This solution to the contingencies controversy benefits everybody in sight.
In October 2004, New York Attorney-General Elliott Spitzer attacked a few major brokers for garnering significant bonus income outside of their normal revenue stream from contingency commissions, Placement Service Agreements (PSAs), and Market Service Agreements (MSAs). In the process, he cast suspicion on the incentive compensation model of the entire insurance industry — including independent agency commissions. Attorneys-general and regulators in other states (not to mention the plaintiffs bar) were quick to follow, and file, suit.
Contingent arrangements between companies and brokers carry the potential for wrongdoing because brokers work for their clients, not insurance companies. Their job is to shop the markets and to get the best product and price mix for their clients. Any agreement between a carrier and a broker to provide additional compensation based on volume or placement of broker clients with that carrier might cause the broker to place business with the carrier even if the best interest of the client lay elsewhere. Unfortunately, this holds true even though the broker might have done nothing wrong and placed the coverage in the best place for the client.
The anti-contingency campaign has impacted independent P/C agents by expanding the inference of wrongdoing beyond carriers and brokers to the general area of agencies’ receiving contingency payments from their carriers in return for placing volume with them. In my opinion, this inference is both incorrect and dangerous! Here’s why:
Independent agents are agents of the carriers that they represent. Theoretically, they work for their companies, not for the clients. They represent multiple companies (something akin to manufacturer’s representatives in other distribution channels). Companies compensate agents for seeking and placing clients that “fit” the company profiles of profit-generating insureds. The added incentive of contingent payments for profitable loss ratios and above-average growth is the historical method that companies have used to reward their agents.
If regulators and plaintiff attorneys succeed in casting doubt on the legitimacy of contingents for agents, the industry will face an interesting — and, perhaps beneficial — conversion of compensation methods (one that Agency Consulting Group has already negotiated between agents and companies for several years). We make agency compensation from carriers sensitive to the financial realities that make agents profitable or not: Loss Ratio and Volume.
Contingents are the carriers’ way of hedging their bets. Agents can earn high contingencies in some years and no contingencies in others. Agency Consulting Group tests several thousand agencies each year through our Composite Group studies. One general trend is that profitable agencies tend to stay profitable (how’s that for confirming the obvious?).
We believe that agencies should be paid commissions from their carriers that fluctuate according to formulas based on their long-term Loss Ratio profitability and growth volume trend. This method helps build agency/company relationships on the most important factors to both partners: Growth and profit. Profitable growth is no longer an afterthought — a “contingency” or “bonus” — to be expected and to be enjoyed outside of the normal operating income stream. It becomes an integral basis of the agency/company relationship.
Agency commission would grow (or decline) based on the length and depth of both growth and Loss Ratio profitability for the company in question. Significant changes would result in changes in subsequent years’ commission. Long term growth-driven and profit-driven agencies would have higher and more stable commissions than agencies that focus on short-term growth and profit. Conversely, agencies with longer track records of volume decline or marginal loss ratios would suffer lower commissions (if they wanted to remain with the carrier in question). Note that this practice does not impede an agency or carrier decision to terminate for normal reasons.
This approach would reward agents for loyal placement of growing, profitable business with their partner companies. It would accomplish the same thing as contingency contracts, without the implication of wrongdoing. It would also strengthen insurance company partnerships with their most successful agents and — finally — result in companies underwriting agencies, rather than individual risks (although underwriting guidelines and approvals would always remain to avoid the assumption of undesirable risks).
It’s high time for our industry to shift from paying for growth and profit as an afterthought to compensating growth and profit as the basis of successful relationships between companies with strong underwriting and sales agencies.