Marketing for Actuaries (LIMRA) - Chapter IV - TRADITIONAL DISTRIBUTION SYSTEMS

Overview

two distinct dist systems in US: Agency and Direct Response

Agency-Building Systems

Career Agents - co recruits, finances, trains & sometimes houses agents to represent them
- field offices - general agencies (headed by GA) and/or branch offices (agency manager)
- GAs appointed by HO and considered independent contractors
  - usually receive expense allowance to cover office-type expenses
  - responsible for fin mgmt of agency
- Branch Office - agency mgr gets assignment from HO and directly supervised by HO in fin mgmt of agency
- difference between GA and agency manager has blurred
Multiple Line (MLEA) and Home Service Agents
- usually exclusive relationship w/ HO
- MLEA also sell P/C products
- MLEA has much higher agent retentino rate than career agents
- Home service Agents - generally work in a debit (defined geog area)
  - works in lower-middle income mkts
  - all business is assigned to a servicing agent (eliminates "orphan" problem)
  - commissions generally NOT vested to writing agent

Independent or Non-Agency Building Systems

Brokerage
- mktg attempt to maintain relationships w/ producers whose primary affiliations are directed elsewhere
- usually do not finance, train, or house agents who represent them
- broker-insurer relationship - independent contractor
- many variations on brokerage - specialized products, substd business, etc
- brokerage supervisor - HO employee who contracts w/ brokers
PPGA
- contracted similar to how brokers are
- co-employed regional directors (RD), MGAs (Managing General Agents) & direct contact via press
- RDs and MGAs authorized to appoint PPGAs
- PPGAs supply own office facilities
- receive tech assistance in form of computers and adv sales support
- usually have contracts w/ several cos
- cu usually has min prod req to continue to receive tech support
Marketing Organization - co contracts w/ independent org to mkt its products
Wholesaling - co produces basic product and producer adds fees or commissions
Producer Groups - groups of high-producing agents agree to place min amts of business w/ a co in return for a share of profits
- usually through reins or stock options

Elements of Agent Compensation

Overview
- major components: FY/RY comm, asset-based comm, bonuses, exp allowances, security benefits
First Year Commissions
- expressed as combination of %FY prem, amt/polcy, amt/$1m, %CV
  - usually just % FY prem
  - often annualized & fully vested w/ chargebacks for early lapse
Renewal Commissions
- rate of compensation (usually % of prem), pattern of comp, conditions fro payment can be fully, partially, or non-vested
- reasons for disparate nature of renewal comm scales
  - competitive concerns
  - regulatory constraints (ex. NY Section 4228G)
  - desire to improve persistency
  - direct agent's efforts in manner conducive to co philosophy
- conditions for payment of renewal comm
  - renewal comm can be viewed as
    - deferred 1st year comp
    - reward for loyalty to co
    - payment (reward) for persistent business
    - payment for service to PO
    - start toward a retirement plan
Asset-Based Commissions
- aka trails
- % of acct value/cash value
- concept from stock/mutual fund world
- more common on annuities
- when on life, usually on UL/VUL products
- not a significant source of income for newer agents
Bonuses and other Compensation
- bonuses focus agents attention on product profitability
- various bonus measures
  - FY prem or commissions
  - net FY comm
  - total prems or comm
  - persistency (s/t and l/t)
  - # new clients or policies sold
  - combination
Expense Allowances
- usually a % of some mesure of slaes
- sometimes based on renewals/persistency
- used (in some cases) when agents pay some/all costs of office adn business expenses
Security Benefits
- a necessary and important part of overall compensation for career agents
- includes live ins, health ins, dis, ret benefits, profti sharing, thrift or savings adn 401(k)
- sometiems includes deferred comp options
- covered under federal and state laws - OASDI, unemployment, workers comp
- benefits ~ 16% of agent earnings
- ERISA - probably biggest impacy adn most important - 1974
- other acts include:
  - age discrimination - 1978
  - TEFRA 1982
  - DEFRA 1984
  - REA 1984
  - COBRA 1985
  - TRA 1986
  - OBRA 1987
- FAS106 - 1990 req'd co's to carry retiree benefit costs as liab on fin statements
Salary Compensation
- usually restricted to new agents
Differences Between Brokerage Contracts and Career Contracts
- career agent usually considered a stat employee adn receives a W-2
- broker compensation on 1099
- brokerage contracts - normally no provision for fringe benefits
- brokers commission schedules generally fully vested and pay rates generally below typical career agent
Compensation for Internal Replacements
- common methods for determing first year comm on internal replacemnt
  - % of full 1t yr comm where % increases based on dur of old pol, usually 100% after 10 yrs
  - full comm on increased prem, reduced comm on rest
  - difference between full FY and nwe and old
  - full FY if new prem > 2x old prem, otherwise %
  - full FY regardless

