Cutting the Big Checks: Mitigating the Financial Risks of Contingent Commissions

If a portion of the profit share or bonus expense hits against the current year’s income instead, this can be a significant risk for the company and its shareholders.

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For the insurance industry, distributing bonus and profit share payments, also known as contingent commissions, helps solidify business relationships and is an important symbol of success. Paramount to success for any pay-for-performance program however, is ensuring that the payments are accurate and booked in the right year. If an insurance company has been on target with its budget and its accruals for bonuses, the expenses are taken in the year that the profitable transactions occurred. However, if a portion of the profit share or bonus expense hits against the current year’s income instead, this can be a significant risk for the company and its shareholders. To help financial professionals mitigate this risk, the following article outlines several strategies to consider.

Salary Bonuses

Segmenting the individuals participating in the bonus program from non-eligible employees is always the first step in working through your bonus accrual. Sometimes the selections are made through business roles, performance ratings or consist of complete departments.

Consider these principles:

  • The gross revenues or net profit of the full company, division or department are the main drivers used to calculate the amount of money put into the bonus fund.
  • Set minimum and maximum thresholds as the parameters for the amounts able to be earned by any one group or individual.
  • Key Performance Indicators (KPIs) gauge the measure of success of the individual and the KPI values determine the expense amounts booked to their different departments.

Profit Shares / Contingent Commissions

The contingent commissions that are frequently paid by insurance carriers to their producers reflect the amount of ‘good’ business that they’ve brought to the company. The producers (agents or brokers) may then distribute a portion of those contingents earned as bonuses to their own top players. Carefully evaluate the following key factors to ensure that their values are accurate:

  • Earned premium is the primary factor in calculating commissions. Booked premium is recorded as policy contracts are executed while earned premium gets recorded when payment has been made and the coverage period has started.
  • Claims incurred, and more specifically, the loss ratio KPI, are critical factors in calculating potential profit share payments. The claim amounts in the formula compared to the premium will sometimes vary by contract but most will also include Incurred But Not Reported (IBNR) claims as well.
  • Other factors considered in many Contingent Commission contracts are year-over-year growth, reinsurance ceded premium and commission, as well as Producers who achieve specific milestones.

Mitigating Your Expense Risk

Insurance itself is the perfect example of mitigating the risk of expensive events devastating any one individual, family, or company. The same concept applies when you want to reduce the risk of your bonus payment and profit share expenses hitting your books in the wrong year. Utilizing budget and forecasting software to automate this arduous process can serve as a critical enabler, increasing the accuracy of your numbers while simultaneously reducing your own stress. A few key strategies to maximize the efficiency of a streamlined budgeting and forecasting process include:

  • Set up report layouts for each unique contract and segment Producers into tiers or groups that have similar contracts.
  • The values and KPIs should be pulled directly from the master budget plan so there is no worry about typos or formula errors causing premium dollars or claims amounts to be inaccurate.
  • Salary Bonus programs work in the same way. Pull the indicators needed into a Wage Bonus Report to match your specific program. Have the report automatically populate with the salaries of the individuals or groups that participate in the program, any multipliers needed, and tie them to the KPIs. Then let the report do the work.
  • Monitoring tools and dashboards allow for seamless review of the imported actuals from the GL and easily populates the remainder of the year with your forecast. You’re now ready to determine if any adjustments need to be made.

Planning, monitoring and revising your expense expectations are critical to the success of your business. Using planning software is an ideal way to perform those functions. Custom reports set up with the indicators and KPI’s that your company focuses on allow you the control you need to best manage your expenses.

In addition, there are analytical strategies you can implement to complement an automated budgeting and planning process.  For example, execute a two-step review process where the calculations are completed independently and compared.   Then, notify the bonus team of all contract changes to determine if adjustments are needed to the accruals or final payments and make sure to include your marketing leads in the review to ensure that the results are in line with their expectations.

While it’s refreshing to cut the big checks to celebrate the success of your company, there are risks to consider.  Being prepared and implementing the right mix of technology and financial planning strategies to mitigate this risk will alleviate the stress related to this practice and ensure the efficiency and accuracy of your profit share and bonus planning.

 

John Orlando // John Orlando, CFO of Centage Corporation, has over 25 years of experience in finance, accounting and administration. He has extensive experience working with both high growth Fortune 500 companies and start-up businesses. Prior to Centage, Orlando served as Group Director of Planning & Analysis at WearGuard (a subsidiary of ARAMARK) where he was instrumental in driving profitability via cost containment and margin improvement initiatives.

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