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Distributing Contingency Income Fairly
Many agencies distribute some or all of the contingency (Profit Sharing) income that they receive from the carriers each year and would like to do so in an equitable manner. If the agency’s ownership percentage is the appropriate distribution method, it doesn’t matter how much volume or how many losses are associated with the people to whom or entities to which the distribution is paid. But many agencies distribute contingency amounts based on quantitative or qualitative results of each owner, each department, each office or each entity in multi-dimensional agencies like Virtual Insurance Agencies, Cluster Groups, Service Center, Conglomerator or other forms of agency.
Historically, if ownership percentage was not the appropriate method of contingency distribution, the only simple way of distributing was by premium volume. We can easily determine that if one entity had 10% of the premium volume for a carrier or of the agency, they get 10% of the contingency income for either that carrier or for of the agency’s total contingency income. Unfortunately, there is an inherent flaw in that distribution method.
As long as each of the participating individuals or entities had similar loss ratios attached to their premium volume, a premium-based distribution works. However, that’s rarely the case. Some books of business are more loss-ratio profitable than others and those loss ratio differences strongly affect the amount of contingency received more than premium volume.
Even when carriers generate sub-producer codes for each entity, it is difficult to determine the loss ratio relativity of books of business while it is always easy to determine the volume relativity.
For many years, Agency Consulting Group, Inc. has offered its clients the FAIR SHARE™ Contingency Distribution Program, designed to calculate both the Volume and Loss Ratio Relativities for each participating person or entity in an agency to distribute contingency in the fairest way possible. The FAIR SHARE™ program first compares the volume of each entity against the total volume. It then develops the relationship of the loss ratio of each entity to the average loss ratio of the agency for the carrier in question. If the loss ratio of an entity is relatively higher or lower than the agency’s average loss ratio on which the contingency income was calculated, the share of contingency for the participant is raised or lowered relative to the entity loss ratio to the average.
As an example: If an agency had three offices/owners/sub-agencies that were involved in contingency distribution, it might look like:
Total Contingency = $50,000
Volume: Entity A = $200,000, Entity B = $400,000, Entity C= $600,000
Volume Distribution A=16.7%; B=33.3%; C=50%
If Contingency was distributed only by volume, A would receive $8,350, B would receive $16,700 and C would receive $25,000. But what if the agency generated a 42% Loss Ratio to earn that $50,000 and A’s book of business generated 21% Loss Ratio, B a 15% Loss Ratio and C generated a 67% Loss Ratio? Would a straight payout based on volume be fair?
In the FAIR SHARE™ Program, the relativity of each Loss Ratio to the agency average would be calculated and A would earn $12,500, B would earn $22,619 and C would earn $14,881 – still totaling $50,000 but weighing the individual loss ratios as well as volume to reward the entities with better underwriting with a higher percentage of the contingency income.
You purchase the program from Agency Consulting Group, Inc. We initialize the program with as much as five years of data from your carriers. After the initialization, you may either choose to have Agency Consulting Group, Inc. input your carriers’ results every year and deliver you the resultant contingency distribution – or you can do it yourself. The FAIR SHARE™ Program will also give you some very valuable information like,
- the growth and loss ratio history and trend of each individual entity and of the agency with each of the carriers represented,
- premium and commission histories, loss ratios and trends for each entity and for the agency in the major divisions of a P&C agency (PL and CL) ACROSS ALL CARRIERS,
- growth and loss ratio histories and trends for the major lines of business in both PL and CL by carrier, by agency entity and for the entire agency.
We use these worksheets in our GPP (Growth, Productivity and Profitability) Analysis of new clients in our initial analysis of their strengths and opportunities. Agencies are rarely able to provide themselves this level of detail with which to determine which components are growing or shrinking, which are using the carriers properly or as desired by the agency and which are creating more contingency through growth and low loss ratios or creating agency problems through low volume and high loss ratios across all carriers. This will give you a new and important level of analysis for your own agency.
Please call us 800-779-2430 to discuss the FAIR SHARE™ Contingency Distribution Program. The cost of initialization and annual input is determined solely by the time it takes us to input the data on the number of entities (owners or divisions for contingency purposes) in your agency, the number of carriers represented and the number of years of input required for the initialization (from one to five years).