This article was adopted from Mr. Nohre's presentation at the American Association of Managing General Agents' University Weekend, which was held in August in Scottsdale, Ariz.)

AS MGAs get larger, they need comprehensive compensation plans. The goal should be to create a system that pays a base wage and benefits at fair market value, and that also has an incentive compensation component that aligns agency and employee objectives. The idea is to link bonuses to factors under employees' control that are critical to the agency's success. Then when employees win, so does the agency.

Once these factors are identified, they must be shared with employees, which requires that the agency disclose a certain amount of financial data. It's also important to continuously clarify expectations and reinforce goals. When goals are not met, employees should be held accountable. You must fire people whose performance is lower than acceptable. A marginal performer tends to de-motivate the high performers, so you must maintain your standards by either developing these people or letting them go.

Bonuses are perhaps best used to create team, rather than individual, incentives. The team can be a department, a profit center, a branch location or the whole agency. As we'll discuss later, everyone on the team doesn't have to earn the same bonus, but everyone's bonus should be affected by the team's performance. Team incentives can create “positive conflict.” People start holding each other accountable even when you're not there–especially if you post results. Employees also see opportunities for productivity gains that a manager may not. With team bonuses, they have an incentive to seize them.

An MGA profitability model
Before you can devise a bonus plan, you should have a firm grasp on your current expenses. Total compensation in a well-run MGA usually amounts to about 60% of revenue (defined here as retained–or net–commissions and fees). It breaks down as follows:
–10% for executive management. This is compensation for the president, CFO, etc. It does not include department managers and others with day-to-day responsibilities for operations.
–7.5% for administrative support. This includes, accounting, IT, receptionists and clerks not involved in policy processing.
–32.5% for underwriting and marketing. This includes underwriters, assistant underwriters and marketing people.
–10% for benefits and payroll taxes for all the above.The other major expense categories are as follows:
–5% for selling expense. This includes advertising, promotion, travel and meals, and entertainment, etc.
–20% for operating expenses (overhead). This includes, rent, utilities, E&O insurance, etc. All the above add up to 85% of retained commissions and fees, leaving a 15% pretax operating profit. To this figure, add contingent commissions. They typically boost the total profit figure to 20% to 25%, although contingent commission can vary significantly. Still, year in and year out, an MGA needs to make at least 15 points of profit before contingencies. The only way to do so is to have acceptable productivity and to set compensation as a percentage of retained commissions and fees.

Incentive plan variables
The first variable faced by an MGA creating an incentive compensation plan is how complicated to make it. A plan with lots of details theoretically should align employees' interests with the agency's better than a simple plan would. The downside is that it is less likely to be well understood by employees and more complex to manage. Therefore, I think incentive plans should be relatively simple. The second variable is group size. As previously mentioned, appropriate definitions must be determined for each team. The third variable is how bonuses will be measured. Often, agency owners award subjective, or what I call “Santa Claus,” bonuses. The owners look at the bottom line at the end of the year and hand out bonuses in accordance with what kind of year they feel they've had. This approach often is used in smaller MGAs that have just one bonus plan for the entire agency. For larger agencies with multiple teams, however, it is best to determine bonuses by objective criteria. The criteria will vary by team, but two that often show us are retained (net) revenue growth and pre-tax profit margin.

Establishing the size of the bonus pool
There are a number of ways to determine how much money to put in bonus pools. One approach is to base bonuses on employees' annual wages. Among the percentages I often see used are the following:
–For rank and file clerical and support staff, 5% to 10% of their annual wages. For example, employees earning $30,000 a year may receive bonuses between $1,500 and $3,000 for hitting their goals.
–For mid-level managers, including department managers, 10% to 20% of annual wages. For instance, a $60,000 manager who hits his or her target might get a 15%, or $9,000, bonus.
–For senior executives (presidents, branch managers, etc.), 20% to 50% percent is a common range, particularly for executives who are not owners. For example, an executive making $200,000 a year may receive a 25%, or $50,000, bonus for meeting his or her goals.

The size of a bonus pool also can be based on retained-revenue growth. For instance, a bonus program for underwriters might reward them with 10% of the growth. Retained revenue takes account of all sources, new business, renewals, fees, etc. It's easy to measure, it's easy to post and it nicely aligns employees' and the agency's interests. It's one of my favorite criteria to use to determine the size of a bonus pool. Bonuses also are often expressed as a percentage of profits, a similar criterion.