Levelized Commissions

high front-end commission structures palce persistency risk w/ cos
level com shifts much of that risk to agents
aligning agents' interestes w/ co may be what is needed ot arrest churning of business
problem w/ transistions to level comm structures
- increase in new agent fin cost since much lower early year comm
- transitioning existing agents from high FY to levelized
Possible solutions:
- option to commute later year renewals to earlier years
- adding add'l comp to existing business during transition
Two major challenges
- what will it cost to make this conversion
- will change produce overall favorable results to co

Estimating the cost of Agent Compenstation

PC(n) - % of companies FY prem producted by agents in nth year of service
O(n,t) - prob FY prem written by agents in nth YOS is from agents who will leave before policy enters year t
O(t) - prob FY prem from agents who leave before business enters year t
- =sum(PC(n)*O([n],t)
P(t) = prob prem fro year t will be paid
P(t)O(t) - prob that in policy year t, prem paid and agent no longer w/ co
r(t) - nonvested renewal comm as % of prem
cost of nonvested newnew comm = sum(r(t)*v^(t-1)*P(t)*[1-O(t)]
To calc O([n],t)
- l(n) = # agents entering nth yos
- w(n) = # agents w/d from service in yer n
- wq(n) = w(n)/l(n) = prob agent entering nth yos will w/d that year
- PRD(n,s) = FY prem produced by one agent during their nth yos who will leave in their n+s-1th yos
- O(n,1) = 0
- O(n,t) = sum(PRD(n,s)*w(n+s-1)) / sum(PRD(n,s)*w(n+s-1)) where first term is summed from s=1 to t-1 and second term is from s=1 to infinity

Financing the New Agent

Overview
- fundamental purpose of financing - make up difference between income needed (on a fair and resonable basis) and income initially earned under co's std basis of compensation
Degree of Financing
- depends on individual curcumstances
- Aptitude
- Preliminary Training adn Supervision
- Company and Agency
- Type of Commission Scale
- Annualization of Commissions
- Personal Circumstances
Types of Financing Plans
- Advances - loans made against future comm earnings
  - security against advances
    - comm on all business produced during financing period only
    - comm on all business, past and future, produced by agent
    - all fo agent's assets, incl commission earnings
  - rarely used
- Subsidy - aka Training Allowance Plan (TAP)
  - payments, on a formula basis, in addition to comm
- Salary
  - payments made in lieu of part (or all) of earned comm
Validation Requirements
- Validation Schedule - contains production requirements necessary to continue agent financing adn/or avoid contract termination
- 3 basic factors to a validation schedule
  - expected growth rate in agent production
  - avg comm scale expected for financed agents
  - avg persistency and modal mix of business sold by financed agents (usually on premium basis)
- need to know what to include/exclude from validation req
  - intercompany mktg agreements
  - subsidiaries
  - non-insurance products
- efforts to reflect indiv performances
  - salary plan that pay comm on sales > validation reqs
  - shift from salary to subsidy plans
  - subsidy plans that pay variable TAP based on performance instead of initial salary level
- some co's set up drawing accts to smooth out income fluctuations
  - aka line-of-credit plans
Variable TAP
- Advantages
  - production driven
  - agent experiences effect of production on income
  - less costly
- Disadvantages
  - income can fluctuate more than for experienced agents
Fixed TAP
- Advantages
  - income stable as production increases
  - strong incentive to produce b/c comm paid
- Disadvantages
  - high producers not rewarded proportionately
  - production does not have to be smooth
  - income can fall below income needs
Line-of-Credit Plans
- Advantages
  - income stable as long as acct cr/dr constant
  - large fluctuations in prod may still yield relatively stable income
  - fairly flexible by incorp adv from other types of plans
- Disadvantages
  - agent could have decr in income after fin period b/c comm withheld
  - production doesn't have to be smooth
  - more costly due to development and admin
Salary Plan
- Advantages
  - Level income regardless of production
  - additional payments if production > certain limits
  - attractive to prospective agents
  - easier for mgmt to recruit
- Disadvantages
  - high producers not always rewarded proportionately - may cause retention problems
  - costly if agents do not produce @ expected levels but continue on plan
  - income may change considerably when agent goes from salary to comm
  - requires close supervision adn strict adherence to validation scheds
Estimating Financing Cost
- avg financing level
- validation schedule
- agent retention rates
- first year prems - estimates should include FY prems by agents who terminate w/in fin period
- persistency rates and modal dist (freq of prem payments)
- comm payments and subsidy payments
- "unvested" recoveries - agents who terminate normally forfeit normally vested commissions on business written during fin period
  - "recoveries" normally subtracted from subsidy payments to determine fin costs
- example p.IV-22
Field Management Cost-Sharing
- provisions for sharing cost and risk of fin new agent usually in GA's contract and now branch managers as well
- Basic approaches
  - field mgmts share of the cost is highest in early part of fin period
    - discourages hast recruitment and careless selection
    - may carry marginal/failing agents until managers share becomes lower
  - field mgmt's share increases during financing period
    - mgr will continually evaluate prospects for sucess
  - field mgmt assums full cost responsibility from point when agent's production falls below some minimum validation level instead of requiring termination
Home Office Supervision
- agencies usually req'd to submitprogress reports on financed agents
Evaluation of Financing Plans
- criteria for evaluating effectiveness of plan
  - cost - ultimate excess of total payments over total comm
  - investment - amt outstanding at any time
  - simplicity of operation
  - understandability
  - degree of control
  - correlatoin between benefits and agents performance
  - dist of cost between co and GA or branch manager
  - likelihood of co's new agents meeting validation schedule
  - relationship of validation schedules to co's training porgrams
- financing plan is ont substitute for training, supervision and sales assistance

