The Tragedy of the Commons is a popular story used to demonstrate the conflict between individual interest and the common good. The English Commons of long ago were plots of land where the farmers of a village collectively grazed their livestock. Each farmer could graze as many animals as he wished without cost or responsibility for the land. No one owned the land, and therefore no one had an incentive to care for it. As a result, the commons were over-grazed and soon became barren. The lesson is that when individuals use a public good, they do not bear the cost of their actions. If each person seeks only to maximize his own interest, he has the opportunity to ignore the cost of his actions on others.
The same situation happens–albeit to a lesser extent–in insurance agencies, where producers are the “farmers” and the staff represent the resources of the land. CSRs require the same time to write an account whether the commission is $200 or $750. A producer who writes many small accounts rather than large ones is not using agency resources wisely. A producer writing small accounts limits the resources available to other producers who are writing more significant ones. But producers rarely have an incentive to use the agency's resources wisely. (Of course, it makes personal financial sense for producers to write larger accounts. However, if money were an effective incentive for all producers to write larger accounts, I would not be writing this article.)
In addition to spending the same amount of time on both large and small accounts, CSRs are paid the same, regardless of account size; so an agency's resources are depleted, and agency profits are reduced. To adjust for working on smaller accounts, should CSRs be paid less? Not usually.
If an agency can make either $750 or $200 for three hours of CSR work, why not make the $750? When I present this idea to agency owners and producers, I'm often faced with staunch disagreement. Many owners/producers believe an agency should write any account that walks in the door and that profits are made on every sale, regardless of account size.
This just isn't true. According to the 2002 Academy of Producer Insurance Studies' GPS Study, the average commercial CSR services 285 accounts (the national average for agencies with $1 million to $2 million in revenue) and is paid approximately $35,000. These 285 accounts thus must generate at least $122.81 each just to pay the CSR's salary. If a producer receives commission on such small accounts, say at 30%, the minimum total commission then must be $50,000, for an average of $175.44 per account. Adding employment taxes and benefits at the industry average of 15% of wages increases the total compensation to $57,500, requiring a minimum average account size of $201.75. This is just for the labor and ignores other costs, such as rent.
Some believe that each sale does not have to cover a CSR's wages. This is the equivalent of saying, “Let's have the larger accounts pay for more than their share of the agency's costs,” or, “The agency's house accounts or contingencies or other producers' books can pay for the agency's costs.”
Other examples of “abusing the Commons” include not following procedures, excessively marketing accounts and endlessly rewriting late-paying accounts. Each of these activities consumes limited CSR resources, and none increases agency profitability–although each can increase producer compensation. Therefore, since no producer bears responsibility to care for the Commons, none has incentive to protect it.
Agencies can create incentives for producers to care for the Commons in several ways:
o Set a minimum account size (not policy size). The size can vary significantly among agencies, and each agency must set its own standard. Agencies have several alternatives for calculating a minimum account size: (1) Calculate the agency's average commission per account and divide by two. (2) Add the agency's average CSR compensation, average producer compensation and average benefits for two people and then divide by the agency's number of accounts per CSR. (3) Divide the agency's total expenses by total accounts.
Once an agency has determined its minimum account size, it can establish a policy for handling minimum-sized accounts. Options include paying no or low producer commission on accounts smaller than the minimum, as well as not allowing producers to write accounts less than the minimum size.
o Pay producers less on small accounts, so they are led to focus their time more productively and better align their interests with the agency's interests.
o Make producers cognizant of the Common's value by giving them a choice. They can get standard agency compensation with larger-than-the-minimum account size, and no or sharply reduced compensation for accounts less than the minimum size. Or, if they really believe every small account is profitable to the agency, set them up with their own business unit. They can keep 100% of the commissions but must pay the agency's average expenses. Agency average expenses, excluding producer compensation, equal almost 78% of revenues and approximately 86% of commissions for agencies in the peer group noted above.
I know many producers do want to protect the Commons and would not purposely abuse the agency in their own self-interest. Perhaps these people just need to be made aware of the situation and given the incentive to do what's best for all.
The Tragedy of the Commons exists in many forms. Does it still exist in your agency?
Chris Burand is president of Burand & Associates LLC, an agency consulting firm. Readers may contact Chris at (719) 485-3868 or by e-mail at chris@ burand-associates.com.
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