Performance Based Owner Compensation Plan
Often, the difference between a well run firm and an average firm is the relationship between the
owners. If one owner feels that there is some inequality among the owners, then cooperation is
limited and the agency's performance will suffer.
The subject of owner's compensation is very sensitive and it can often be the unspoken thorn in
the sides of many business partners. When the original compensation plan is never revised,
despite changes in the effort and the roles of the partners, dispute will arise. Oak & Associates
recommends that agency owners annually review their compensation plans.
Compensation Plans
There are several common ways that agency owners compensate themselves, each with their own
pros and cons. For example, some business partners may choose to pay themselves the same
salary. This is a simple solution that may foster team work in the beginning. Resentment may
eventually occur if one person slows down yet still draws the same salary. Some agencies may
pay the owners strictly for production. This method becomes unfair if one person is spending
more time on management than the other owners and their production is impacted.
Oak & Associates recommends performance based compensation plans. The best plan has three
components: a fee for management, a production component and a share in the profits (return on
investment).
Each agency should set aside a strategic management fee from 4% to 8% of total revenues. The
larger the firm the smaller the percentage. Larger firms tend to have middle management to assist
the owners with the strategic management of the firm. The owners of smaller firms need to be
more active. This strategic management fee is then split up to pay the owners for their
contribution to management.
The specific formula used can be tailored to the uniqueness of the agency's operations. Oak &
Associates recommends the following split based on the typical average amount of time spent
managing these functions: 15% for Administration & Operations, 15% for Financial Affairs, 10%
for Market Relations and Placement, 20% for Sales Management, 35% for Management of the
Service Function (PL, CL & L&H) and 5% for Automation.
The fees are for strategic management, not the day to day management of affairs. The owner in
charge of Financial Affairs does not handle the day to day accounting for the firm. Strategic
management for financial affairs would include reviewing monthly financial statements and
initiating the firm's budget. Any major decisions still need to be approved by all owners.
Each management role could be assigned based on each person's talent and preferences and/or
the roles can be rotated annually among the owners. Some functions can be shared. For example,
there should be one lead person for the marketing/placement function. The relations for the
individual companies however should be assigned to the owner with the best relationship.
Large agencies or firms with a large portion of revenues outside of P&C commissions can develop
the management fee based on each profit center rather than a single fee based on total revenues.
A profit center could be employee benefits department, commercial lines department, programs,etc. This will take into consideration the wider variety of management roles that may exist in a
larger firm or firms with diverse sources of revenue.
The second component of the compensation plan should be based on each owner's production.
The formula can be (and is recommended to be) the same as the non-owner producers in the firm.
In a typically agency, the commission earned by the owners averages 40% for new business and
30% for renewal. Oak & Associates generally recommends that there should be no commission
paid for personal lines or small commercial accounts, unless the producer/owner does the service
for those accounts.
The last component of the plan is a share in the profits of the firm. This would be a share in the
firm's profits net of retained earnings for capital investments. The split of profits should be based
on three main components: production (new and renewal), management and ownership equity. In
other words, the profits should go to the owners who generate them.
Compensation Methodology Sample
Agency Profile: For purposes of this sample let's assume a firm has three owners with $1,250,000
in total revenues. Approximately 90% of book of the business is from P&C accounts. The firm
was able to generate a 10% before tax profit margin for the past year. The firm will retain $25,000
in profit for future capital expenditures. Therefore, the owners' bonus for this year will be $100,000
(a profit of 10% on $1,250,000 in revenues less $25,000).
Based on the size of the firm they have set aside 5% of revenues or $62,500 for a strategic
management fee. Table 1 shows the ownership split, each owner's management role and the
amount of commission from their books of business. The production component will be 30% of
the renewal book of business.
Table 1. Owner Compensation Components
Owner
Ownership Split
Management Role
Management
Fee Split
Book of Business
Owner 1
20%
Financial Affairs
Automation
15% or $9,375
5% or $3,125
$300,000
Owner 2
30%
Market Relations
Sales Management
10% or $6,250
20% or $12,500
$425,000
Owner 3
50%
Admin. & Operations
P&C Service Mgt.
15% or $9,375
35% or $21,875
$250,000
The information in Table 1 can then be summerized in a matrix as show by Table 2. Each owner
receives three components for their compensation based on the their relative contributions.
Table 2. Summary of Compensation
Owner
Management Fee
Production
(30% of Book)
Bonus
Total
Owner 1
$12,500
$90,000
$30,000
$132,500
Owner 2
$18,750
$127,500
$35,000
$181,250
Owner 3
$31,250
$75,000
$35,000
$141,250
Total
$62,500
$292,500
$100,000
$455,000
This compensation sample demonstrates how the plan works and its flexibility. Owners that
choose to slow down and not work on management will receive less compensation for that
component. The owners that have to pick up the slack will be compensated for their additional
effort. Owners who excel in production will be compensated accordingly. It is a simple and
equitable method.
Summary
Owner compensation plans need to be flexible to allow for the natural change in owner's
contribution to the firm over time. The plan needs to also be fair yet rewarding to the major
contributors. Compensation is often a sensitive subject to discuss. Establishing a well thought
out plan that can automatically adjust to the owner's contribution will remove the potential for
disputes or hard feelings between owners.
About the Authors.
Bill Schoeffler and Catherine Oak are partners in the international consulting firm, Oak &
Associates, based in Northern California. The firm specializes in financial and management
consulting for national and international insurance agencies, including valuations, mergers
acquisitions, clusters, sales and marketing planning as well as perpetuation planning. They can
be reached at (707) 936-6565 or by e-mail at catoak@sonic.net.
