Despite criticism and legal action by regulators over insurance brokerage contingent commissions, a new report by two Wharton School of Business professors argues such fees are a necessity in the marketplace.
In their newly published report titled "The Economics of Insurance Intermediaries," professors David Cummins and Neal Doherty noted that while most contingent fees are eventually passed on to policyholders in the form of higher premium, it is "a matter of debate" whether this harms or benefits policyholders.
The professors argued that contingent fees actually can be beneficial to clients despite allegations that such fees are a kickback from the insurer that compromises the intermediary's obligations to its clients.
The professors said that contingent commissions can "align incentives between buyers and insurers and thus facilitate the efficient operation of insurance markets."
Contingent commissions--particularly those based on profit--may further stimulate competitive bidding, the report said. And by aligning its interest with that of the intermediary, the insurer can have more confidence in the selection of risks and in the information provided by the intermediary.
The contingent-fee arrangements also represent "converging incentives." An insurer promoting a certain class of business might design a commission structure that rewards such business. The insurer would offer this reward scheme to intermediaries who have an expertise in that class, the professors wrote.
They suggested that from the intermediary's perspective, these arrangements increase access to the insurers that are best able to compete for clients' business and have the risk appetite.
The study also found that contingent fees also help new insurers break into the commercial property-casualty insurance market.
"Absent contingent commissions, new insurers might find it difficult to obtain high quality placements from intermediaries, who would naturally prefer dealing with established insurers with whom they have developed relationships," the professors said.
But by linking the intermediary's compensation to the underwriting quality of the business provided to the insurer, the new entrant can ensure a flow of business that meets its underwriting standards and can compete more effectively with established rivals.
The authors of the report point out that the increased competition resulting from new entry into the industry ultimately is beneficial to insurance buyers.
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