“There is a market equilibrium that influences commissions,” said one company executive. “Set too high, the company experiences adverse selection. Set too low, agents resist sending business.” He advocated level commissions on each piece of business, plus a profit-based contingent commission, contending that “profit-sharing agreements encourage teamwork and good ethics in everyone's operations.”

Another company respondent agreed: “An agent who is rating properly and giving the company accurate information will produce a higher profit for the insurer. Rewarding these people by the use of profit bonuses is completely ethical.”

Justification for profit as a part of compensation for producers was provided by another company executive with agency experience: “Outcomes of insurer profitability are stable rates and coverage, less 'knee-jerk' reactions of underwriters, consistency in underwriting, and predictable cash flows that stabilize insurer surplus, agency plans and insurance availability for the insured. All are good results for all parties.”

A Florida producer offered proof that a profit-based bonus leads to better business. “We are one of an insurer's high-profit group of agencies. As a group, we represent 20 percent of all agencies, yet we produce 60 percent of their business. Our group loss ratio is 10 percent less than other agents. To do this, we must and do provide better and additional services to both the insurer and the insured. Our reward only comes if we, individually, are profitable for the company.”

Another company executive made a distinction in compensation methods for agents and brokers: “Agents, as company representatives, should be paid solely by the insurer. Agents may be rewarded with profit-sharing bonuses and trips. Brokers, as the insured's representative, should be paid solely by the insured. Brokers should be prohibited from accepting anything with more than a nominal value from an insurer. This system would greatly reduce conflicts of interest.”

Another insurer executive sees no distinction: “On premiums above a certain level, such as $10,000, both agents and brokers should get a flat percentage commission, with that amount listed on the declarations page. They should also be free to add any additional amount the insured is willing to pay.”

His reasoning? “I believe insurers have been far more active in seeking to reduce the transaction costs of insurance. I do not believe agents and brokers have been as active. This method of sales compensation would force both insurers and production houses to focus on their own service and cost structure.”

He also opined: “I see no role for incentive commissions for independent producers in the future. These incentives, at the margin, steer business with no justification. The most ethical and reliable compensation system for high-premium accounts would be a pure fee-for-service model.”

An executive with a residual market plan also believes incentive commissions lead producers to steer business. “What would happen to a marginal-risk client that qualifies with two insurers? Company A has higher rates or poorer coverage and, because of agency loss experience, the producer has no chance of obtaining a profit-sharing commission. Company B, who the producer also represents, has a better policy or a lower price and a likely profit contingency. The producer may place this marginal client with Company A just to protect the contingent from Company B. No contingent commissions would mitigate against this possibility.”

Two producers agreed that fee-for-service offered the least incentive for unethical behavior. One said: “The pure cost of the insurance would be disclosed and the producer would negotiate a fee structure for the account. Everything is out in the open.”

However, the other producer, who would only allow licensed brokers to charge a fee, noted: “Even a fee-for-service broker could receive a profit-sharing commission from the insurer. There is no conflict of interest with upfront disclosure of the possibility of such payment.”

Most producers responding believe the current flat commission on an individual account plus a profit incentive on the production unit's book of business is perfectly ethical.

The Florida producer quoted earlier said: “Regardless of what you buy, the purchaser always pays for the expense of delivering the product or service. People do not always pay the same amount for the exact same product or service. For example, hospitals charge more for the same service to uninsured patients than they receive from an insured patient.”

He added that “price is not a factor if the customer seeks service. Better service deserves better compensation. If producers reduce loss- or transaction costs with service, both the insurer and insured benefit. Such producers should be rewarded. Who actually 'cuts the check' does not matter because the client is, in the end, paying.”

Producers responding do not believe profit-sharing steers business. For example, a Kentucky producer has an agency policy of not selecting an insurer on commissions of any nature. “If we do a good job, the client, the insurer and the agency all benefit. We do what is best for the client and we all come out ahead.”