Fixed-dollar bonuses also are common. If a department or agency hits its revenue target for the month, everybody gets $100. Personally, I don't like a plan that rewards everybody the same. If I'm a department manager, I don't want to have to give the same amount to slugs, mid-level performers and superstars. If I do, where is the financial incentive for my staff members to become superstars?

After you decide how much money to put into a bonus pool, how do you divide it up among the team members? If you base the overall size of the pool on percentages of team members' salaries, this is not an issue. You simply divide the pool by the percentages you previously used. Thus a department head will receive a larger bonus than a clerk on the department head's team. A second way of dividing the pool is to simply give everyone on the team the same amount. How the pool is split up often is a reflection of the agency's culture. Those with a “one for all and all for one” culture often hand out equal bonuses to everyone.

Tying bonuses to performance
In my opinion, the best way to determine the size of teams' and individuals' bonuses is by tying them to objective criteria that are relevant to each employee's responsibilities. Here is how the participants in such incentive compensation plans might be paid:

Executive management: I recommend just a couple of measurement criteria: revenue growth and profits. They can result from new business, high retention, new relationships or whatever. I think the senior management should have a fair amount of their compensation at risk. They should be well rewarded, but exclusively on results.

Brokers: I would view wholesale brokers, for MGAs that have them, the same as I would retail producers. They don't receive a bonus per se, because they can earn their own through production. They should be paid 20% to 30% of their retained revenues, which includes fees but not contingencies. That should be the figure whether they are on straight commissions or a base salary (or draw, for new producers) and commissions.

Suppose a broker is paid a $100,000 salary. Such a salary is “validated” once production reaches $400,000 in retained revenue. (The broker's compensation is then 25% of production, which falls into the aforementioned 20% to 30% range). Because not all expenses associated with production increase with volume, brokers could be paid bonuses for exceptional results. Perhaps the broker receives 25% of retained revenue on the first $500,000 in his or her book. Then on the next $250,000 of production, the figure rises to 30%.

Underwriters: In the typical MGA, the underwriters are the primary production people. Often, they're helped by assistant underwriters or processors. To grow revenues, new business has to be written and retained. It also needs to have a good loss ratio to protect the agency's company contracts and generate contingent commissions. To me, those three criteria–new business, retention and loss ratio–should be used to determine the size of an underwriter's bonus.

MGAs can afford to pay underwriters a base salary of about 20% of their books' retained revenue. Thus, an underwriter making $50,000 a year needs to handle a book generating at least $250,000 in retained revenue. Bonuses can be awarded based on production above that figure.

Assume you have four underwriters who collectively manage $1 million in business. One simple way to create a bonus plan would be to put 10% of the growth above that figure into a pool for the underwriters. Thus, if retained revenue increased by $200,000, there would be a $20,000 bonus for the underwriters to share. (That figure could be adjusted up or down according to whatever loss ratio target you use. Contingent income could be a substitute criterion for loss ratio.) Meanwhile, if the agency's profit rate was 25%, it would make $50,000 on this growth. Of that, it would give $20,000 to the underwriters in the form of a bonus and keep $30,000. (I feel the agency always should retain at least half of the incremental profit.)

If I were designing a bonus program for underwriters, I'd first find out where productivity stands. Let's say my underwriters' salaries already equal 30% or more of their books' retained revenues. In that case, I would not want to implement a bonus plan. I would tell the underwriters we first need to improve productivity to the point that their books' retained revenue is at least five times as large as their salaries.

I used to be against sharing contingencies with underwriters (e.g., allocating 10% of the growth in contingencies to them), but that approach seems to work well for some MGAs. It also provides an incentive to not just write anything that walks in the door.

How do you split up the bonus pool among underwriters? Let's assume four underwriters have equal opportunities, and two of them are outperforming the others. I might calculate the bonus as a team but then divide it according to individual production, while keeping the option to take extenuating circumstances into account.

Assistant underwriters: Their bonuses should be based on retention. Also, I would make sure they couldn't earn a bonus unless their underwriters did. I'd want them joined at the hip in terms of production, motivation and accountability.

