The history (or mystery) of the broker remuneration debate

Broker remuneration has been an issue of contention for years despite broker commission being universal, yet the history of it is far from simple.

For example, an exact date for when this debate began seems to be a mystery.

According to Insurance Times’s archives, Airmic was one of the first to call out the model back in 1998, urging the UK government to ban contingent commissions completely.

Sources in the industry say the debate has been around as long as they can remember.

But the debate resurfaced again recently following a report from compliance firm Mactavish calling out the broker remuneration model as a “huge conflict of interest” which many brokers including Biba disagreed with.

The issue lies in transparency – the way that brokers are paid for their services, a fee arrangement between the client and broker is one kind of arrangement.

More commonly, brokers earn commission (fixed or varied) which is agreed with the insurer and taken out of the premium that is paid by the insured.

In some instances, the insurer and broker enter a further arrangement whereby the broker receives an additional fee or commission from the insurer for hitting a certain level of business – this is known as contingent commission.

Like its name, ’contingent’ commissions are negotiated with insurers and depends on the business volume or loss ratio, as well as the portfolio of business instead of individual risks.

For this reason, they are not known in advance and are not measured until the underwriting year has ended.

Therefore, with brokers acting on behalf of the insured’s best interests under the Insurance Distribution Directive (IDD), and insurers hoping to maximise on both the sale and distribution of their own products. Is there any wonder that there is a perceived conflict of interest?

Double agents

Ashwin Mistry, executive chairman at Brokerbility told Insurance Times: “[Brokers] are agents for the client and the insurer, and that is where the conflict about whose interest we are representing started from.

”Ultimately, we are distributing the products from a number of providers and conversely, we are acting on behalf of clients.

“The grey area is there because we [brokers] distribute products of the carriers but represent the end client.”

However, as brokers’ business models evolved, commissions have been looked at.

Airmic in 2009 published its first broker remuneration guide in response to members wanting support on how to communicate with brokers about fee structures.

Mistry said that the first wave of consolidators meant a “land-grab” for insurers – feigning disproportionate commissions against the threat of losing premiums.

Soft market

In the recent report, Mactavish’s chief executive Bruce Hepburn argues that despite broker business being traditionally commission based, brokers might earn around three times the fee income commissions.

“Those commissions were straightforward and relatively transparent, but in later years the model switched to a greater dependence on direct client fees. That was a welcome move as it removed all potential for conflicts of interest. However, competition over fees, especially in soft market conditions placed enormous pressure on individual brokers and the system as a whole,” he said.

In the 80s and the 90s brokers innovated to get around this problem.

Pay to play

Hepburn continued: “Sadly, rather than service innovations that would have improved the client experience and increased the value that policyholders place on broker’s work, the focus was on extracting income from the supply-side.

”Contingent commissions, profit shares and various forms of ‘pay to play’ meant that brokers could increase their revenue while keeping direct client fees very low.

”Of course, in the end, the policyholder pays for all of this, they simply do not realise it. For us, this represents a major failing in sales and marketing on behalf of the industry.”

Mactavish argues that broker fees should be around three to four times what they are today, however those fees should substitute for lost insurer income – not add to it.

Mistry on the other hand, has called out this assumption, stressing that in a hard market, the broker earns more.

Push back

In recent years brokers have pushed insurers for greater commissions, especially in commercial lines, Branko Bjelobaba managing director at Branko Ltd told Insurance Times.

He said: ”This is down to their increased costs or the better performance of accounts which could be agreed with profit shares - so if the customer makes fewer than anticipated claims or no claims the broker’s overall account with that insurer is subject to enhanced payments.”

For example, in the managed property market, brokers generally share commissions with property managing agents to maintain a reasonable level of commission they demand extra commission, he added.

But Bjelobaba remembers a time when commission was fixed and varied according to type of policy.

He said that personal or commercial lines and insurers generally stuck to similar amounts, so the only competitive aspect was as to how good the insurer was in terms of service and claims handling.

“The amount was never commensurate with the work done in respect of placing the risk and bear in mind that the broker only gets paid if they place the risk following all that work done - so if the client decides to go elsewhere then no payment for assessing their requirements, going to market, getting the quotes and then making the presentation to the prospective client,” he added.

Broker commissions are only disclosable if the client asks the broker directly – this came into force during October 2018.

Front loading

With standard general insurance products being annual contracts, the customer has the option to shop around and assess the value they are getting from their broker over a period of 365 days. The client gets this 14-21 days before renewal.

