In January of 2011, 10 ACE Group Companies agreed to pay $70 million in settlement fees to the New York Workers’ Compensation Board after an investigation into whether certain insurance companies had been overcharging policyholders.
Contingent Commission Whitepaper
Consumers rely on insurance brokers, as trusted experts, for guidance in procuring the best available insurance in terms of price, service, and coverage. That is precisely why incentive compensation, such as contingent and supplemental commissions, paid by insurance companies to brokers based on benchmarks such as profitability are problematic.
Incentive compensation is big business. For example, among the one hundred biggest insurance brokers operating in the United States during 2005, contingent commissions comprised as much as twelve percent of annual gross revenue. However, contingent commissions have been challenged by multiple states as little more than a system devised by insurance companies to corrupt brokers against their clients.
What is a Contingent Commission?
Insurance brokers often receive two types of compensation. First is a flat commission calculated as a percentage of the premium amount a consumer pays for the policy. On top of that insurance companies pay incentive compensation, commonly referred to as Contingent and/or Supplemental Commissions. Under this arrangement, an insurer pays a bonus fee or to a broker that is calculated based upon measures such as profitability and business growth.[a] There is no legislative requirement for this arrangement to be disclosed to policyholders.
Contingent commissions allow brokers to profit in at least two ways. First, brokers steer business, either as new policies or renewals, to certain insurance companies who in turn pay extra commissions to those brokers for the retention and/or increased volume of business. Second, if brokers sell policies that terminate without a claims loss, the insurance company pays a commission based upon the increased profitability. In other words, the more business a broker places with an insurer or the fewer claims policyholders successfully file, the more money that broker collects. Because contingent commissions can represent a significant portion of a brokerage’s profit, participating brokers are incentivized to place business with underwriters offering the best commissions and not necessarily the best terms for the client.[b]
Interfering with the Claims Process.
Consumers also rely on insurance brokers to offer expert guidance and assistance in filing legitimate insurance claims. Contingent commission agreements can not only poison the relationship between broker and client from the inception of the relationship – i.e. the biased policy recommendation– but also can corrupt the claims process.
By paying incentive commissions to brokers for policies with low claims ratios, insurers provide brokers with a hefty financial incentive keep successful claims to a minimum. Brokers who participate in such programs have a direct conflict of interest between their own profit margins and their clients’ interests in settling legitimate claims. This can potentially lead to a pattern of non-cooperation and obstruction by overly conflicted brokers.
The concern with this type of conflict is that a consumer can ultimately be left to fend for herself against a large insurance company with unfair claims settlements practices that are designed to cause confusion and delay. To add insult to injury, the cost of contingent commissions are literally passed off to consumers in the form of increased premiums and frivolous denials of legitimate claims.[c]
Contingent Commissions Under Fire: Spitzer on the War Path.
In one of the biggest insurance scandals in U.S. history, NY Attorney General Elliot Spitzer investigated whether ACE, AIG, Marsh & McLennan, and other large insurers and brokerages had violated state and federal laws through the use of contingent commissions and other questionable insurance practices beginning in 2004. Spitzer asserted that incentive compensation contributed to the widespread practice of “bid-rigging” where brokers solicited fake bids for consumers with deliberately less favorable terms than the bid offered by the insurance company paying the highest commissions.  [d]
Some insurance companies and brokers, including ACE, Marsh, and AIG collectively paid more than one billion dollars in settlements. They also agreed to reform business practices, including a multi-year restriction on the use of contingent commissions in specified lines of insurance and increased transparency of broker compensation to consumers. Furthermore, roughly twenty insurance executives pled guilty to various criminal charges related to conduct that included participating in bid-rigging schemes, price fixing, accepting contingent fees, and improper accounting methods. This count includes Patricia Abrams who plead guilty to attempt to restraint of trade and competition after being terminated from her position as Vice President of ACE, Ltd.'s casualty group.