Marketing representatives: Some MGAs have marketing representatives. For their incentive plan, overall agency growth could be a criterion. Other possibilities include the number of new relationships they develop and the revenue that flows from them. The criteria will depend on the nature of the reps' jobs. Is it to massage existing relationships with retail agents and try to get them to sell more products? Is it just to establish new accounts? I think that if their bonuses are based on the agency's entire revenue growth, that would align them well with the agency's objectives. I'd allocate a fairly small percentage of the agency's retained revenues to their bonuses, depending on how many marketing reps the agency has.

An MGA needs to grow retained revenue at least 5% a year. After inflation, that's almost like standing still. So for a bonus, marketing reps could receive a 5% salary increase if agency growth exceeds 5%. If growth topped 10%, the reps could see a 10% salary increase. Usually, there are so few marketing reps in an MGA that it's easier to figure their bonuses as a percentage of their salaries than as a percentage of agency growth in retained revenue. Certainly, awarding them 5% or 10% of growth in the example above would be far too generous.

Policy support personnel: Their bonuses should be based on such criteria as units processed, backlog, productivity and service standards. As with the marketing reps, I'd express their bonus as a percentage of their salaries.

Administrative support: Completed projects constitute a criterion that works especially well for accounting, IT and other employees not directly involved in production. Projects could include the implementation of a document imaging system, the creation of an interactive Web site or the attainment of a certain receivables figure.

Let's say your IT manager makes $75,000, and you're going to give her the opportunity to make a 10% bonus, or $7,500. Create three important tasks for the IT manager to carry out. Write down the projects in as much detail as necessary. Then tell the IT manager she will receive $2,500 for each project completed.

Another criterion could be staying within, or coming in under, a budget. Spending in IT departments often tends to get out of hand. Let's say you have a $10 million (retained revenue) operation and budget 2.5%, or $250,000, for the IT department. You could award the IT manager a bonus for staying within that budget.

Where do you find the funds for bonuses for administrative support's employees, since they are not directly involved in production? One possibility is to allocate a small percentage of all other team's bonus pools to one for the support staff.

Making the transition
After you create your new incentive compensation plan, you have to implement it. The transition from your current system will take time. Here are some suggested rules:

1) The transition should have a timeframe, not longer than three years. When you're doing things that affect people's pay, you have to give them some notice. Tell them what the plan is going to be, then phase it in over the transition period.

2) Another good rule is that during the transition period, no one takes a pay cut. So perhaps you calculate bonuses both by your old method and your new one, and base bonuses on whichever figure is higher. By the end of the transition period, all employees should know what they need to do to drive agency profits and have become proficient at doing so, so everyone makes more money.

In some cases, the bonuses paid under the new plan will never top those granted under the old one because employees essentially were being overpaid. But at least under the new plan, employees should see what they must do to make an equal amount of money.

Educational goals
Along with creating a goal-oriented incentive compensation plan, make sure all employees have professional development goals and objectives. Specify the training they need to advance in their careers. Review their development each year and tell them what classes to take. Don't permit employees to wait until a continuing education deadline approaches and then take whatever training is available or convenient. Make sure the classes are aligned with their duties and responsibilities. If you link a bonus to the attainment of a designation or other educational goal, your success rate increases substantially.

Employees also should be encouraged to develop appropriate skills. Skills are different from technical knowledge. They include such things as leadership skills and communications skills. Such training is particularly important for those employees in management positions, or those being groomed for them.

The payoff
The type of plan described in this article will make everyone's total compensation vary with the fortunes of the agency, and there could be objection to that. Underwriters, for example, may say their compensation should not decrease if the size of their books falls during a soft market. But this is precisely why some of their compensation should, in essence, be at risk. You want the underwriting team to have the financial incentive to ask, “Where are there other growth opportunities? Can we grow our territory? How can we increase our penetration? Where in the market are there still good margins and good loss ratios? What else can we do to add value to the process and increase the revenue we're bringing in? How can we become more efficient? How can we make life easier for retail agents, so they'll want to place more business with us?” Once the underwriting team (and all other teams) adopts that kind of attitude, you're about to make real progress.

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Incentive Compensation Plans for MGAs

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