Readers Tackle Ethics Of Contingency Commissions

It is extremely difficult for a knowledgeable insurance person to talk about contingent commissions in general terms. It was widely noted that no two contingency agreements of insurance companies are the same.

Most true contingency agreements emphasize profitability of the overall book of business. Some, intermittently, emphasize growth in premium volume, and some have minimum premium volume requirements before any profit-sharing contingents apply.

Other contingency contracts emphasize retention of business from year to year. Further, contingency commission contracts are subject to frequent, if not annual revision.

What is important for ethical motivation is that contingency agreements encourage front-line underwriting and risk-control activities. As an Ohio producer put it: "Quality of service of the producer and professionalism in the treatment of risk should be encouraged. Regular commissions are paid purely on volume. Anyone can sell insurance. Contingent agreements encourage me to be a professional to put my client's interests ahead of my volume-based income."

An association executive added: "There is nothing wrong with a system that pays for excellent performance. The incentive is to do good, pre-sale risk management with the client. Buyers want the best coverage compared to the premium they pay. Most buyers do not pay fees and are not concerned with how, or how much the producer is paid."

A former president of a national agent association recognized the most basic principle of ethics and professionalism: "In general, contingency-commission agreements are ethical as long as agents and brokers recognize what I call the "Guiding Principle' keep the customer's interests in front and in focus."

A Minnesota agent put it another way: "I'm paid some money up front when I sell a policy, and if I do a good job helping all my clients control losses, I get a little more later. What is wrong with encouraging quality, professional service?" After noting a difference between a pure commission purchase and a fee-for-service purchase, a risk manager agreed: "Agents are ethical if they put the client's interests first, notwithstanding any contingent agreements."

Because of obvious legal reasons, insurer executives were reluctant to provide responses. One insurance company president was willing to say that generally he saw nothing wrong with providing sales incentives. "Building a relationship with a large sales volume allows insurers to be both more efficient and effective. This lowers the cost of insurance and benefits all parties to the transaction."

The second theme among respondents to our first questions was that most true contingent commission agreements that is, those designed for a purpose other than increasing the normal commission income of a brokerage firm have so many factors included in the formula for determining the final payment that it is virtually impossible to determine in advance how any one particular sale will affect the final payment.

Further, the individual non-owner producer is usually not compensated based on the results of the contingency contracts. Those producers, therefore, are not driven or otherwise affected by contingency commissions.

For example, a Florida producer noted: "Given that most contingent agreements include factors other than volume, and that individual account premiums typically are not in the hundreds of thousands of dollars, any individual account cannot have a predetermined effect on a contingent payment. Also, most producer compensation is not related in any way to the contingent commissions received by the agency. These producers are not influenced in the sale by contingency agreements."

An association executive added, "Agents do not control the factors that go into contingency contracts, and the results come too far in the future to have any one piece of business affect it."

A prominent educator added, "A contingency based primarily on sharing profits generated by the agent or broker for the insurer and based on items such as losses and retention is perfectly ethical and beneficial for the overall economy."

The final theme among respondents to question one was that contingency commission contracts most likely to encourage unethical behavior are agreements solely based on volume, such as those targeted by New York Attorney General Eliot Spitzer in his various probes.

In reality, these particular agreements are not, and should not be described as contingency commission contracts for reasons explained below.

If a contingency commission agreement is solely based on profitability (with or without a minimum volume requirement), it is most likely to benefit the client, insurer and producer, and is least likely to lead to unethical behavior.

However, this is not an indictment of contingent agreements that are, in part, based on premium volume. The Florida agent opined: "Nothing is bad or good except by comparison. Volume alone in a contingent agreement may be considered questionable, but increased volume may allow the insurer the ability to offer better coverage and price for my clients." In other words, an agreement that encourages, but is not limited to, volume offers clients greater and more economical choices for coverage.

In summary, respondents believe contingent commissions are generally ethical but complicated, and it is volume-only contingents that offer the greatest opportunity for unethical behavior.

The second question presumed most would say contingent commissions are ethical, and asked for circumstances when they could be unethical.

A universal answer is reflected in the response of an Ohio agent: "Any agreement that is used as part of a bid-rigging scheme is unethical. Contingent agreements are ethical it is the way some people used them that is unethical."

A former risk manager agreed: "If a producer increases the price or reduces coverage, and in doing so puts his or her interests above the customer, it is unethical. It remains true no matter the motivation."

A Pennsylvania producer put it this way: "When a producer has access to more than one insurer, the motivation must be for the best value for the client. If the motivation is different, the action is unethical."

An association executive added an economic argument: "It makes no economic sense to overprice an account guaranteeing some commission, such as 12 percent, for the possibility of an additional 2 percent later."

The Minnesota producer indicated his belief that there is a greater potential for unethical behavior in commercial lines if commission levels can be negotiated. That would put pressure on the producer to increase revenues in some other way such as through contingent commissions.

The company executive believes contingent commissions can lead to unethical behavior if (1) business is churned to earn such commissions; (2) a fee arrangement exists, but the contingent commission agreement is not disclosed; or (3) the client is told the placement decision was based on coverage or price, but it was actually driven by a contingency agreement.

A Texas educator said contingent agreements are used unethically when commissions are maximized at the expense of the client, or when the producer is dishonest actively or passively about the existence of such agreements.

A Utah risk manager believes they are used unethically when the best interests of the client are sacrificed. Finally, a New York broker said contingents are used unethically when business is moved to a company solely because of an excellent loss ratio with that company.

Like all tools, contingent commissions have a place in the overall marketing strategy of an insurance company and can be designed so that the agreement works to the benefit of all. But, like all tools, those who do not follow the "Guiding Principle" can misuse them.

Unfortunately, all types of bonus commission agreements appear to have been lumped together as "contingent commission contracts" and have been made to appear by some as a per se unethical device of the insurance business.

Next week, readers address the question of how agents can convince clients and regulators that such arrangements do not lead to unethical behavior.

Peter R. Kensicki is a professor of insurance at Eastern Kentucky University in Richmond, Ky., as well as a member of the Ethics Committee of the CPCU Society in Malvern, Pa.

Sidebar:

Flag: Response Themes

Head: What Do You Think?

Three themes characterized answers to the question of whether contingency commission arrangements are ethical:

It is hard to talk about the ethics of contingent commissions in general, since no two contingency agreements are alike.

True contingency agreements are complicated and ultimate results are difficult to predict, thus it is virtually impossible to determine in advance how any one particular sale will affect a single producer or agency.

Volume-only-based contingency agreements create the greatest potential for ethical abuse. However, agreements based in part on premium volume may still have advantages for buyers and agents alike.

Second Sidebar:

Flag: What's Next?

Head: A Question Of Ethics?

In examining the ethics of contingent commission agreements, it became evident that there were disagreements as to the most ethical way to compensate sales personnel in the insurance business. From the perspective of an insurance company marketing executivewhether using the independent agent, exclusive agency or direct writing distribution systemwhat do you believe are ethical sales incentive tools that will generate increased sales from your ultimate sales force?

Second, from the perspective of an insurance agency or brokerage owner, given that the client ultimately pays you for your work, what is the compensation method or methods that would least challenge an ethical producer?

Please forward your responses to Dr. Peter R. Kensicki at ethics@eku.edu or snail-mail him at Eastern Kentucky University, 107 Miller Hall, Richmond, Ky. 40475-3101. All responses will be kept confidential.

Reproduced from National Underwriter Edition, April 29, 2003. Copyright 2003 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.