Producer Compensation

Raises Ethical Quandaries

By Peter R. Kensicki

This column asked NU readers to address ethical methods ofproducer compensation from two perspectives–from the standpoint ofthe insurance company, as well as from the agency or brokerageowner. However, the responses for both were essentially the same,with most providing ethical justification for the model offlat-rate plus profit-based contingent commissions.

“There is a market equilibrium that influences commissions,”said one company executive. “Set too high, the company experiencesadverse selection. Set too low, agents resist sending business.” Headvocated level commissions on each piece of business, plus aprofit-based contingent commission, contending that “profit-sharingagreements encourage teamwork and good ethics in everyone'soperations.”

Another company respondent agreed: “An agent who is ratingproperly and giving the company accurate information will produce ahigher profit for the insurer. Rewarding these people by the use ofprofit bonuses is completely ethical.”

Justification for profit as a part of compensation for producerswas provided by another company executive with agency experience:“Outcomes of insurer profitability are stable rates and coverage,less 'knee-jerk' reactions of underwriters, consistency inunderwriting, and predictable cash flows that stabilize insurersurplus, 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 leadsto better business. “We are one of an insurer's high-profit groupof agencies. As a group, we represent 20 percent of all agencies,yet we produce 60 percent of their business. Our group loss ratiois 10 percent less than other agents. To do this, we must and doprovide better and additional services to both the insurer and theinsured. Our reward only comes if we, individually, are profitablefor the company.”

Another company executive made a distinction in compensationmethods for agents and brokers: “Agents, as companyrepresentatives, should be paid solely by the insurer. Agents maybe rewarded with profit-sharing bonuses and trips. Brokers, as theinsured's representative, should be paid solely by the insured.Brokers should be prohibited from accepting anything with more thana nominal value from an insurer. This system would greatly reduceconflicts of interest.”

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

His reasoning? “I believe insurers have been far more active inseeking to reduce the transaction costs of insurance. I do notbelieve agents and brokers have been as active. This method ofsales compensation would force both insurers and production housesto focus on their own service and cost structure.”

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

An executive with a residual market plan also believes incentivecommissions lead producers to steer business. “What would happen toa marginal-risk client that qualifies with two insurers? Company Ahas higher rates or poorer coverage and, because of agency lossexperience, the producer has no chance of obtaining aprofit-sharing commission. Company B, who the producer alsorepresents, has a better policy or a lower price and a likelyprofit contingency. The producer may place this marginal clientwith Company A just to protect the contingent from Company B. Nocontingent commissions would mitigate against thispossibility.”

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

However, the other producer, who would only allow licensedbrokers to charge a fee, noted: “Even a fee-for-service brokercould receive a profit-sharing commission from the insurer. Thereis no conflict of interest with upfront disclosure of thepossibility of such payment.”

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

The Florida producer quoted earlier said: “Regardless of whatyou buy, the purchaser always pays for the expense of deliveringthe product or service. People do not always pay the same amountfor the exact same product or service. For example, hospitalscharge more for the same service to uninsured patients than theyreceive from an insured patient.”

He added that “price is not a factor if the customer seeksservice. Better service deserves better compensation. If producersreduce loss- or transaction costs with service, both the insurerand insured benefit. Such producers should be rewarded. Whoactually 'cuts the check' does not matter because the client is, inthe end, paying.”

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

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

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

Another producer said: “The unethical producer will giveinaccurate information to the underwriter in order to obtain alower price or lesser coverage. The ethical producer offers thebest combination of price, coverage and service. The flatcommission plus profit-based bonus system rewards honesty andintegrity. Why not continue its use?”

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

Another insurer executive commented that “in the American agencysystem, salary from the insurer is not an option. Any salesprofessional–that is, one who places the client's interestsfirst–deserves an incentive. Insurance distribution systems thatpay a salary diminish the incentive for that professional.”

Also weighing in was an agent association executive: “Salesincentives do not hurt consumers–unethical sales people who misusethem do. Neither producers nor insurers should be ashamed orapologetic about sales incentives. A professional salesman willpresent all relevant facts and a buyer may then inquire aboutanything else that is important. Being informed is the ethicalresponsibility of every citizen living in a private enterpriseeconomy.”

A former risk manager of state government added: “You cannotmake a good deal with an unethical person and you cannot make a baddeal with an ethical person. The bottom line is that anycompensation system for sales will, directly or indirectly, bereduced to a percentage of sales. Therefore, the most honest way topay sales people is that percentage of sales. Anything else masksthe truth.”

The comment most pointedly directed at New York Attorney GeneralEliot Spitzer and the disparagement of the insurance businessresulting from his probes into bid-rigging, steering andcontingency fee abuse was: “If contingency commissions areadditional or an 'after-the-fact reward' based on improved resultsfrom or for superior performance in one's activities, Eliot Spitzeris requesting a 'contingent' in his bid for the New Yorkgovernorship.”

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

Infographic: (with shot of money changing hands)

Flag: Money Talks

What Insurers & Brokers Say

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

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

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

o It does not make sense to change a logical and ethical systemof compensation for ethical producers, because a system free ofunethical activity by a few disreputable individuals will never beinvented.

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

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

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

Flag: What's Next?

A Question Of Ethics?

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

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

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