A Texas producer added: “Sales incentives are a fact of life in our economy. They are neither inherently good nor evil. A contingent commission based, at least in part, on profitability of a book of business does not create any incentives to direct business to a particular insurer. It is the needs of the client and the ability of the insurer to meet those needs that should and does drive the placement of business.”

An Illinois producer reiterated that, from the standpoint of the production unit, profit- based contingent commissions are not controllable and, therefore, play no part in the placement of any one piece of business. “I could place an account with one insurer to meet some volume requirement, but having no control over losses, I might not get a payout. Why waste the energy? I do what is best for the client,” he said.

Another producer said: “The unethical producer will give inaccurate information to the underwriter in order to obtain a lower price or lesser coverage. The ethical producer offers the best combination of price, coverage and service. The flat commission plus profit-based bonus system rewards honesty and integrity. Why not continue its use?”

A company executive noted that agents and brokers must predict revenue to effectively run their business. “A flat commission accomplished that goal. A profit-based bonus allows the middleman to reward good work by all personnel. I estimate only 30-to-50 percent of the production houses with which we have contracts meet the profit-based contingency requirements. Insurers should want to reward professional work.”

Another insurer executive commented that “in the American agency system, salary from the insurer is not an option. Any sales professional–that is, one who places the client's interests first–deserves an incentive. Insurance distribution systems that pay a salary diminish the incentive for that professional.”

Also weighing in was an agent association executive: “Sales incentives do not hurt consumers–unethical sales people who misuse them do. Neither producers nor insurers should be ashamed or apologetic about sales incentives. A professional salesman will present all relevant facts and a buyer may then inquire about anything else that is important. Being informed is the ethical responsibility of every citizen living in a private enterprise economy.”

A former risk manager of state government added: “You cannot make a good deal with an unethical person and you cannot make a bad deal with an ethical person. The bottom line is that any compensation system for sales will, directly or indirectly, be reduced to a percentage of sales. Therefore, the most honest way to pay sales people is that percentage of sales. Anything else masks the truth.”

The comment most pointedly directed at New York Attorney General Eliot Spitzer and the disparagement of the insurance business resulting from his probes into bid-rigging, steering and contingency fee abuse was: “If contingency commissions are additional or an 'after-the-fact reward' based on improved results from or for superior performance in one's activities, Eliot Spitzer is requesting a 'contingent' in his bid for the New York governorship.”

The most uplifting comment came from the Kentucky producer: “The insurance business has a good future in the U.S. economy, and important ethical-cleansing events such as [Mr.] Spitzer's [probes] should encourage ethical young people to seek insurance careers.”

Infographic: (with shot of money changing hands)

Flag: Money Talks

What Insurers & Brokers Say

There were six common themes from readers weighing in on the ethics of agent and broker compensation plans that include both straight commissions and incentive fees of some sort.

o Professional–that is, ethical–producers put the client interest first and ignore commission levels of any kind.

o The current system ain't broke and does not need to be fixed.

o It does not make sense to change a logical and ethical system of compensation for ethical producers, because a system free of unethical activity by a few disreputable individuals will never be invented.

o If changes are necessary, a movement to fee-for-service is ethical.

o If disincentives for unethical behavior are necessary, direct them toward the unethical by making penalties more severe.

o Both buyers and sellers need to be more sophisticated so that automatic checks and balances are in place.

Flag: What's Next?

A Question Of Ethics?

A critical component in discussions of ethics and producer compensation is disclosure. Many professionals, at least in part, already reveal compensation to clients. Such information tends to be “gross” and actual “profit” is not revealed. For example, a physician reveals the charge for an office call, while plaintiff attorneys have clients sign contracts that reveal the percentage of any settlement that will go to the attorney.

Ethically, what components of agency or brokerage revenue and expenses, if any, should be disclosed to clients?

Please forward your responses to Peter R. Kensicki at [email protected] or Eastern Kentucky University, 107 Miller Hall, Richmond, Ky. 40475-3101. All responses will be kept confidential.