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  • Writer's pictureChris Burand

Unintentional Consequences

It has now been 20 years since New York Attorney General Elliott Spitzer began investigating the insurance industry, and particularly one broker initially, for artificially inflating the price of insurance through “kickbacks”. He alleged the broker received these kickbacks through contingencies and also that the broker leveraged their threat to move carriers’ business if the carriers did not pay more. (Note: I am not sure these are the correct legal terms. These are my common person interpretation of what was alleged.)

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I recall this caused significant turmoil, especially when so many other state attorney generals joined the band wagon smelling blood. Many agents and brokers spent tens of thousands and upwards into the millions of dollars defending themselves, providing documents that ultimately sat unreviewed in storage rooms, and all this defense was in response to rather nebulous charges. The national carriers made severe changes to their contingency contracts, that last today, to comply with their agreements to change practices. The regional carriers made virtually no changes to their contracts. The changes the national carriers made generally worked to their favor by reducing expenses and negotiating leverage under the guise of compliance.

It was a time of considerable grandstanding built on weak legal pretext as evidenced by the results: zero successful prosecutions, a negative ROI to taxpayers, and the subsequent explosion of even more leveraging.

The genesis of the original investigation has not, to the best of my knowledge, been officially revealed to this day. I would enjoy reading whatever it was, and from whom, that catalyzed Mr. Spitzer into such energetic prosecution of an empty situation. A rumor I read at the time, published out of London if I remember correctly, was that a particular carrier’s CEO reported “abuses” of that one broker to the NY AG.

That carrier has since fallen far further while the accused broker has done pretty darn well. The carrier was later investigated for some pretty serious reinsurance shenanigans costing the CEO his job. Maybe the ancient Chinese saying is true, “When you point a finger at someone, look at where the other three fingers are pointing.”

Another far more important result is that the rest of the industry awoke to how pliable insurance carriers were to negotiating extra compensation without having to give anything of real value in return. Money for nothing. These smarter, sharper aggregators and acquisition firms realized they could get carriers to pay much more in overrides, not necessarily contingencies. In other words, leveraging books has grown exponentially since Spitzer said he would shut it down.

A couple of better solutions existed then, and now. The situation is much larger now in scope because so much more premium is affected, premium is so much more concentrated in 40 or so distributors, and because Spitzer pushed the extra compensation from contingencies which arguably benefit consumers to overrides which have few performance conditions that can be argued to be beneficial to consumers (especially given A.M. Best’s recent report showing commission expenses have increased materially over the last ten years). As a result, carriers have more expense and more risk now in fixing their problem.

Yet an open secret is that many carriers are frustrated with the poor, even negative, ROI’s they have on these books. The original complaint was meant to save carriers money and all it did was cost carriers more and put more of their premium at risk because the result increased the speed of consolidation (especially with networks/clusters/aggregators).

I’ve studied the results of the carriers who play the game versus the ones who do not. The winners are pretty clear. Having a spine and not playing the game is good for a higher ROI.

Of course, if you are running a financially weak carrier and/or a vanilla carrier with nothing special to offer agents, maybe all you can do is pay more. Paying more is a competitive advantage, though an expensive one. And it is only defensive, a strategy to hold one’s place rather than to advance one’s place.

A better strategy is to mark this anniversary by redoing compensation plans. Historically regulators and insurance companies preferred a socialistic distributor compensation system whereby everyone received the same commission rate. Regulators like this model because it’s easier to regulate. Carriers like this model because it’s easier to operate. Also though, the reality is that given the antiquity of some of their IT systems, and thought processes, they cannot do anything more modern and performance based.

Carriers will say that distinctive quality/performance is what contingencies are for but with predictive modeling, and especially with aggregation, the large distributors’ loss ratios are the carriers’ loss ratios so paying based on loss ratios is a concept with little value today. Pretending otherwise is an expensive charade. It causes underwriters and marketing reps to focus on the wrong goals. More importantly, it causes significant friction with the better distributors for two reasons. First, the messaging is not aligned with reality. I’ve had carriers tell me they realize this is true but don’t know how to change their messaging. Second, like all socialistic systems, it rewards those with size and marginal to poor performance.

Change your compensation systems to measure the return on investment rather than the power of size and the fear such concentration causes. Doing so will likely aid some dilution of that concentration, but more importantly, designed well, these compensation systems will create alignment and simultaneously decrease your expenses. The best distributors, even some of the largest distributors, would like to be paid for their performance because they realize, far better than the carriers, they are subsidizing their lazier competitors with socialist compensation systems.

Twenty years is a long time in most industries. Insurance changes at a snail’s pace. But this hard market will forever change carriers’ market positions and the winners will address this point constructively (the losers will simply reduce commissions across the board). I built my first merit-based carrier performance plan in 1992 which proved savings could be had simultaneously with paying the most deserving agents more. The time is now to think modern, go to the orthopedic store and buy a spine, and secure your future with merit-based compensation plans.


NOTE: The information provided herein is intended for educational and informational purposes only and it represents only the views of the authors. It is not a recommendation that a particular course of action be followed. Burand & Associates, LLC and Chris Burand assume, and will have, no responsibility for liability or damage which may result from the use of any of this information.

None of the materials in this article should be construed as offering legal advice, and the specific advice of legal counsel is recommended before acting on any matter discussed in this article. Regulated individuals/entities should also ensure that they comply with all applicable laws, rules, and regulations.

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