“I would concede that in the first year that some brokers [may reduce commission or fees] in the first year to get the customer onboard but that’s [down to each] broker’s business model.

”Brokers don’t necessarily recover their costs from the first three to four years for any placement because the costs are all front loaded,” Mistry added.

Front loading is a practice whereby insurers subtract the expense charges, fee, commissions, or interests of a policy immediately from the initial premiums paid.

For brokers, Mistry added: “If you scrap all fees, then you are going to be relying on commissions.

”If you are charging your customer gross inclusive of commission, you are paying 12% Insurance Premium Tax (IPT) on that gross amount.

”If you are charging a fee, then you can [put your] commission down, then you pay IPT based on the net not the gross.”

Therefore, he said it is in the client’s interest that brokers work on a transparent fee rather than a transparent commission.

Mistry also believes that there are a number of “fundamental assumptions” made in the Mactavish report. For example, he questions which broking cohort the report looks at.

“The danger in this report is that it distorts the whole image of broking. Are we a profession or are we an industry? The paper suggests that broker remuneration is the major conflict of interest when I think the catalyst for the paper was the ineffective cover for Covid-19,” Mistry said.

Spitzer

Back in the US, in 2004, the property-casualty market was rocked by a bid-rigging scandal that involved Marsh & McLennan.

The broker was accused of defrauding customers by rigging bids for its own gain.

Eliot Spitzer – a New York based solicitor filed a lawsuit against Marsh’s practice of paying brokers and agents an additional compensation contingent on sales and risk profitability.

Spitzer alleged that as contingent commissions are not adequately disclosed to policyholders, they threaten the competitiveness of the P&C market.

The 2005 Spitzer settlement with Marsh & McLennan, Aon and Willis banned all from accepting contingent fees until 2010.

Since then, brokers have begun accepting them to varying degrees again under certain circumstances.

But Hepburn describes this period as a “lost opportunity”.

“The initial clean-up wasn’t maintained, and we question why the regulator has allowed a proliferation of new opaque remuneration structures over the course of the last decade which have expanded inexorably in scope and scale.

”If anything, the Spitzer-influenced reforms were a caesura rather than a full stop,” he said.

He explained that the model change distorted the insurer’s traditional role and meant that rather than acting as agents for the client, brokers became, as BIBA recently put it: “the agent of the client as well as the insurer”.

Mactavish believe this is at odds with most clients’ understanding of the broker’s role. Hepburn said that in many instances, brokers today act more as distributors for insurers than anything else.

Mistry added: “If Spitzer is still being ignore by some of the brokers concerned, that is not for regional brokers to be addressing.”

Treating brokers as ’the market’

Hepburn said that Mactavish believes that the option for clients today is to treat brokers as “the market” and have them run head-to-head “Written Lines Tenders” in tandem with their insurance partners.

“While this doesn’t solve the industry’s deep structural problems, it does mitigate the symptoms at the individual account level.

”The results of this injection of competition can be quite incredible. Every case we have worked on has resulted in a saving of between 20 and 50% against broker estimates – saving clients millions of pounds whilst also improving the quality of cover,” he said.

Although Hepburn said that many clients do not run tenders in this way, but demand and receive full transparency from their brokers on fees.

“This brings us to what we consider to be the ‘transparency conundrum’: brokers tell the FCA that their account teams don’t have full visibility over insurer revenue as this is how they manage conflicts of interest – so, how can those same account teams tell clients that they provide full disclosure?

”Only one of these things can be true. This paradox throws into sharp relief the fundamental structural problems inherent in the way in which the industry is.”

Law of agency

Bjelobaba added: “Brokers should remind their clients that they can ask for details of their commission at any time - do they state that clearly?

“Under law of agency brokers must not make secret profits without knowledge or sign off by the client - do they know that? Is the payment fair for the amount of work done? Is the broker being paid too much in line with the time spent?”

The FCA could have mandated commission disclosure in Oct 2018 but they chose not to.

He said that potential conflicts could be if the broker has an MGA and recommends explaining this to customers.

Lastly Mistry said: “Broking is a relationship, it is trust, it’s understanding the client’s exposures – so to just focus on commission is missing the point.

”But clients are not ignorant, they are businesspeople who are savvy, they will challenge and test brokers periodically. At renewal dates, the client will decide for themselves whether the price and value are commensurate with what their experience is.”

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Read more…Biba denies broker commission is “huge conflict of interest”

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