Elements of Field Mgmt Compensation

GO or agency manager - vital position in co's mktg org
many responsibilities incl
- recruiting/selection of agents
- agent training/development
- sales assistance and support
- 2nd line mgmt development
- business mgmt
- agency planning and admin
agency mgmt pay partly income for doing job and partly reward for taking risk
five major categories of risk
- development risk - associate w/ weighting various sources of business and productivity of source
- persistency riks - assoc w/ payment/nonpayment of renewal prems and conservation of assets
- expense risk - running the agency w/in certain standard for "controllable" expenses
- product mix risk - multiple products w/ smaller exp loading and profit margins
- time risk - delay between "virtuous activities" adn "result" that system rewards
  - may also be stabilization factors adn deferrals which futher separate reward from behavior
General Ageny vs Agency Manager Systems
- Theoretical Differences
  - GA is indep dist adn therfore assumes greater business risk in return fro greater l/t reward
  - 3 distinct types of GA contracts
    - general agency contract calls for specific overrideg comm to the GA and provides separately for the soliciting agent's comm
    - company pays comm to GA and PG pays to comm to agents - seldom used today in agency-building situations
    - PPGA contract primarily a producer contract
Personal Production
- regualar comm on personally produced business often not a substantial element of agency head's income
- agency managers historically viewed as sales managers w/ principal responsibility to increase sales of co's products
  - expected to recruit/select/develop career agents whose perforamcne will help co achieve corp growth adn profit objectives
Compensation Overview
- Salary - exclusive to managerial systems since inconsisten w/ indep dist philosophy of GA approach
- First-Year Overrides - motivate new sales
  - most sytems place significant rewards on this component
- Renewal Overrides - usually paid in a GA system, less freq in a managerial system
- provides CF stability to a GA and incentive for persistent business
Vesting - usually subject to vesting provisions that give GAs ownership of future override streams if they leave co
- originally intended to continue the return of invested capital after GA returned
Service Fees - common in GA systems
- orig established to cover prem collection and certain service functions
- usually not vested
Bonuses - do not usually vest
- aka leverage elements
- ex agency productivity, new agent organization, agency persistency, growth
Expense Allowance/Business Management Factor
- GA pays all expenses (in theory)
- managerial approach - co provides agency office and support
- GA expenses generally lower since he makes decisions based on actual CF
Sharing of new Agent Financing Cost
- loss-sharing assures better supervision and encourages more economical use of co resources

Copyright © 2004 Steve Welander.
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