Levelized Compensation

Transcription

1 Levelized Compensation Is the Concept Still Appropriate? By Bill Weeks, CLU Special Consultant, LIMRA Consulting Services t LIMRA s Annual Meeting in Orlando last fall, the CEOs of Protective Life (John Barrett) and of Western and Southern (Bryan Dunn) advocated level commissions from the podium during a CEO interchange. While they were not willing to go first with their own companies, they said that the industry would be better off if it (as a whole) adopted the concept. In 1995, the relevant New York State regulations were changed and level commission systems could be adopted for those companies that operate in New York State. At that time, it was widely thought that several companies would adopt that approach, but here we are 10 years later and the concept of level commissions is still just talk within the United States with a couple of minor exceptions. Back in 1995, I wrote an article called Levelized Comp Revisited in this magazine that addressed the issue of who would win and who would lose if levelized compensation were adopted. Given the prominent mention just given the concept, it s time to look at it again. As both Mssrs. Dunn and Barrett stated, individual companies are not likely to adopt the concept of their own accord as they fear that their producers would leave en masse for companies still offering heaped commissions. Nonetheless, there is also a feeling that regulators might force a move away from heaped commissions in an effort to improve overall market conduct. 8 LIMRA s Marketfacts Quarterly / Spring 2006

2 Is levelized compensation (LC) a good fit in today s environment? Should the industry be proactive and migrate somehow to a level commission structure? Or are there other concepts that would be a better choice if the industry were forced (or led) to a wholesale change in its compensation structure? A Brief Look at Level Commissions In comparison with traditional or heaped commissions, level c o m m i s s i o n s o r l e v e l i z e d c o m p e n s a t i o n r e d u c e s t h e commission rates paid in the first year of policies and spreads the savings over the renewal years. In the purest version it is literally level for all policy years. In practice, there is usually a modestly higher first-year payment or a growth bonus added to first-year pay to encourage making new sales. Traditional or heaped compensation has a much higher first-year compensation opportunity, either integrated into the commission rate or with the addition of potential bonuses. A long list of Canadian companies adopted level commissions in the early 1990s. Since then, only a few have not been merged into other firms (not due to LC), and these report higher persistency and better producer retention than do their American cousins. They have struggled, however, with increasing LIMRA s Marketfacts Quarterly / Spring 2006

3 the number of producers and the number of sales made. Still, level compensation cannot be directly connected to those results. Only a couple of American companies have moved to a level compensation structure. The theory behind a level commission approach is that it will encourage producers to stay in close touch with their clients over the life of policies they have written and that the persistency of policies will move significantly higher because of it. In turn, because it takes some pressure off the need to always make new sales, the retention of producers will improve as their income becomes much more stable over time. Are the advantages of level commissions sufficient to warrant the costs required to implement that approach? What headaches will level commissions help relieve? A typical life insurance company in today s environment using a traditional compensation system (heaped first-year and low renewal commissions) is struggling with a variety of issues, including these five: 1. The economics of hiring and training new producers Many have abandoned it altogether, while others have cut back substantially. Yet, companies cannot survive long without adding new policies, and without adding producers, new policy counts will continue to slide particularly as the bulk of the industry s producers nears retirement age. 2. Substantial numbers of orphan policyholders It is not unusual for a company to have over 50 percent of its clients without an active or even assigned agent. The orphans far outnumber any reasonable ability of the current field force to service and still make new sales. 3. Significant fluctuations in cash flow for producers of all production levels under traditional compensation systems Field and company management waste valuable time and money collecting debts, setting income guarantees, and helping producers and managers manage their cash flow. 4. The need to improve levels of customer service A variety of consumer studies show the insurance industry providing poor levels of customer service when compared with other financial services companies (i.e., banks, stockbrokerages). Consumers now expect quality service as a matter of course. 5. Continuing pressure on distribution margins This is because of the increasing pressure from stockholders, rating agencies, producers, technology, and of course inflation (on their respective sides of the issue). Can LC help address those issues? Level commission systems can have a positive impact on all these issues. Consider the impact on experienced producers. By increasing the payment level made on renewing sales, producers would still make a substantial income from customer relationships when their companies begin to profit from sales. That is, LC aligns the profitability schedule of producers with the profitability schedule of the company and its employees. A level system also provides a much more stable income flow to producers, which helps improve their retention and reduces net financing costs for new hires. By providing an income flow that more closely resembles those of other occupations, LC will increase the attractiveness of the profession. And, it can be used to seed new producers books of business and improve their probable success rates. (This approach contributes significantly to the superior retention rates enjoyed by multiline companies.) In turn, producers are encouraged to pay more attention to existing clients, which improves persistency and the likelihood of repeat sales. Level commissions strongly discourage replacements and improve market conduct accordingly as producers have meaningful incentives to service their own as well as assigned customers. Level comp also aligns the economic interests of company employees and producers. Home office employees whose income and job descriptions require 10 LIMRA s Marketfacts Quarterly / Spring 2006

