Socialism involves minimizing the value of merit. In the world of insurance, where is the value of performance if every single agency gets exactly the same commission rate regardless of merit?
Historically carriers partially mitigated their socialistic commission schedules with profit sharing. But today, with so much aggregation, whether through networks or acquisitions, distributor books are so large that statistically, their loss ratios should mimic the carriers' loss ratios. Additionally, while virtually no carrier will admit it, one of the goals of predictive modeling is to achieve a balance between X% growth and Y% loss ratio. This means eliminating low loss ratios because low loss ratios correlate to low growth, eviscerating the balance. And the loss ratio goal is around 55%, too high for-profit sharing in most contracts.
Therefore, the mitigating effect of profit sharing is dead, but the industry is still pretending merit matters. Playing along with a carrier who still wants to believe their company emphasizes low loss ratios, consider the following actual results of an agency's book with one such carrier:
Premium equals $10,000,000.
Five-year loss ratio is 40%.
Profit margin, all else being equal using the carrier's own expense ratios, is 30% on this book.
Their standard profit margin is 12%.
The profit sharing and any extra overrides equal 6% of premiums which is four percentage points higher than the carrier’s average (2% vs 6%). At a 14% commission rate, they are making 20% on $10,000,000 or $2 million.
The carrier is making 18 percentage points more and only offering the agency four percentage points.
The agency could easily double this book to $20,000,000 (this agency has excellent organic growth) and increase the loss ratio to 50%. Using an average 14% commission and the average 2% profit-sharing/override, they would make 16% of $20,000,000 or $3.2 million.
Which is the better deal for the carrier? They are making 18% on $10 million or $1.8 million. Or they can make 8% on $20 million which equals $1.6 million. Which option is best?
Yep, that's why socialism fails. It incentivizes marginal to poor results simply by failing to adequately incentivize quality results. At a 50% loss ratio, this agency would still be outperforming the company overall.
Most carriers are hyper focused today on expenses rather than loss ratios. This focus makes sense. My own studies show material correlations between expense management and carrier success, but only to the degree that expenses are not minimized in a manner that increases the overall combined ratio. A carrier arguing they cannot afford to pay more for an excellent combined ratio is cutting their nose off to spite their face.
I have designed a lot of compensation plans for carriers, networks, and producers. Compensation plans focused on merit drive better results. A carrier hyper focused on expenses will never achieve success with a socialistic commission schedule because there is no incentive for distributors to help the carrier decrease its expense ratio.
Three large barriers exist though to creating a merit-based commission schedule. From a regulatory perspective, rates include commissions and it is easier to include a flat commission applicable to all agencies in a rate filing than to include a variable commission schedule. But making this happen is why actuaries get paid the big bucks. If a carrier can employ 500 variables in their rates, they can surely address a variable commission schedule.
The second is simply accepting within the carrier that a variable commission schedule makes sense. The time has come. True, it means the company will need to talk to its agents to explain it. The shoe is kind of on the other foot here because this is what agents must do in explaining the huge rate increases.
The third is accepting the reality that a lot of agents will scream bloody murder. If you are an under performer being paid in excess and now someone takes away the excess unless you begin performing, humans naturally scream. Everyone wants a free ride and psychologically, no one thinks they are a free rider. I have had so many of these meetings that I can now clock each stage of the argument. Kubler-Ross's five stages of grief is an excellent model for how the meeting will go.
But this industry works on the Pareto curve. 80% of the production derives from 20% of the agencies (or if in an agency, the producers). You'll have more screamers than applauders, but the applauders are the ones that matter. Giving voice to poor performers is a mistake.
And if carriers do not begin better rewarding performance, adverse selection will accelerate. Many estimates suggest a majority of all commercial premiums are already in the Alternative Risk Transfer market (ART). Why wouldn't a great distributer decide that if a carrier is not going to treat them any better than poor performers, effectively resulting that agency subsidizing their competitors, not take that book to the ART market? This is already happening at the highest levels.
But now, market mechanisms are making it easier and easier for agents and brokers to move smaller books and smaller but quality accounts into this space. The capital exists too because the providers recognize the opportunity primary carriers are ignoring or taking for granted.
Commissions should be based on performance. The agencies that generate the growth, or a reduced new business acquisition cost or (if the carrier wants high retention--not all do) high retention or whichever performance metric is most important, should be rewarded accordingly. Whether in business or national economies, socialism causes results to be worse than what the mean otherwise would be because the incentive is to lag and that's what the current commission structure emphasizes. If you want to be a winner, reward merit.
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