This type of contingency contract makes sense for agents, companies — and consumers.
Since October 2004, there’s been widespread media coverage of lawsuits against brokers for alleged conflict of interest when they accept fees from their clients, as well as contingency bonuses from insurance companies. Although the nature of the suits varied, the attorneys filing them and the reporters writing about them didn’t seem to understand contingency contracts. Perhaps semantics is the issue, because the lawsuits and the press referred to the bonuses variously as “profit-sharing agreements,” “contingency bonuses,” “contingency fees,” “volume bonuses,” and “placement-service agreements,” as if these agreements are all the same — when in reality, they differ significantly.
After analyzing hundreds of bonus agreements throughout North America, talking with hundreds of agents about using these contracts strategically, and giving dozens of speeches on the topic, I’ve gained more insight than most into the subject. Based on my experience and the supposition that contingency bonuses pose a conflict of interest, I would place contingency contracts and their resulting bonuses into one of two categories: (1) Those in which insureds’ loss ratios are a factor, and (2) those in which they are not.
When loss ratios are not a factor and bonuses are awarded simply for the volume of business placed, a conflict of interest probably does exist, especially if agents/brokers charge their clients fees. In these cases, bonuses should always be disclosed.
Litigation stemming from contingency contracts in which loss ratios are used to calculate bonuses troubles me more. Contingency contracts with loss-ratio provisions work to everyone’s benefit if — and this is a huge “if,” as I will show later — agents and brokers read and understand the contracts.
Contracts with loss-ratio provisions generally pay contingency bonuses if the agent/broker achieves an adequately low loss ratio. Top contracts that emphasize loss ratios will pay large contingency bonuses for low ratios. Insurance companies benefit from such contracts because the bonuses they pay are significantly less than the claims they otherwise would pay if the loss ratios were higher.
Customers win, too, because by taking a proactive approach to loss prevention, they should experience fewer claims, which reduces their costs in two ways: (1) They will pay lower premiums by reducing the size and frequency of losses; and (2) they avoid the uninsured costs associated with covered claims, including deductibles/retentions and the time and effort spent on the claim-filing process. Clients’ employees also benefit because proactive loss prevention means that they work in a safer environment.
Again, everyone wins — which leaves me befuddled as to why anyone would sue agents or brokers for accepting loss-ratio-based contingency bonuses. Even if one contends that the practice creates a conflict because competing interests are compensating the agent/broker, I’d think that the complaint would be nullified, or at least outweighed, by the fact that both parties are seeking the same goal.
If we assume for the moment that agencies and brokers injure clients by placing accounts with carriers that pay the most under contingency contracts with loss-ratio provisions, rather than with the carriers best suited for them, we must also assume that agents and brokers read their contracts and know which ones pay the most. I can confidently state that only a minority of agents read all their contracts — unless something goes wrong, and perhaps not even then. It’s even rarer for agents and brokers to use their contingency contracts strategically to increase their bonuses. An incentive might as well not exist if the party who it’s supposed to influence never reads the contract providing it.
I’ve encountered many agency owners who haven’t read their contracts in 20 years. A large number, perhaps a majority, can’t even find all their current contingency contracts. When my firm analyzes agency contingency contracts, we offer a 10% discount to those who send us all the necessary information the first time. In 10 years, we’ve granted this discount only once. When I offer to analyze agents’ and brokers’ contingency contracts and show them how to use the agreements strategically, one of the biggest barriers I face is their absolute refusal to place business with certain carriers to increase their own revenue if doing so would injure a client. Although most agencies can place business more strategically with their carriers without injuring anyone, because so many agents are so cautious about this, I take extra care to explain the possibilities and methods involved. The questions raised are not only ethical; they also involve E&O exposures.
Our industry has failed to educate the press and the public about how contingencies work and how the generic term “contingency” conceals huge differences among contracts (maybe this is because we haven’t read the contracts!). If the current suits succeed and companies stop offering contingencies based on loss ratios, everyone will lose.
Historically, agencies’ and brokers’ profit margins have been 5% to 10%, and contingencies have been 5% to 10% of revenues. Without contingencies, either fees or commissions must increase — which means higher premiums. What’s more, employers will lose a great incentive to make their workplaces safer!