Tony Cornell, insurance consultant, looks at the likely impact that striking profit share deals with insurers will have on brokers.

Tony Cornell, insurance consultant, looks at the likely impact that striking profit share deals with insurers will have on brokers.

Christmas and the new millennium are rapidly approaching and the country's thoughts are turning to the celebrations ahead. Many principals of brokers, however, have one eye on the performance of their profit share deals with the insurers. From being the icing on the cake, profit share payments can now make the difference between a trading profit and a loss, and have even become vital to some brokers for survival.

The soft market and competition in the late 90's means many firms are only breaking even or indeed are losing money on their normal trading activities. That Christmas bonus, those much-needed investments in new technology, new marketing initiatives and even that new car may all depend on what happens in December.

Impact on premium target
Most profit share deals have two triggers to be eligible for a payment: the meeting of gross written premium and loss ratio targets. A big claim can eliminate a payment with one insurer or even worse, a local or national weather incident can impact a number, reducing the expected pay-outs significantly.

The transfer of a large case can affect profit share earnings if the result has not been thought through carefully as it could easily impact on any premium target. In one case, it could mean a target is not met or in another one that it is. Principals need to be aware of this before allowing staff to transfer large cases. There are many instances of profit share deals not being triggered because unknown to the boss, a case has been moved from one underwriter to another.

December monitoring is vital
Most deals are struck in the first quarter and then filed away and forgotten until the cheque does, or sadly does not, arrive in February the following year. Now is the time to dust off the files and check what is happening.

This may not be as easy as it seems. The mergers, acquisitions and resultant insurer consolidation may mean it is difficult to get updated information from them. Key staff with detailed knowledge of the deal when struck may no longer be around. Even when it is obtained, there may be doubts about its accuracy. Claims can be wrongly stated, revenue transferred internally by insurers between one underwriting company or another and new business filtered into a company which was not party to the original agreement. Estimates on claims for previous years may have increased, affecting this year's profits. The worst scenario is where a major partner insurer is in a shambles and just doesn't know what is going on! If they have been an important source of payments in previous years, this can cause some sleepless nights for brokers.

Produce an action plan urgently
If it hasn't been done already, brokers should produce an urgent action plan covering the spectrum of profit share arrangements they have. This plan should cover details of all the deals. These can vary bewilderingly between insurers so they need to be tabulated in a consistent format covering:

1. Period of deal: deals can be one, two or three years, or on a rolling three-year basis. It is important to understand the period and the effect the previous year's trading can have.

2. Classes covered: all classes can be included in an arrangement or commercial classes only. Some exclude motor and some employers liability and engineering. It is important to understand this criteria and what is or is not included.

3. Trigger points: the trigger points for payment can be gross written premiums, new business, loss ratios, retention rates, net new, accounts settlements or any combination of these. Loss ratios may exclude movements in previous years claims or large losses may be capped. Poor years may be carried forward affecting the current year. Brokers need to understand, in-depth, these details.

4. Payments: these can be made on growth or new business irrespective of profit or may be conditional on profit. They may be calculated on gross written premiums or only on earned premiums. The latter is likely to be lower than the former on a rapidly expanding account. They may be on a percentage of notional profit or a fixed amount according to a pre-set formula. There may well be payments due from previous years which have been carried forward. These variations need to be identified.

5. Progress: the crucial step is to obtain the latest data for each deal. Challenge any inconsistency and assess the probability of triggering each one. Some will. probably, already be dead and buried. It may be impossible to meet growth objectives because of the insurer's trading stance, or the loss ratio position may be irrecoverable. These should be written off. A short list of potential payers should be produced and the trading with these monitored closely during December.

Of all the functions of a managing director, this analysis should be the most rewarding as any resultant payment will impact totally on the bottom line.

Conflicts of interest
All staff who are responsible for placing decisions should be aware of the position.

The transfer of a £50,000 case for a five per cent premium saving or an extra 20% commission is a loss of a £25,000 profit shared cheque. Obviously, this should not be allowed to happen.

However, the client's interest should not be prejudiced and should be considered above everything else. Business should not be transferred between insurers just to earn extra rewards for the broker. Continuity of insurer can still be important, especially when the current insurer has a detailed knowledge of the risk. It may well be important to preserve this.

If cases are to be transferred, it may be worthwhile satisfying themselves this is really in the best interests of the client, not for your own profit. This could be an area which GISC may be interested in in the future.

Looking to the future
The detailed analysis outlined above gives brokers a view of which deals work or which ones are just so complicated or unmonitorable they are not worth the paper on which they are written.

It should be remembered, insurers do not want to share their profits. They have enough difficulty already meeting shareholders' demands, and certainly the underwriting results for 1999 will not make matters any easier. The rationale for entering into these arrangements is to focus brokers on to growing business with them profitably. Market conditions mean profit share is a better way of achieving this than by paying enhanced commission. This means any deal struck has to achieve this aim and offer a "Win Win" position for both parties to be sustainable over the longer term.

One of the first tasks for brokers which has to be achieved in 2000 is to set up profit share deals for the millennium. The experience in monitoring the 1999 deals should influence these. Guidelines should be set for entering into negotiations. Deals should be:
- Simple and easily understood
- Capable of monitoring by both sides
- Subject to the ability to produce regular, meaningful progress reports
- Achievable, otherwise no party wins
- Avoiding conflicts of interest by the broker with its clients

Treat all deals to this five point test and the millennium will be a lot simpler and far more prosperous.

Tony Cornell can be contacted on e-mail at