4 excellent administration of company funds, document processing, or customer service will be valuable assets to producers. While they would remain justifiably anxious about how applications are being handled, their whole livelihood will no longer depend on the outcome. Can It Get Any Better? Each of these changes helps companies become more profitable and helps producers have more stable and predictable income. Producers win, companies win. Yet, if this is such a clear win-win, why aren t more companies jumping to it? Or, more pointedly, why aren t at least a few companies going to it? There is a long list of reasons starting with the usual bugaboos: inertia and the cost of making system changes. That inertia is cemented into place by fear of change and risk of failure. While those reasons will certainly be hard to overcome, they pale in comparison to these three: 1. The risk, costs, and trauma associated with transitioning from high-low to level commission systems particularly if not done on an industrywide basis 2. Perceived inability to stimulate new sales under an LC system 3. The de facto changes in companies sales and service strategies that have occurred in the past few years Let s look closer at each of those key reasons. Transitioning to Level Comp The natural first reaction of sales personnel in any industry to a change in their compensation is a fear that their pay levels will be cut. Level commission systems are typically not intended to reduce compensation; instead they are intended to achieve better alignment between the agent, the company, and the customer. While careful, complete, and oftrepeated communication of this will help alleviate this fear, the challenges of transitioning producers to level commissions are significant. The actual dollar costs can, however, be spread out over time and may be paid for by improved persistency. This is a cost that companies must incur producers will not finance the change for them. Expecting producers to migrate to a level commission system from a traditional approach over time will not work either. Companies that have offered level commission product options have found it has worked only when an agent wants to defer income toward the end of a fiscal year. Several Canadian companies made highly successful transitions by paying the level (renewal) commission rates on policies already in their renewal years. They may have paid more than necessary, but they retained their producers and policyholders. Yes, companies can be successful in transitioning producers to level compensation. Unfortunately, it must be all or nothing within a company. One well-known U.S. company attempted it with just new producers and found that established producers unconsciously sabotaged the change by alerting new hires to heaped compensation alternatives. Stimulate New Sales Suppose you made your living selling widgets and you needed to sell 100 a year to afford your standard of living. If someone told you that they would pay you the same amount in the future if you sold only 85 widgets and keep them in good repair, would you still sell 100? That is the basic dilemma facing companies that implement level commissions. Compensation design can successfully address that dilemma, but the solutions require different approaches than most companies now have in place, thereby aggravating the fear of change. Level commission systems do not need to stand LIMRA s Marketfacts Quarterly / Spring

5 In the final analysis, companies have limited capacity to increase sales with their existing field force. on their own. They can be combined with other initiatives such as cross-selling bonuses and assetbased compensation. They can also encourage new sales through a variety of methods: A premium growth bonus to reward new sales as long as those sales represent a net addition to the agent s in-force block of premium. Adding a per-policy fee once producers exceed X number of sales per month. One Canadian level commission company implemented this after finding how successful it was with their inexperienced producers. Making level commissions contingent on minimum persistency results. This ensures that producers pay attention to existing clients. Increasing the performance expectations of producers for recognition, contract retention, and conference attendance. (Level commissions begin to function like golden handcuffs in this scenario. Producers find that they can t afford not to do the minimum required new business or leave the company, for that matter.) None of these are revolutionary concepts, but they do require disciplined execution over time to be successful. In our industry, we often do not have the patience for that. In the final analysis, companies have limited capacity to increase sales with their existing field force. In most cases, significant growth requires horizontal growth, not just vertical growth. Adding more producers is probably easier to accomplish with level commissions than it is with high-low systems. So, yes, you can transition the incumbents and you can stimulate new sales adequately under a level compensation approach, but it requires a lot of change. The big question then is whether it will be worth it. New Sales and Service Strategy Aligning compensation design with an incumbent s job description is a basic tenet of compensation 12 LIMRA s Marketfacts Quarterly / Spring 2006

