Victory !! ?? !!

Travelers and Chubb have agreed to stop paying contingency commissions in 2008 (for year 2007) as a response to the litigation brought against them (and other carriers and brokers) due to “bid-rigging” accusations against them and the brokers in the last year.

Both carriers have assured their preferred agents that they do not intend to stop paying “bonuses” for high performance (strong loss ratio profitability and strong growth). They have defined the ruling and their resultant actions as the termination of “contingency” contracts based on performance in the current year in favor of “guaranteed” bonus money based on the agent’s historical performance. If this means that the agency can count on specific percentages of premium as payments for performance in the following year, this is a good thing. If the amounts of payment are mitigated to provide the guaranteed funds and would not result in the same amounts to high performance agencies as prior contingency contracts, then the agents are taking a step back in their income in years of strong profitability and growth (like 2006). Only time and the carriers will tell as the new programs develop and are publicized. Travelers, mysteriously, has altered its contingency program to a guaranteed bonus program for Personal Lines ONLY (but not Commercial Lines even though the target of the litigation by New York, California and other states was specifically commercial (and large commercial, at that) accounts). They are offering, but not mandating, the conversion to guaranteed bonus for commercial lines in 2007.

The industry is taking a deep breath, but many other carriers may try to surf this wave of change rather than risk the scrutiny of the regulators regarding their treatment of agents and clients. They may be forced to change their way of paying for performance if the Travelers and Chubb bonuses become “guaranteed” making them far preferable to standard contingency contracts.

Initially, the elimination of contingency income sounds disastrous to agents, many of whom lose money on operating income every year and need contingency income to remain afloat. However, if the result is guaranteed funds for performance rather than the “iffy” contingency income that has agents holding their breath and praying to the weather gods in the fourth quarters of good loss ratio years, the results may be positive and bonus money may be more assured.

But this may also be the “forced diet” that slims down an insurance agency industry who has been held hostage by the insurance companies who would pay a “bonus” for growth and profitability once each year (in March or April) based on a series of convoluted formulas that no one (including most of the carrier employees) could understand or explain. Some of us in the consulting industry made a good living simply re-formulating contingency formulas to insurance agencies so that they could understand how much they stood to get from each of their carriers.

For many years we have tried to get contingency income converted to higher commissions (paid to agencies every month for at least a year) based on the productivity and profitability of those agencies to the specific carrier. A high percentage of agencies need their contingency incomes for operations instead of for profit and asset growth. Receiving a check in March or April is great, but getting that money spread over the full year permits agencies to use those funds to sponsor their operations.

And why should an agent who has a long history of marginal (60%+) loss ratios and minimal growth get the same commission percentage on the business they place with a carrier as one whose historical loss ratio annual growth is strong with that carrier? Why shouldn’t a carrier pay a provisional commission rate to an agency during its initial years of appointment until volume and loss ratio prove the agency’s worth? An agency will always promise the moon (strong growth and low loss ratios) at appointment, but there has been no way for a carrier to know (or incentivize an agency) to pursue those lofty goals.

The only downside to conversion of contingency to preferred commission rates is the payment of a portion of those commissions (if they are treated as part of the agency’s standard commission) to producers for their efforts. In reality, producer commission rates have been and continue to be reduced as agency expense ratios have increased. Increased production has been the only way for producers to regain strong income positions. What incentive does an employed producer with no agency ownership have in refusing marginal business? Every agent counts on his producer to ‘do the right thing’ and underwrite the accounts that are brought to the table to be written. Why, then, shouldn’t the producers share in the commission boost of being employed by high quality agencies when the producers are responsible for the risk selection as well as relationship maintenance? And, in times when agencies have difficulty attracting high quality producers, wouldn’t the best agencies (having the highest commission contracts with their carriers) be able to attract better producers and keep them longer because of the natural differentiation of commission advantages?

We KNOW that the decisions of the regulators regarding contingency for insurance agencies is flawed. Few agencies collude with carriers to place certain lines with one or the other to the exclusion of its other companies. It just doesn’t work that way on most insurance accounts. Agents will always seek the best price for clients, regardless of potential contingency impact. How many agents have actually placed business away from one carrier and into another because the second carrier had a better contingency contract?

Most agencies simply try to underwrite their books of business and grow them to carrier specifications for the “carrot” of extra income through their historical contingency commissions. As usual, the regulators have over-reacted and punished the majority for the deeds of a small minority.

We HOPE that the companies are smart enough to avoid the temptation to terminate the contingency agreements with no replacement for loyal, profitable and growth-oriented agencies. The ruling of the regulators is not meant to create wind-fall profits (albeit short term) for the carriers as they retain that commission that has been traditionally paid to their strong agencies to continue to sponsor both growth and (more importantly) front-line underwriting to low loss ratios.

Here’s what might happen – several carriers, claiming to be ruled by the regulators, cease payment of contingency income with no replacement (or lower value ‘bonus’ payments than historically earned) and force standardization of commission contracts among all agencies.

The Results – a large number of agencies will shrink or fold within two years since they have existed on contingency income, having spent more than their operating income on agency fixed and variable expenses. Some can eke out one or two years without contingency (they have in the past during high loss ratio years), but not much more. As replacement income, agencies will increase the charging of fees (where permissible) and will become more aggressive (and less selective) in their growth plans. Look at how agencies treat wholesalers and the residual marketplace – if the risk is acceptable at its face, the account is placed with the carrier responsible for underwriting and risk selection.

The Alternative — Carriers analyze each agency on a three to five year basis for both growth and loss ratio. Several tiers of commissions are created with agencies qualifying or moving between tiers based on their growth and loss ratio trends with the carrier. The carrier pays the highest commissions to those agents who grow consistently and are consistently profitable. One year of results, good or bad, will not change a commission schedule – trending is more important than one bad year (or one good year). Agencies will be able to plan their expenses on a twelve month basis since their compensation will include that income that they previously received from carriers once each year for achieving growth and/or profit goals. The companies win by forging long-lasting relationships with professional agents who are proud to be the carrier’s front-end underwriters. Agents who do not perform or who just want the carrier representation “in case” it is needed must live with lower commission rates than high-performing agents. Agents win by tying loyalty to performance with a carrier. Commission rates will be empirically determined, rather than by who likes you and who doesn’t.

Provisional commissions for new agents and roll-over commissions for agents who can prove the profit and value of seasoned books of business are just a few twists that can be managed to add and change agencies.

So we would like to declare the action by the regulators and by Chubb and Travelers A VICTORY and would encourage them and all other carriers considering similar actions to use this to actually strengthen their relationships with their best agents, rather than to keep a few points of premium that had been paid to the agents through their contingency programs. Guaranteed bonus is GOOD. Conversion to preferred commission rates based on historical agency performance is BETTER.