Recently, a number of articles have appeared in the press concerning lawsuits brought against brokers, alleging a conflict of interest when they accept fees from their clients as well as contingency bonuses from insurance companies. While the nature of the suits vary, the attorneys filing them and the reporters writing about them don't seem to totally understand contingency contracts. Or perhaps semantics is the issue, because the lawsuits and the press refer to the bonuses variously as "profit-sharing agreements," "contingency bonuses," "contingency fees," "volume bonuses" and "placement-service agreements," as if these agreements are all the same-when in reality, they differ significantly.

After analyzing hundreds of various bonus agreements throughout North America, talking with hundreds of agents about strategically using such contracts, and giving dozens of speeches on the topic, I feel I have gained more insight than most into the subject. Based on my experience and the supposition that contingency bonuses pose a conflict of interest, I would place contingency contracts and their resulting bonuses into one of two categories: 1) those in which insureds' loss ratios are a factor, and 2) those in which they are not.

When loss ratios are not a factor and bonuses are awarded simply for the volume of business placed, a conflict of interest probably does exist, especially if agents/brokers charge their clients fees. In these cases, bonuses should always be disclosed.

Litigation stemming from contingency contracts in which loss ratios are used to calculate bonuses troubles me more. Contingency contracts with loss-ratio provisions work to everyone's benefit if (and this is a big "if," as I will show later) agents and brokers read and understand the contracts.

Contracts with loss-ratio provisions generally pay contingency bonuses if the agent/broker achieves an adequately low loss ratio. Top contracts that heavily emphasize loss ratio will pay large contingency bonuses for low loss ratios. Insurance companies benefit from such contracts because the bonuses they pay are significantly less than the claims they otherwise would pay, were the loss ratios higher. Customers win, too, because by taking a proactive approach to loss prevention, they should experience fewer claims, which reduces their costs in two ways. First, customers can earn lower premiums by reducing the size and frequency of losses. Second, they avoid the uninsured costs always associated with even covered claims, including deductibles/retentions and the time and effort spent on the claim-filing process. Even clients' employees benefit because, through proactive loss prevention, they work in a safer environment. Again, everyone wins, which leaves me befuddled as to why anyone (other than for personal aggrandizement) would sue agents or brokers for accepting loss-ratio-based contingency bonuses. Even if one contends that the practice creates a conflict because the agent/broker is being compensated by competing interests, I'd think the complaint would be nullified or at least outweighed by the fact that both parties are seeking the same goal.

Assuming for just a moment, however, that agencies and brokers injure clients by placing accounts with carriers that pay the most under contingency contracts with loss-ratio provisions, rather than placing them with the carriers best suited for them, we then must also assume agents and brokers actually read their contracts and know which ones pay the most. I can confidently state that only a minority of agents read all their contracts-unless something goes wrong, and maybe not even then. It is even more rare for agents and brokers to use their contingency contracts strategically to increase their bonuses. An incentive might as well not exist if the contract providing it is never read by the party that is supposed to be influenced.

I've encountered many agency owners who have not read their contracts in 20 years. A large number, maybe a majority, cannot even find all their current contingency contracts. When my firm analyzes agents' contingency contracts, we offer a 10% discount to those who send us all the necessary information the first time. In 10 years, we have granted the discount only once. When I offer to analyze agents' and brokers' contingency contracts and show them how to use the agreements strategically, one of the biggest barriers I face is the resolute refusal to place business with certain carriers to increase their own revenue, if doing so will injure a client. Most agencies can place business more strategically with their carriers without injuring anyone, but because so many agents are so cautious about it, I must take extra care to explain the possibilities and methods. The issues raised are not only ethical; they also involve E&O exposures.

Our industry has failed to adequately educate the press and the public regarding how contingencies actually work and how the generic term "contingency" conceals huge differences among contracts. (Maybe this is because we haven't read the contracts!) If the current suits succeed and companies stop offering contingencies based on loss ratios, everyone will lose. Historically, agencies' and brokers' profit margins have been 5% to 10%, and contingencies have been 5% to 10% of revenues. Without contingencies, fees must increase or commissions must increase, which in turn means premiums will increase. Plus, employers will lose a great incentive to make their workplaces safer!

Special Reports /

For The Manager: What's so bad about loss-ration-based contingencies?

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