The government has no business dictating how insurance agents and brokers get paid. Quite simply, attorneys general, insurance-industry executives and self-proclaimed consumer advocates who want to modify compensation for insurance agents and brokers don't know what they are talking about.
The insurance industry pays upfront commissions and year-end bonuses—also called contingent commissions—in about the same way as other industries do. Judged by its practical applications and consequences for consumers, this combination of commission types does a good job aligning the interests of those who sell insurance and those who buy it.
Some basics on the controversy first: One can buy insurance through either an agent or a broker. Both agents and brokers pass similar exams, provide advice and guidance about insurance purchases, and help match consumers with insurers. But they get paid differently.
Agents are always paid directly by insurers, while brokers typically get paid by their customers. Sometimes, however, brokers collect commissions from insurers in much the same way that agents do.
Most controversies over insurance-producer pay center on "contingent commissions," which are often paid as year-end bonuses. While many factors go into determining their size, such bonuses depend mostly on what consumers do after they buy an insurance policy.
A producer who sells policies that make lots of money for an insurance company will receive large contingent commissions; one whose policies lose money for an insurer will receive little or nothing.
In 2004, then-New York State Attorney General Eliot Spitzer raised questions about whether brokers deserved such compensation and accused brokerages of conspiring to submit false prices to inflate commissions. The two sides fought and, after legal wrangling, insurers and brokers settled with several attorneys general and state insurance regulators, agreeing to change commission structures.
Even if the brokers acted dishonestly in 2004, the accusations against them then have little to do with the current disputes that some regulators and consumer advocates have raised with retail independent-insurance agencies. Nobody even alleges the current contingent-commission system involves any type of conspiracy. Indeed, it isn't even unusual.
In fact, almost every kind of sales job involves some type of contingent commission. Stockbrokers, realtors, financial advisors and even sales staff at chains like Nordstrom and Trader Joe's all have opportunities to earn commissions based partly on consumer behavior.
As a practical matter, contingents make sense because they help align interests.
- For agents, such commissions provide an income stream that is not reliant on closing a consistent number of sales day to day. This lets agents keep their lights on and pay office rent and non-sales staff even during the inevitable sales lulls that any business sustains.
- For consumers, the existence of contingent commissions gives agents added incentive to take a long-term view. If agents get their commissions entirely up front, then their purely financial incentives are to make large sales without regard to real consumer needs.
- For carriers that actually provide the capital to underwrite policies, being able to give additional rewards to agents who do best for them offers an added level of assurance that agents will look out for insurance companies' long-term interests. This increases financial soundness and competitiveness of insurers.
IN PLAIN SIGHT
Nobody hides the system of insurance contingent commissions. Mandatory disclosures in every state, as well as professional ethics, general insurance law and common sense (since consumers don't pay agents, who does?) make it pretty clear that insurers pay agents in the same way that other businesses pay their sales forces.
In some places, perhaps these disclosures could be made more clearly. Where this is so, legislators, agents and regulators should strive to clarify.
But any effort to ban or even limit contingent compensation will impose unnecessary burdens on the industry while bringing no benefits to customers. The best producers will almost always be able to find products that meet consumers' needs, produce profits for insurers and let them make a living. The worst—however they are compensated—won't do any of these things and will end up leaving the business.
Some consumers may feel more comfortable with one sort of commission structure or another, and all producers have a duty to explain commissions in a clear and straightforward manner. But the practice of paying contingent commissions makes logical sense for consumers, insurers and agents alike. So long as it's disclosed, the government shouldn't have anything to say about it.
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