Paul Margus, FSA, MAAA

Field Compensation Case Study

Field compensation has long been controversial.   Itís part of a more general tradeoff: how to maximize total long-term profit.   Total profit is the profit per sale (often the Actuarial focus), multiplied by actual sales (the Marketing Departments mission).    Sales are increased by liberalizing the premiums and field compensation; but that reduces the profit per sale.

I have constructed a hypothetical example.   Itís somewhat contrived, because I didnít want it to resemble existing company too closely.   This company has a diverse field force of independent brokers.   Over 60% of them generate less than $30,000 of new premium annually.    Looking at the top two brackets, we see that the 30% of producers sell 80% of the companyís business.

New Premium Bracket

Producer Count

New Premium

($000,000)

Average per Producer

$0

to

$29,999

27,000

60.7%

$410.0

12.2%

$15,185

$30,000

to

$74,999

4,000

9.0%

$200.0

5.9%

$50,000

$75,000

to

$399,999

12,450

28.0%

$2,077.5

61.8%

$166,867

$400,000

+

 

1,050

2.4%

$675.0

20.1%

$642,857

All Brackets Combined

44,500

100.0%

$3,362.5

100.0%

$75,562

 

To stimulate sales, the companyís compensation rates increase with production level; Ö

Policy Year

Individual Production (New Annualized Premium)

$0

$30,000

$75,000

$400,000

to $29,999

to $74,999

to $399,999

+

1

35%

50%

75%

90%

2

-

10

5%

10%

15%

20%

11

+

0%

2%

2%

2%

 

Ö resulting in a parallel progression of increasing compensation costs.

New Premium Bracket

One yearís Sales

New Premium

($000,000)

PV of New Premium

($000,000)

PV of Compensation

($000,000)

Cost, expressed as a Level Percent of Premium

$0

to

$29,999

$410.0

 

$4,738.8

 

$256.3

 

5.4%

$30,000

to

$74,999

$200.0

 

$2,311.6

 

$230.2

 

10.0%

$75,000

to

$399,999

$2,077.5

 

$24,012.0

 

$3,482.3

 

14.5%

$400,000

+

 

$675.0

 

$7,801.7

 

$1,418.3

 

18.2%

All Brackets Combined

$3,362.5

 

$38,864.2

 

$5,387.1

 

13.9%

 

As expected, the downward progression of profits mirrors the above pattern.

New Premium Bracket

All items are expressed as a Level Percent of Premium

(PV of the item divided by PV of Premiums).

Claims

Compensation

Other Field Expense

(60% of Comp)

Home Office Expense

Premium Tax

Profit before Federal Income Tax

Total

$0

to

$29,999

60.0%

5.4%

3.2%

10.0%

2.0%

19.3%

100.0%

$30,000

to

$74,999

60.0%

10.0%

6.0%

10.0%

2.0%

12.1%

100.0%

$75,000

to

$399,999

60.0%

14.5%

8.7%

10.0%

2.0%

4.8%

100.0%

$400,000

+

 

60.0%

18.2%

10.9%

10.0%

2.0%

-1.1%

100.0%

All Brackets Combined

60.0%

13.9%

8.3%

10.0%

2.0%

5.8%

100.0%

 

In practice, decisions are often made solely on the composite profit.   In fact, in pricing a new product, we often skip the breakdown by New Premium Bracket.   In this example, our decision would be based solely on the 5.8% pretax margin.

And yet most business people would accept the above breakdown.   The controversy is in what to do about it.    In the high production bracket, does each additional policy actually decrease the bottom line?

Before jumping to conclusions, could we justify reallocating some of the Home Office Expense to the lower producer brackets?   After all, even the largest producers need only one license.   Additional data may show that larger producers write bigger policies.   And the small producers may need extensive technical assistance for their one or two policies per year.

In our example, these adjustments would probably eliminate the red ink in the top bracket.    The real question is: what do we do if the problem persists despite these efforts?   That is, does each new policy in the top bracket really decrease the bottom line?   If so, perhaps we should adjust our compensation scale.

But there may well be some business reasons to accept the situation.

  • Large producers may control the sales of smaller ones.
  • Depending on the producerís contract, the problem may be confined to policies sold late in a calendar year, because the producer spends the early months in a lower bracket.

Although we have no conclusive answer, one thing is certain.    We should use all available data to identify weak cells and inherent cross-subsidies.   Then, we can make rational business decisions, which may entail consciously accepting a few such imperfections.  The key is to fully understand the implications of these decisions.

 ©2009 Paul Margus

 
 
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