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Producer Profitability Analysis
Agency Consulting Group, Inc. can conduct a Producer Profitability Analysis on each producer in your agency to answer that question.
The basic principle under which a profitability analysis is conducted is that there are two forms of revenue in an agency, Operating and Other and the costs of operating an agency (including producer compensation) must be derived from its Operating Income only.
Operating Income is comprised of Commissions and Fees, assuming that both are recurring forms of revenue that are controllable by an agency’s or a producer’s activities in sales and customer retention.
Other Income, which may be substantial, is transitory and may not be renewable or repetitive based on the vagaries of the insurance or regional economy. Contingency income, interest and investment income and miscellaneous income generated by an agency fall into this, Other, category.
Producers should be compensated from only Operating Income, the monies coming into the agency on which they can exert some influence in the generation of new business and the retention of existing clients.
An agency should break even (at worst) on its Operating Income and most successful agencies earn a profit from this revenue flow. This means that the agency controls its expenses to no more than its commission and fee income, thereby providing a stability that would not require the elimination of people or the reduction of owners’ income in the event of a bad loss ratio year reducing contingent income. It also means that the Other Income of the agency is available to be used to “seed” and grow the agency through acquisition of people or books of business or may be released as excess profits to the owners of the agency.
When Agency Consulting Group, Inc. conducts a Producer Profitability Analysis it first determines how much an agency can afford to pay producers by defining the agency profitability vs. Operating Income. Normal financial statements consider Total Income and Total Expenses in the derivation of profitability. But if we eliminate non-Operating income from the stream, we can determine the costs (excluding producer compensation) as a percentage of Operating Income in order to calculate the percentage of Operating Income that is the maximum a specific agency can afford to pay its producers. Remember, our guiding principle is that the agency should pay for itself, including producer compensation, from its Operating Income, leaving Other Income to fund capital investment or profit.
The determination of Actual Producer Compensation as a percentage of Operating Income is relatively easy. Most agencies can tell us the size of each producer’s book of business and the total compensation the producer earned each year. The ratio of compensation to assigned book of business defines the percentage to compare against the maximum affordable cost to break-even.
If the percentage paid to the producers are within the range of the maximum percentage available to the agency, all is well. However, two things happen often;
- The agency spends more than its Operating Income on its costs and the derived maximum producer compensation is a negative number, and
- The actual cost of a producer exceeds the maximum percentage of operating income for producer
There are solutions that can be implemented in the agency for either of these circumstances.
If the agency is using every dollar of income on its expenses, adjustments can be made over a year in some of the discretionary expenses in the agency, or the agency can enter an austerity budget period to allow Operating Income to gradually catch up with its expenses.
If the existing producer costs exceed the maximum allowable costs, two further activities can be implemented;
- Each year the producer must add a small amount of revenue to the agency before additional compensation is implemented. Even a 2% growth each year will result in a 10% reversal of negative compensation expense over five years.
- The agency must rethink its producer compensation program because this result may demonstrate that the more the producer sells, the greater the agency LOSS on the book of business. This type of agency problem can’t be afforded for many years before more drastic action must be taken.
If you find that your agency’s cash flow is insufficient to manage your expenses and your producers are enjoying a healthy compensation level and lifestyle while the agency owner’s total compensation from the agency is being reduced, it is time to conduct a Producer Profitability Analysis as a part of the solution before you are required to sell the agency to get out whole. Call us (800 779 2430) to discuss the Producer Profitability Analysis.