Industry News

Scholars Conclude Profit Sharing Helps Ensure Fair Insurance Pricing

A new study by two Wharton School of Business scholars concludes that profit based contingent commissions are a necessity in the marketplace. The study, "The Economics of Insurance Intermediaries," by Professors J. David Cummins and Neal A. Doherty concludes that "although contingent commissions, like most business practices, can be misused by the unscrupulous, in general this type of incentive compensation plays an important role in aligning incentives between buyers and insurers and thus facilitates the efficient operation of insurance markets." The study was financed by the American Insurance Association (AIA).

According to the study, intermediaries are usually better informed about the risks of their clients than insurers and when such risk information is accurately transmitted to the insurer, carriers compete more vigorously for business and price more competitively and fairly. In this way, the study reports, agents and brokers "assist the flow of information in the insurance market and enhance the efficiency of the market to the benefit of all players."

The authors noted that intermediaries match buyers with insurers "who have the skill, capacity, risk appetite, and financial strength to underwrite the risk, and then help their clients select from competing offers." The authors said that the role of the intermediary is "to increase competitiveness, by providing the buyer access to a wider range of possible insurers and by helping the buyer to compare these bids on the basis of price, coverage, service and the financial strength of the insurer."

"Our research provides empirical evidence that most of the contingent commissions are passed on to policyholders in the premium," notes the study. "However, whether this harms or benefits policyholders is a matter of debate. Despite recent allegations that contingent commissions are a 'kickback' from the insurer that compromises the intermediary's obligations to its clients, such commissions can actually be beneficial to clients."

Among other core aspects/findings of the Cummins-Doherty study:

• The conventional economic-legal role of agents in other industries is contrasted with the role of intermediaries in the insurance buying process, where information must be shared with both sides in order to come up with a product for the buyer. Their analysis argues that if risk information about the buyer is not shared with sellers/insurers, low-risk buyers will be penalized by having to pay higher prices than their risk level warrants; i.e., they would end up unfairly subsidizing higher-risk buyers.
• The authors explain how intermediaries can reduce market inefficiencies and alleviate the cross-subsidization problem for low-risk buyers by assessing the risk level of the buyer and providing that information to the insurer.
• Because the intermediary is, in effect, performing a critical underwriting function for the insurer (conducting comprehensive risk assessments of individual/organizational buyers to establish precisely the risk level represented by those buyers), some form of financial incentive (e.g., a contingent commission) from insurer to intermediary is appropriate.

The study concludes that "although contingent commissions, like most business practices, can be misused by the unscrupulous, in general this type of incentive compensation plays an important role in aligning incentives between buyers and insurers and thus facilitates the efficient operation of insurance markets."

The authors also found that premium-based commissions constitute the vast majority of intermediary revenues, contingent commissions account for about 4 to 5 percent of brokers' overall revenues, and that contingent fees help new insurers break into the property-casualty market.

"Absent contingent commissions," the professors said, "new i

PIA's Brevik Defends Agent Compensation and Conduct

WASHINGTON, April 18, 2005  - The National Association of Professional Insurance Agents today reiterated its support of contingent commissions being a part of the compensation received by Main Street professional insurance agents.

The PIA statement was issued in response to an assertion made by Joseph Plumeri, CEO of Willis Group, who said at the annual conference of the Risk and Insurance Management Society (RIMS) that contingent commissions should be abolished throughout the insurance industry to include mega-brokerages as well as retail independent agents.

"This is a hypocritical suggestion, in that it comes from the CEO of the nation's third-largest insurance broker - a firm that earlier this month agreed to pay $51 million in restitution to policyholders to resolve concerns about anticompetitive practices involving incentive fees in property and casualty insurance sales," said Leonard C. Brevik, executive vice president and CEO of PIA National. "The timing of Mr. Plumeri's comments makes them particularly dubious." The settlement resulted from an investigation conducted by New York Attorney General Eliot Spitzer and Minnesota Attorney General Mike Hatch.

"This is another indication of people talking about the insurance industry in broad terms without having a complete understanding of all the issues involved," Brevik said. "One mega-broker's experience should not be extended to pontifications regarding the entire industry."  

Brevik noted that even New York's Attorney General has clarified his position to distinguish between mega-brokers and Main Street agents.

"As he continued his investigations, the attorney general developed a more complete understanding and appreciation of the entire industry, of the differences between its sectors and the honesty of its participants," Brevik said. "So much so that in January, Mr. Spitzer said he did not think contingent commissions should be banned industry wide. And, in February, he said the vast majority of agents and brokers are honest, and he cautioned against anyone generalizing or jumping to conclusions."

In a speech to the National Press Club on January 31, 2005, Spitzer said contingent commissions "may be appropriate...I don't want to say they should be banned industry wide." And in an interview broadcast on FOX News on February 15, 2005, Spitzer said, "...the vast majority of insurance brokers and agents are honest, hardworking, good individuals...the last thing anyone should do is generalize or jump to conclusions about an entire group of people who are in a sector that is vitally important. The importance of the insurance sector to our economy can't be overstated."

Brevik added he hopes Willis CEO Plumeri, like Eliot Spitzer, develops a better understanding of the various participants in the insurance industry.

Founded in 1931, PIA is a national trade association that represents member insurance agents and their employees who sell and service all kinds of insurance, but specialize in coverage of automobiles, homes and businesses. PIA will celebrate its 75th anniversary in 2006.