THE INVESTIGATION of contingency payments that started last year in one way or another will affect even the smallest independent insurance agency-and probably every insurer and general agency using independent agents and brokers. These investigations focus on whether these various incentives have prompted agents and brokers to improperly steer clients to carriers that provide the best contingency bonus to them, rather than offer the best coverage or price to their clients.

Some in the insurance industry, myself included, have contended that true performance-based contingency contracts benefit all parties involved. The most important factor affecting bonuses in performance-based contingency contracts is loss ratio. (The bonus also can be affected by volume, growth and retention, however.) When an agency can earn a bonus based on performance, the agency encourages insureds to practice loss control, which, if successful, reduces the insureds' insurance cost (plus they avoid all the uninsurable costs associated with claims-e.g., time spent on defense). When clients experience fewer, smaller claims, the agent's loss ratio drops, which generates a bigger profit-sharing bonus for the agent. With lower loss ratios, insurance companies pay less for claims, so their profits increase. Everyone wins.

(For purposes of contingency contracts, the loss ratio generally is defined as losses divided by earned premium. The definition of losses varies considerably from company to company, though. Some include one or more of the following: allocated loss adjustment expenses, incurred but not reported losses and unallocated loss adjustment expenses. These elements constitute a significant bone of contention between agencies and companies, as will be noted later. Other factors affecting the loss ratio include whether the losses are calendar-year or accident-year, and whether a stop loss adjusts the applicable loss ratio. Some companies calculate loss ratios using one year of losses, while others use two, three and even four years of losses.)