for a receptionist, or total number of agency customers for administrative employees and total number of policies for processing employees. All employees can virtually measure their own performance toward a potential raise during the year.
Does this eliminate discretionary bonuses?
Generally, yes! However, bonuses are still possible for extraordinary efforts that deserve one-time rewards. Standard bonuses (i.e. Christmas or year-end bonuses that become institutionalized and expected) are eliminated in favor of the ICP.
What if an employee is not performing up to our standards?
The ICP is completely separated from Performance Evaluations. The best way to look at it is that management decides, through Performance Evaluations, whether or not an employee is performing adequately enough to be employed at the agency. If so, the employee decides how much s(he) gets in compensation by virtue of his/her productivity and profitability to the agency.
How is an ICP administered?
One of the difficulties in implementing an ICP is the preparation need to create one and the time it takes to completely put it into effect.
Only Planning agencies can implement an ICP. A Plan that fairly an accurately determines income projections, and a budget for expenses is necessary to anchor the ICP in achievable dollars and percentages of revenue.
If an agency cannot measure either employee, department or agency productivity (in terms of revenue per employee) and profitability, it must create these measurements before it can establish an ICP. If the information is available, these are simple calculations. If not, it takes a year to build the “track” on which the ICP is to run.
The ICP is meant to be self-administered by the employees, themselves, since they are most concerned with their own compensation levels. Each employee has a measurement tool (i.e. commission size of the serviced book of business) and a goal. Management provides the mechanism for the employee to measure his/her own performance in this key area on a monthly basis to permit them to gauge their chance and amount of an annual raise.
How long does it take to implement an ICP?
Incentive based compensation is a big change both for agency principals and for the employees, themselves. Like any change of this magnitude, taking it slow and easy makes it more comfortable and understandable for everyone.
We recommend that ICP’s be implemented over three years in three distinct steps.
Compensation growth at the end of the first year is based on revenue growth for the department (for service staff) or for the agency (for administrative staff). This is always easiest to measure since we seek gross commission income or agency revenue only.
In the second year, compensation growth is triggered by individual growth, rather than department growth. The example, above would be a good second year example.
During Years one and two, the agency creates profitability models for each operating department, as well as for the agency as a whole. In year three, compensation is determined by a combination of individual growth and department profit (or agency profit for administrative employees).
If an ICP is created and managed, the agency owners will find that the employees’ morale increases as does their spirit of entrepreneurship. The agency is providing them with an excellent reason to care about every new and existing client and every transaction and how they affect the client/agency relationship. The primary change needed for agency owners is to plan for profit instead of expecting windfalls when growth is unexpected. The knowledge that compensation expense can only rise above budget levels if the gross revenues also increase above expectations and that every growth dollar will bring more to the bottom line than the percentage paid to compensate employees should comfort the agency owners seeking full control over their compensation levels.