Insurance companies use contingent agreements to reward independent agencies that place profitable business through them.
Agents have fiduciary and monetary reasons to help insureds find the best value. However, insurance companies rightfully believe that in those many instances where the value propositions for the insureds are roughly equal, that agents will favor their company due to compelling contingent contract provisions.
But is the awarding of contingent dollars always sound, and does it deliver the right results?
Despite the millions of dollars spent by companies through contingent commissions, are they getting the results they want?
Might current contingent contract provisions incorrectly apply what are meant to be 'positive reinforcement' techniques?
Could the companies actually be 'shaping' their agents to act in ways that are counter to larger business objectives?
Getting ahead in the rat race
I first learned about manipulating behaviors during college, an era defined by the Beatles and the Vietnam War. Drugs hadn't found my conservative campus, and "protest" was still primarily a verb and not an event.
As part of one of the final courses to complete my psychology major, we had to shape, or train, a naïve lab rat to negotiate a complex set of behaviors.
The key to training rats was to establish clear goals and advance the rat in ever more demanding approximations of that required behavior.
For example, if you wanted the rat to press a bar in order to be rewarded with a food pellet, you would start by rewarding him for being in the right half of the operant chamber, or cage. Once the rat understood that stimulus/reward chain, you would advance the criteria for the reward.
The next step is rewarding the rat for being in the right fourth of the chamber. Then, you would only rewarded him when he touched the bar — and finally, only when he pressed the bar.
To motivate the rat, you starved him down to 85% of his normal weight and kept him hungry for the duration of the training.
To pass the course, the rat had to pick up a marble and place it on top of a cylinder in the chamber. He then had to crawl on top of the cylinder and drop the marble through a hole. Then he had to get down from the cylinder, reach up and swing an overhead trapeze bar three time, and then go to the bar and press it twenty-five times. Once the rat had completed this entire circuit three times in-a-row he received a food pellet — and you received a passing grade.
Carriers nearly all adjust loss ratios for contingent calculation. (Photo: iStock)
Applying business psychology
Insurance companies have starved agents by reducing their up-front commissions from historic levels. (B. F. Skinner, the father of behavioral psychology, would approve of the average reduction from 13% to 11%, which is eerily close to the 15% weight reduction we used with the college lab rats.) At the same time, companies have enhanced their contingent commission agreements in an attempt to shape the behavior of the independent agent.
But in doing so, have they established an adverse stimulus/response chain?
For example: Agent A has been growing at an inflationary rate of 2% with Excellent Insurance Company. Five years ago, Agent A was at $4.9 million of Written Premium with the company, and now is at $5.4 million. Agents B was at $1 million five years ago, has grown at an annual rate of 40%, and also is now at $5.4 million with Excellent Insurance Company. Both agents have 45% loss ratios and will receive the same contingent commission amount.
Agent B is the much better agency for the company. Besides the fact that Agent B's business isn't seasoned yet, Agent B's superb growth is penalized because of the lag in earned premium catching up to written premium, which results in a distorted loss ratio. Agent A would have incurred over $200,000 more in Loss and LAE to arrive at the same loss ratio.
Many companies seemingly mitigate this dynamic by including a growth factor. However, the growth factors usually only consider one year, and consequently often reward book transfers much more than organic growth. In addition, the growth bonus is relatively small compared to the favorable aspects of Agent B's book of business.
The power of positive reinforcement
During the rat training sessions I attended, one of the other students inadvertently rewarded a rat (with a food pellet) that had jumped up and hit its head on the glass ceiling of the chamber. The rat knocked itself silly trying to get more food pellets, and eventually had to be removed from the lab. The power of positive reinforcement is immense.
Agent A has been provided positive reinforcement for minimal growth and logically will continue that behavior. While Agent B has also been rewarded, he will have drinks and idle chat with Agent A at the agents' convention, and will subsequently feel a certain level of dissatisfaction.
Researchers still use the same basic operant chamber design I used in the late 1960s. Similarly, in the 1970s, I was "the" underwriter for Northfield Insurance Company. As part of my duties, I conducted a study of contingent commission agreements.
Judging by the agreements I have recently reviewed, not much has changed.
Companies nearly all adjust loss ratios for contingent calculation in various ways. It would seem easy (and fair) for companies to add an adjustment to loss ratios for contingent calculations for percentage of growth. Or, perhaps they could simply use written premium instead of earned premium to calculate loss ratio for contingent purposes.
Of the dozens of companies I've worked with, none have used written premium instead of earned for this calculation.
My belief is that at no time did corporate officers at Excellent Insurance Company, or any other insurance company, sit down and decide to starve their agents so they could shape their behaviors. However, that is where the road has led us over the last twenty years. Now, companies need to carefully review their contingent arrangements to establish responsible positive stimulus/response chains.
Insurance industry veteran Jim Holm is the CEO of Enhancedinsurance.com. He can be reached by sending email to jim@interagency.com.
The opinions expressed here are the writer's own.
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