Defenders of incentive compensation argue that the conflict of interest concerns with incentive compensation can be solved with disclosure. However, one of the biggest targets of the Spitzer investigation, Willis North America, publicly admitted that merely disclosing the presence of contingent compensation in a transaction is inadequate to protect consumers.[e] Over time ACE, AIG, Willis, Marsh & McLennan and AON reluctantly agreed to discontinue or severely curb contingent commission arrangements. While there is currently no outright ban on contingent commissions in any state, it could be argued that these concessions amount to de-facto recognition by the industry that the practice is improper.
Same Old Tricks: Are Supplemental Commissions Just as Bad?
While the movement towards curbing the use of contingent commissions seemed promising at first, insurance companies shifted to favor another form of incentive compensation that is also vulnerable to deceptive practices. So-called Supplemental Commissions, this new breed of incentive compensation still provides financial incentive to brokers in exchange for minimizing loss ratios and maximizing revenue growth and profitability by providing additional compensation based upon an agent's past performance.
Proponents of supplemental commissions argue that they are different than contingent commissions because they enable brokers to calculate and disclose commission packages to consumers at the beginning of a policy period. However, nothing actually requires insurance companies to disclose this information to consumers so it is unclear what percentage of brokers actually make adequate disclosure. For example, in the online producer compensation disclosures made by the ACE Group of insurance companies, ACE acknowledges that it does in fact pay supplemental commissions to independent agents based upon measures of profitability and revenue growth. However, ACE fails to provide any detailed disclosure about how much it pays in supplemental commissions.[f] In fact, a state industry lobbying group is doggedly fighting landmark legislation in New York State that would require insurance companies to disclose incentive compensation agreements to consumers. 
The fact remains that the growing use of supplemental commissions is widely considered to be no more than the same horse racing under a different name. London based brokerage giant Willis has stated that, “[Supplemental Commissions] have performance-driven elements that make lump-sum payments contingent on factors such as retention, growth and profitability-features that rendered contingent commission plans incompatible with conflict-free transparency and our clients' best interests.”  Willis was the first insurance brokerage to publicly shun supplemental commissions as it did with contingent commissions.
Overall, supplemental and contingent commissions remain in the public debate because of the dangers they pose to unwary policyholders. Consumers rely on brokers as experts. Insurance companies can prey upon this reliance by creating compensation structures that fatally conflict brokers in their duties to their clients. Stringent and uniform financial disclosure regulation, as proposed by the State of New York, will go a long way toward giving consumers the information needed to make sound decisions. However, disclosure does not eliminate the conflict. It is time for state insurance regulators to just say no to incentive compensation and to clearly define the duty an insurance brokerage owes to its clients.
[a]“Since at least the mid-1990s ACE and other insurers have paid hundreds of millions of dollars in so-called ‘contingent commissions’ to the world’s largest insurance brokers . . .” ACE Assurance of Discontinuance, p. 2, para 1 
[b]“Ace entered into a number of contingent commission agreements *(also known as “override” agreement) to pay compensation to [brokers], such as Marsh, Aon, Willis and Gallagher as a result of which they steered insurance policies to ACE to increase the volume of policies written by ACE, to keep retention levels of existing ACE polices above certain benchmarks, and to direct policies to ACE.” ACE Assurance of Discontinuance, p. 2, para 4 
[d]Ace Assurance of Discontinuance, p. 3-5  Regulatory Impact Statement for the Adoption of 11 NYCRR Part 30 (Regulation 194)  “New York State Attorney General and the New York State Insurance Department commenced a joint investigation in 2004 that uncovered instances of criminal bid rigging by a large insurance broker and several large insurers, as well as steering schemes involving a number of major insurers and other insurance producers. The investigation culminated in settlements between 2005 and 2006 under which producers and insurers paid more than $1 billion to recompense customers for harm resulting from bid rigging and steering.” 
[e]"As important as transparency is, it still isn't enough. We do not believe that it is enough to just reveal a practice that you know is not in your clients' best interests. That's not honoring the spirit of making your clients' interests paramount . . ." quoting Donald Baley, CEO of Willis North America.
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