Critical Issue Report

Brokers' compensation

The contingent commission question

By Phil Zinkewicz

Sometimes it’s amazing how things change in a short period of time. Only four or five years ago, then New York State District Attorney Elliott Spitzer’s cause célébre was broker compensation, specifically contingent commissions being received by brokers as “favors” for bringing in more favorable business to certain insurers. Spitzer’s war on contingent commissions shook the insurance industry to its core and even played a role in unseating one of the insurance industry’s giants, Maurice (Hank) Greenberg, who was until then considered indestructible.

Spitzer’s success in weeding out what he considered “unethical behavior” at best on the part of the insurance industry won him the New York State governor’s seat in a landslide election. Surprisingly, though, Spitzer’s reign was to be limited. He was forced to resign a little more than a year later for conduct unbecoming when his frequent visits to high-priced call girls were exposed. This was ironic to say the least because Sptizer, in addition to Wall Street and the insurance industry, had also taken on the high-priced call girl industry as one to be investigated.

But, again, it’s amazing how things change in a short period of time. Spitzer has now returned to the spotlight and has entered the lecture circuit beginning with Harvard University discussing (what else?) ethics.

Nevertheless, Spitzer must be credited with bringing to the forefront a common practice in the insurance industry of insurers paying contingent commissions to agents and brokers for bringing in the cream business while they, those same brokers and agents, were also being paid by the buyers at the other end.

Over the years, the courts have ruled in favor of contingent commissions for the smaller independent agents because it was considered a kind of profit sharing. However, in the higher echelons of insurance industry transactions, where the large brokers who were supposed to be representing risk managers of major corporations and were being paid by them, the use of contingent commissions has fallen somewhat into disrepute.

Broker transparency

Broker transparency is the name of the game today. When a risk manager is working with a broker in obtaining insurance coverage for a corporation, the risk manager should be aware of any and all compensation that the broker is receiving from all parties involved. But is that always the case?

Recently, the Risk and Insurance Management Society (RIMS) addressed that very question. A special Webinar directed to risk managers, titled “Take Control: Know Your Rights Regarding Broker Compensation,” was sponsored by the RIMS Connecticut Valley and New York chapters. Panelists included: Terry Fleming, director, division of risk management services in Montgomery County, Maryland; William J. Kelly, president of WJK Advisory, LLC, an insurance and risk management consulting firm; and Deborah M. Luthi, director, enterprise risk management services at Matheson, a freight company.

The Webinar was intended to demonstrate to risk managers how to leverage their significant power in the marketplace to drive a higher standard of conduct regarding broker compensation disclosure. Opening the panel discussion, Luthi said, “The Webinar is aimed at providing the risk manager with the tools necessary to understand the issue of broker compensation and the potential conflicts of interest that can arise.”

Issues covered in the Webinar included types of broker compensation, the importance of knowing how much an employer is paying both for insurance coverage and for related services, how to incorporate full broker compensation disclosure into requests for proposal (RFP) and service level agreements (SLA) and, finally, an overview of the current status of broker compensation in the state regulatory arena.

Fleming began by giving a brief history of contingent commissions, noting that it was a concept of the 1960s, which grew in importance to independent agents right away. “It became an additional source of revenues for independent agents that persisted into the 1980s,” said Fleming.

“By the 1990s, contingent compensation was being used in national transactions, involving big brokers. Brokers brought larger volumes of business to specific insurers and worked to keep losses down so that they could enjoy the contingent commissions,” Fleming continued. “The problem is they were also being paid by the buyer so that brokers enjoyed revenues from both ends of the business setting a scenario for conflicts of interest.”

Compensation practices

The director of risk management said that certain back-door phrases began to enter the business—phrases such as “friendly business” and “tying bids.” Friendly business refers to steering business to a certain insurance company that was willing to pay the contingent commissions. Tying bids referred to brokers who refused to bring business to particular insurers if those insurers didn’t promise to provide special incentives. “For example, the broker might refuse to bring business to an insurer unless the insurer promised to provide the reinsurance on the contract, thereby providing additional commissions to the broker,” Fleming said.

Kelly said that insurance brokers provide a valuable service to the buyers of insurance and should be compensated properly. “Brokers represent insureds in insurance contract negotiations, but if they receive other fees from the insurers, that’s a conflict of interest,” said Kelly.

“It’s not only in the insurance industry. There are other industries where similar possibilities of conflict of interest exist,” he continued. “But buyers of insurance need transparency in broker arrangements. Risk managers must insist that brokers inform them of what services their premiums are paying for and what other monies the broker is receiving from insurers.”

The traditional methods of compensation for brokers have been commissions and fees, said Kelly. “However, other forms of compensation include: contingent commissions, fiduciary funds interest income, advanced commissions and sales commissions, among others,” he said. “Full disclosure of these arrangements is vital. This disclosure can be achieved on a voluntary basis on the part of the broker, regulatory requirements in some states, upon request of the insured or, if necessary, by demand of the insured. Basically, the insured must say to the broker ‘Tell me what I’m paying for.’”

And, Fleming added, “There has to be a level of trust between the insured and the broker. However, the risk manager should be watchful and demand transparency at all times.”

The author
Phil Zinkewicz is an insurance journalist with more than 40 years’ experience covering the international insurance and reinsurance arenas. He was the insurance editor of the Journal of Commerce for a number of years, handling all their domestic and international supplements. In addition, he regularly writes for a number of London publications.