Following years of adverse press regarding insurance broker compensation, many buyers of insurance still have little knowledge as to how their broker is compensated. While there are many approaches to compensation with no one “right” answer, buyers have a right to understand how their insurance dollars are being allocated and to what extent (if any) the broker is being influenced by “external sources”.

Insurance brokers and agents receive compensation from several key sources, the most common of which are “commissions” paid by insurance companies for the placement of insurance policies. Commissions are established by insurance companies, and typically range from 5% to 15% of the premium for property and casualty business, while commissions on employee benefit products average approximately 3%-5% of the total premium. Such commission percentages vary by insurance company, by type of insurance coverage, and sometimes in accordance with the volume of premium a particular broker has with an insurance underwriter.

While commission compensation is commonplace, policyholders have a right to the disclosure of this information. Of course, a quality broker will select the insurer(s) that best meets their client’s insurance coverage needs without regard to commission levels.

Many brokers also manage insurance programs on a fee-for-service basis. In this situation, the broker should not also receive commissions from insurance companies on the same policies which he or she is paid a consulting fee. In fact, this practice is illegal in most states. In situations where a broker is earning both a fee and a commission from the same account, but for different policies (which is an acceptable practice), a written agreement should be in place clarifying the compensation structure.

Another often controversial source of broker compensation is contingent income. These include amounts paid by insurance companies which are based on various year-end factors such as the overall loss ratio (losses versus premiums), and volume of new and retained business. Contingent income is not related to a specific client, account or policy; rather, contingent income is paid on the basis of the performance of all accounts or policies placed with an insurance company during a specified time period. Contingent income became a source of contention several years ago when a number of the Fortune 500 insurance brokers became embroiled in compensation and bid-rigging scandals. However, for the majority of independent insurance agents and brokers, contingent income is not a consideration when placing business and the importance of such agreements to overall agency operations is nominal.

Some brokers also receive fees, commissions and other forms of compensation from third-party service providers such as independent consulting firms and loss remediation services. While fee-for-referral arrangements are a common business practice in virtually every industry, many insurance buyers are unaware that their broker may be recommending service providers with whom they have a financial interest. Larger brokerage firms may even own the third-party service firm whom they are recommending. While such referrals may not generate direct income for the referring broker, the issue is the same: all motivating factors directly related to a broker’s recommendations should be disclosed to the client.

Reputable insurance agents and brokers should readily disclose all sources of compensation related to the placement of their clients’ insurance coverages. By providing clients with a clear understanding of their revenue sources, brokers position themselves as trusted advisors.

Knowing how all your key business advisors, including your insurance broker, are compensated is an important step in building long-term relationships. Full and open dialogue on compensation minimizes the potential for miscommunication between you and your advisors.

This notice is provided as information only and should not be considered a legal opinion. If you have questions about this Client Advisory, please contact Seacrest Partners at 912-544-1900.