Hard vs. Soft Dollars: Determining The Real Costs Of Distribution

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One of the biggest challenges facing senior management is determining how to maximize the value of each dollar spent on distribution. Distribution spending can be broken down into two basic categories: “hard dollars” and “soft dollars.” Companies that identify how they spend these dollars take a significant step to understanding the dynamics of their distribution system.

Hard Dollars. A “hard dollar” is cash in an agents pocket. First-year commissions, gross dealer concessions, renewal commissions, trails and expense reimbursement are examples of hard dollars. These costs are expressed as a percentage of sales, and the actual dollars paid by the company vary directly with the level of production.

However, hard dollar compensation is only one aspect of the overall expense a company has in maintaining a distribution system.

Soft Dollars. A soft dollar does not go directly to the agent as cash. Rather, it is anything that supports a producers ease of doing business. Ten years ago, soft dollars were called the “value-added” that a company brought to the table.

Soft dollars do not always fall into the traditional definition of compensation. Common soft dollars include advanced underwriting, agent financing and training, marketing materials and tools, lead generation initiatives, conferences and contests, health insurance, matching 401(k) contributions, matching FICA, and sales seminar support.

In practice, a strong distribution program and a good compensation package are built on a complex system of hard and soft dollars. These systems evolve over many years, sometimes decades, and it is often difficult for companies to define and identify the soft dollar services they provide.

Soft dollar services are frequently introduced with very little cost benefit analysis, and they are maintained because the company does not know what might happen if the program is eliminated.

The Cost. Both hard and soft dollars have two things in common: They provide benefits to the distribution channel and they have cost to a company. Most companies can easily identify the costs associated with hard dollars. Ask any senior executive, and he or she can easily list the hard dollar expenses: We spent $15 million on life commissions, $4 million on mutual fund commissions and $6 million on annuity commissions.

Companies have a much more difficult time calculating the cost of soft dollars because the accounting treatment for these soft dollar services is more complex. The accounting systems for soft dollars are not self-managing; they require yearly budgets and staffing that do not automatically change with varying levels of production.

One of the main economic characteristics of soft dollars is that they often contain a fixed cost element. For example, marketing materials involve a large fixed investment in development, but once finalized, the cost of ongoing production is low. This means the soft dollar cost, when expressed as a percentage of sales, decreases as sales increase. The chart lists some common characteristics of hard and soft dollars.

The Value. Agents place a very high value on hard dollars. However, agents place the same value on these hard dollars without regard to which company provides them. There is nothing that a company can do to increase the value of each hard dollar, other than to pay more hard dollars than the competition.

In the agents mind, however, there is a trade-off between hard and soft dollars. The value of a soft dollar benefit is not measured in monetary terms but in the perception and preferences of the agent. This value is based on how useful and beneficial the soft dollars are to increasing the agents ease of doing business.

This difference between the agents perceived value and the actual cost of soft dollar services can provide a company with a competitive advantage when designing marketing support for a distribution channel.

Profitability. Ideally it is possible to create an optimal mix of cash and services to the field. This optimal mix will present agents with a bundle of cash and services to keep them productive, to create an environment in which the agents want to remain and to attract new agents to the company. However, while the value to the agents may be optimized, the company must take care that the cost of this bundle is within its distribution allowable and that it is profitable.

In surveys we conduct for our clients, agents generally state a preference between receiving either additional marketing support or 10 points more on base commissions. Using our modeling tools, we then quantify the agents perceived value of each soft dollar item and determine the actual cost of each soft dollar item within our clients distribution systems. By comparing the perceived value with the actual cost, a company is then able realistically to assess the profitability of its soft dollar spending.

For example, if the perceived value to the agents of seminar support is two points, but the cost to the company is nine points, the company may decide to discontinue this seminar. On the other hand, if the perceived value to the agents of advanced marketing case design support is 12 points and the cost to the company is four points, the company may decide to add more advanced marketing support.

Once this analysis is completed, a third alternative is available: The company can create a win-win situation by offering an optimal mix of soft dollar services, passing part of the savings to the agent as hard dollars and retaining the remainder as company profit.

Using this process to gain understanding of the trade-offs between the real costs and benefits of hard and soft dollars, a company can maximize the effectiveness of its distribution channel by giving its agents the best mix of hard and soft dollars while still maintaining profitability for the company.

Adrian Pask, ASA, MAAA, is an associate actuary of the Hartford office of Milliman USA. He can be reached at adrian.pask@milliman.com.

Randy Masters is a senior associate at Management Research Associates. He can be reached at rmasters@mrainc.org.


Reproduced from National Underwriter Life & Health/Financial Services Edition, August 25, 2003. Copyright 2003 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.