The commercial marketplace for property and casualty insurance has inherent structural conflicts, granting the true power to the suppliers (insurers, agents, and brokers), not the buyers. It’s first important to understand how the marketplace is organized, with insurers, agents, and brokers.
Agents Don’t Work for You
Insurance agents are just that—they are legal agents representing the insurance company’s interests. Insurance companies generally don’t sell their insurance directly to buyers; rather, they use agents to act on their behalf. If you’re purchasing insurance for your company and go directly to an insurance agent, the first thing you need to recognize is that the agent is not representing your needs and interests. Agents are charged with selling as much insurance as possible, at the most profitable margin. They are directly compensated by how much premium they place into a particular insurer.
If you’re relying on your agent to tell you which insurance to buy or not buy, that’s a risky proposition because agents are directly conflicted.
Brokers are Incented to Act on Their Own Behalf
Brokers, on the other hand, are supposed to act independently from agency arrangements between insurance companies and buyers, and are supposed to bring the best options to the table for both the market and the buyer. The reality is, brokerage firms are also all licensed agents, which can confuse their roles.
The intent is for companies to pay a broker a fixed fee to find options in the marketplace to meet the insured companies’ various needs. However, what isn’t widely known is that brokers receive a variety of incentives that prevent them from exclusively acting in the insured’s best interest, even if they’re not receiving a direct agency commission.
Even if you choose to pay your broker a fixed fee, the broker has a direct financial conflict because he or she is likely receiving a contingent commission. Contingent commissions are broker fees from insurers based on volume of premium placed as well as the profitability of that premium to the insurer (i.e., low claims paid). This allows brokers to earn financial compensation directly as a “kickback” from insurers for all the premium they place with each insurer.
Broker Culture is Contingent on Premium Placed
If you ask an individual broker about contingent commissions, also known as market service agreements, he or she may not be aware of it, and could be telling the truth, unaware of what their brokerage is up to. But even if the individual isn’t, it is better personally for each broker if he or she has a book of business indicating that his or her clients are paying a lot of premium. Their prestige in the company is based on how much premium they are managing, so it’s in the broker’s best self-interest to have higher premiums, even if they are unaware of the structural conflicts.
Many brokers view the world as “more premiums, better lifestyle for me,” and the salaries and bonuses are often directly connected with how much business, or premiums, they are getting.
In addition, brokerage fees end up being surprisingly close to what they would have otherwise earned in commissions, so in the end, brokers are taking what they would earn on commissions based on the premium in the marketplace and calling that a fee. Instead of basing the fee on the amount of work to be done for a client, it will still be based on the amount of premium that’s to be charged to that client.
Broker Income from Premium
The final structural conflict that creates conflicts of interest for brokers is the income they receive from “premium interest”. Premium interest is the money that brokers earn by holding on to your insurance premiums and investing those funds. Brokers will sometimes keep premiums in their accounts for months before paying your premium to the insurance companies.
Many insureds are aware of the direct conflicts of insurance agents, but are often not aware of the structural conflicts of insurance brokers. It’s critical that you have an independent, educated buyer involved in your insurance purchasing.