6 [ Figure 1 ] policies and clients sold 1,400 1,200 1, Net Active Clients YEAR Policies in Force design. For those few companies that expect the primary relationship with the client to be provided by the agent (from the date of initial contact through claims payment, surrender, or annuitization), level commissions provide a perfect match. This may well be the case for those companies whose producers operate in a high-end market with a small group of active clients. Still, it no longer seems a match for the remainder. Most companies have moved away from expecting agents to provide much service after the sale without consciously implementing any change. Let s examine the evidence. Many companies now offer a variety of products such as level term and long-term care and disability plans that are lapse supported. Without a comparatively high level of lapsation (compared with traditional or universal life), they cannot make a profit on theses sales. Many have also added surrender charges or back-end policy loads, which move responsibility for persistency from the agent to the policyholder. Agents affiliated with producer groups as well as a significant share of our bigger insurers have moved upscale and are selling much larger policies than they were some years ago. These have much higher persistency rates than smaller policies. Customer service centers have become much more adept at providing both a broader range of services without agent involvement and at successfully referring the client back to an agent for additional sales. Each of these changes has contributed to improved persistency for most product lines. Whether intended or not, companies are no longer expecting agents to provide the proactive service after the sale, which LC plans would encourage. There is also some question regarding what service is now being provided when agents are being paid to provide service. In a recent distribution project with a midsize insurer, we found that policies still associated with the original writing agent had lower persistency than orphans assigned to agents or even unassigned orphans. While the differences were not huge on a percentage basis, they were just the opposite of what we expected. (These results were calculated after excluding sales made by newly hired agents, who often have poor persistency.) Another issue deserving more study is what a producer can realistically be expected to do. Consider this scenario: A new producer starts with a goal of selling 100 policies a year and seeing all current clients once every three years. If he or she sells 1.2 policies per close and spends 2.5 days (counting all time spent in marketing, preparation, selling, training, and compliance) on new sales, and has good lapse rates (12 percent new, 8 percent on renewals), he or she will have over 550 clients and over 650 policies in his or her sixth year under contract (Figure 1). If our hypothetical agent were to work a full 240 days a year and spend 0.4 days (about 3 hours) each LIMRA s Marketfacts Quarterly / Spring

7 [ Figure 2 ] Allocation of Time With One Third Serviced Per Year DAYS YEAR the office and got alarmed when they had to call long distance. Today, a typical customer prefers to handle his or her own service over the Internet, and thinks nothing of calling a toll-free number and never talking to a live person. While producers still need staff to expand their sales efforts, adding service staff within a life producer s office no longer seems appropriate. (The opposite should be said for sales support staff.) Selling New Customers Servicing Clients time he met with an existing client, he soon runs out of time to do it all. In fact, he runs 30 days short of all the time needed to do that job in that same sixth year under contract. Figure 2 shows that by his or her 10th year in business, our hypothetical producer runs short almost 80 days. Is it any wonder that producers do not proactively service their entire existing block of clients? Without adding administrative staff in their personal operation, producers quickly run out of capacity to do both sales and service at the levels we assumed. We could have a lengthy discussion about whether these are the right assumptions and in particular about whether producers should be pursuing new clients when they might be more effective intensively working a small group of clients. Regardless of what tweaks we might make, it becomes a question of when not whether a producer must hire administrative staff to handle much of the service and sales preparation work. Not every producer wants that risk and responsibility. Years ago, encouraging agents to add service staff within their offices was the right answer. Back then, policy records were kept in an agent s office on a policy card and clients brought their premium payments to Net Available Conclusion Level compensation plans for producers can be the right answer in a few select situations. For those companies whose clients require high levels of high-end service over time, it aligns their pay with their job description. Most companies, however, cannot afford to reduce the incentive to make new sales to new clients. Much of what level compensation plans support can be encouraged through product design and innovative compensation elements without the massive change required. Given the choice between encouraging more service to renewing policyholders and encouraging more sales, the choice seems clear. c Bill Weeks, CLU, is a special consultant for LIMRA, who specializes in sales and incentive compensation plans and distribution effectiveness. Weeks has been affiliated with LIMRA for eight years, interrupted by a four-year stint as Vice President of Sales Compensation for Prudential Financial. He holds a master s degree from Syracuse University and has over 20 years of experience in compensation design and distribution management. Weeks can be reached at ( , wweeks@limra.com). 14 LIMRA s Marketfacts Quarterly / Spring 2006