Equity Options for Insurance Agency Producers

The topic of producer equity has been a conversation in the insurance industry for decades. It’s understandable that there is an inherent sense of ownership on the part of producers due to their contributions to the agency and relationships with clients. Offering producers a path to ownership is a strategy used by many agencies to help recruit and retain talent. If set up properly, it can be a legitimate way to incentivize organizational growth.

Producer equity or book ownership can make or break long term value within an insurance agency. If it isn’t set up correctly with clear and aligned goals for both parties, it often is a leading cause of producer disputes and sources of litigation for an agency owner due to ambiguity of agreement language.

There are different methods to which an agency can extend equity, so it’s important to understand mutual goals and the desired outcome so the appropriate plan can be implemented. It’s also important to note that this article is meant to be an introduction to various equity methods and doesn’t go into detail regarding strengths and risks. This article is the first of several in a series to discuss equity options for producers and employees within an agency.

Here are a few ways to offer producer equity within your agency:

1. Equity Partnership and Ownership of Shares

Many established agencies operate with a producer partner model which is a great perpetuation plan option. As a partner prepares for retirement, they can assess options for other partners to buy their shares or invite other producers or key employees to participate in their buyout. This is often seen as a way for partners to be thinking as owners and not solely vested in their own performance.

As an agency grows, it is common there are multiple partners with varying ownership levels. For this to operate well, it requires a good working relationship with one another, a professionally written operating agreement, and solid agency management of operations and finances. We also recommend having continuity and succession plans in place, just in case.

Some common issues we often consult to help resolve are partners who aren’t aligned on tax strategy or profitability, growth goals, or managing the agency finances to support a partner’s exit. Too often a management philosophy to avoid taxes causes problems for an agency’s value and support for a buyout. In many cases there are disputing partners who remain together because they can’t afford to buy the other out . . . no different than spouses who choose to live together because they can’t afford to move out.

2. Phantom Equity

Don’t let the name fool you. It’s called phantom equity or shadow stock but it’s real money. If you want to offer an equity-based incentive without share ownership this can be a great option. Phantom equity offers a benefit to the vested party that mimics the underlying company shares. It can be designed to either pay a portion of proceeds equivalent to the value of the underlying shares. Phantom Equity is administered by granting certain rights to the award holder to call in financial benefits relative to the defined events in the contract such as an agency sale, retirement, or profit-sharing bonuses.

Phantom equity is regulated under IRS rule 409a which defines Non-Qualified Deferred Compensation (NQDC). There are special rules governing these types of plans because of the complexity with deferred income that require diligence in designing the plan for compliance. If not administered correctly it can incur tax liabilities and penalties for both parties.

If you are considering phantom equity in your agency, let’s talk. We partner with a phantom equity management platform that facilitates the contract and administration within an easy-to-use portal.

3. Book Vesting for Deferred Compensation

I mention it above, but have you ever heard of 409a? Most people have heard of 401k or 403b plans, which are qualified deferred compensation plans defined by the IRS. 409a refers to NQDC plans that are alternative compensation plans for key employees. If the producer’s goal is to receive a cash buyout or deferred compensation based on their book of business when they retire, then you need to consider a NQDC plan.

This type of plan also creates a better direct reward for producers that grow their book of business, compared to granting shares in the agency itself, and adjusts with producers when their book of business shrinks. Because a producer’s book can often fluctuate up or down, many owners are hesitant to offer a fixed percentage of equity or phantom equity in the event the producer doesn’t continue performing.

A book vesting program is often designed with milestones to include minimum revenue thresholds and tenure. A properly designed plan will have a defined path to vest in the program, the terms that trigger a liquidity event, and a formula that defines what is being paid and when.

One of the first projects I got to experience in an agency was reviewing producer NQDC plans and analyzing the impacts of commission for assigned accounts upon their retirement. We have tools that help evaluate the feasibility of a book vesting NQDC plan and help with plan design if this is something you are interested in implementing.

4. Employee Stock Ownership Plans (ESOPs)

While not exclusively for producers, an Employee Stock Ownership Plan (ESOP) provides a company-wide program that rewards employees through vested ownership. Properly administered and managed ESOPs are a way to help everyone benefit from their efforts and the long-term success of the company. ESOPs are governed by ERISA, typically must be available to every full-time employee, and grant voting rights to shareholders.

A few things must be in place for an ESOP to be successful, such as the agency’s management and employees having a shared vision, the agency having sufficient financial performance to fund the plan, and a proper set up and administration of the ESOP. There is no minimum threshold for an ESOP to be used but administration requires considerable resources, which can hinder most small agencies from pursuing setting one up.

Producer Equity and Selling Your Agency

While producer equity offerings are designed with the intention of fueling equity growth for agency owners, it can add complexity to a transaction. The challenges of navigating producer equity through a sale will vary based on what agreement you have with producers, but it is critically important to address a potential future sale of the agency within the producer agreement, including the assignability of restrictive covenants.

“Producer equity”, in whatever form you design, will typically need to be settled prior to or at closing when you sell your agency. If not properly planned, it can derail the closing or leave you in a position where you net much less from the sale than you anticipated.

Keep the End in Mind

No matter what option you choose to implement it should be designed with the end in mind. As the musician David Wilcox says, “Start with the ending it’s the best way to begin.”

If an agency makes the right hires with quality producers, it can be a viable option to offer some type of equity or deferred compensation incentives to reward long-term value growth. Some major questions should be answered prior to drafting and signing an agreement if this is something you are considering.

Schedule a free consult to see if producer perpetuation or deferred compensation is a viable option for your agency.

Posted by: Colby Allen VP of Valuation and Consulting / CFO
Direct: (321) 255-1309