Analysis of Effects of Contingent Insurance Agreements Based Solely on Conjecture
INDIANAPOLIS (Jan. 28, 2005)––“Where’s the proof of misconduct among agents and brokers in small business and individual lines?” asks National Association of Mutual Insurance Companies (NAMIC) Public Policy Director Robert Detlefsen. Detlefsen was responding to a report released Wednesday by the Consumer Federation of America, Contingent Insurance Commissions: Implications for Consumers.
“The CFA report offers no evidence of bid-rigging or steering conspiracies among producers receiving contingent commissions from the nation’s small business and individual insurance companies,” said Detlefsen. “Because some producers and some carriers conspired against large commercial accounts, it does not automatically follow that anything remotely similar took place in small business and individual accounts.”
The CFA report singles out independent agents and brokers as being especially susceptible to corruption, because independents are more likely to operate on a contingent fee basis. Captive agents who are employed by particular companies, the report acknowledges, do not receive contingent commissions. Yet companies employing captive agents dominate the small business and personal insurance market. Since these very large companies are enormous players in the small business and individual markets, competitors who rely on independent agents would be at a competitive disadvantage if these agents were disserving customers in order to receive higher commissions, as the CFA report suggests.
“Instead of scare mongering, CFA should demonstrate the existence of actual misconduct in these lines,” said Detlefsen
Notably absent from the CFA report is any acknowledgment of the benefits that contingent commission incentives bring to the insurance marketplace. For that, one must turn to the objective analyses of disinterested experts. According to insurance scholars Scott Harrington of the Wharton School and Kenneth Scott of Stanford University, the benefits of contingent producer commissions based on company profit and premium volume are considerable. In a recent American Enterprise Institute white paper, they write:
Profit-based compensation to a broker based on the insurer’s claims experience raises issues of loyalty, but it can encourage brokers to reveal information about clients’ risks to insurers, which in turn helps underwriters quote more accurate prices. More accurate prices obviously benefit those clients who obtain lower prices commensurate with their lower risk of loss. More generally, increased accuracy in insurance pricing helps provide incentives for policyholders to control losses and otherwise manage risk efficiently.
Contingent commissions based on the premium volume for business placed by a broker with a particular insurer have a related function. Greater volume improves the statistical reliability of claims experience for business placed by the broker. It therefore improves the insurer’s ability to monitor the quality of that business, and it facilitates the use of profit-related compensation as an incentive device. Greater volume also helps achieve some degree of scale economies between a broker and insurer and lowers business acquisition expenses. Consequently, greater volume with an insurer reduces costs and increases the broker’s ability to negotiate favorable terms for its clients.
The complete AEI white paper, along with contact information for Professors Harrington and Scott, can be found online.