The level of payments made by insurers to brokers is under pressure and could rebound unfavourably on customers. David Smith explains

In a world where most insurers and brokers are making profits, major change to a key dynamic that underpins this seems a pretty silly thing to do. The level of remuneration paid by insurers to brokers is one such dynamic and the emotions it arouses can sometimes cloud sound judgment. There is a real need for commissions and overriders to fluctuate and evolve due to a variety of factors. But they have, by and large, remained in a band that allows joint profitability and represent a fair deal for customers.Brokers periodically ask for increased payments based on volume, profitability and workload/expense saving, and insurers respond (lamentably, this is usually based on volume). Things have not got too far out of kilter, but there are signs of change in some quarters.There are a number of issues and dynamics currently raising the pressure on commission and other payments. These are:

  • Aggregation - as the brokers' market consolidates, the old 'volume means more commission' argument raises its head
  • Overriders - have become relied upon by many brokers as essential income, not as a potential payment for differential performance based on the value created for insurer and customer
  • Softening market - we are not in the soft market that we have seen in the past, but there is a softening (that is, rate increases running below claims inflation) fuelled by pockets of irresponsible underwriting. Some brokers are seeing reduced premium, so pressure to maintain earnings naturally increases
  • Technology - is finally beginning to show the promise of reduced expenses. There are beliefs that these savings should translate to increased commissions.
  • AggregationThe aggregation of premium - which equals more commission - is the fastest growing trend. While there is a certain ring of logic to the concept, the reality is somewhat different. The argument is underpinned by some myths:Volume automatically reduces insurer expenses. In itself, this is nonsense. If a broker purchases another broker then no greater volume is brought to the insurer than he had previously with the two separate organisations. If a greater share is provided and unless there is some change in the mechanics of trading, then no real expense saving is made. Even when expense saving is made, expectations are often wildly optimistic. For an insurer with an expense base of 12%, with half of that fixed, a 20% saving in the workload equates to around 1% expense saving. Insurers have been pretty poor at explaining this and even worse at acting upon it.'Good brokers' are always purchased, with a 'profitable book'. For single or low numbers of acquisitions this is possible, but for indiscriminate, multiple purchases it doesn't wash. Producing a sustainable, differential claims ratio from a disparate band of 10, 20, or 30 regional brokers is more difficult than from a single independent with firm and close management control.International brokers always get a better deal.In fact, payments to internationals are significantly lower than many of the demands made by regional market aggregators. Put in objective terms, higher commission rates of 25% to 30% for aggregation compared to base rates of 17.5% are unsustainable, not in the customer interest and unfair to brokers with lower volumes of profitable business.

    OverridersOverrider payments are prevalent across the international and larger regional broker channels, the norm when a broker reaches a certain size. The vast majority are currently based on volume and profit share, the latter generally calculated on a crude incurred claims basis. More myths:Profit share is always fair and 'self funding'. Profit share for some brokers means that customers are paying inflated prices - it simply reduces overall insurer profitability which has to be made up elsewhere. This is not to say that such payments made for the true profit or value created by a broker are not justified. Let's not delude ourselves who is paying. (Such payments would be self-funding if a 'loss share' was also taken - but I've yet to see anyone ask for it.)Incurred claims figures, say 40%, mean healthy profit. A significant proportion of commercial business is long tail; incurred claims figures are meaningless. In addition, annual figures are habitually used. With current low catastrophe frequency, the 40% figure can quickly and dramatically rise even on a short-tail SME property book.Overriders can easily be explained to customers. Payments are invariably year end, based on volume and profit. Whatever words are used, such payments cannot be directly related to an individual customer. Some other method of rewarding a broker for the value brought to the insurer is needed; if the FSA doesn't enforce this, the customer will.

    TechnologyIt's been a long time coming, but there are now positive and tangible demonstrations of the use of technology to reduce expenses, whether it is via software firms or insurers' websites. The pace will be upped in the coming months by significant advances by imarket. The greatest danger is that the savings made are used to mask inefficiencies. Savings should go directly to the customer, not in additional remuneration.

    Softening marketThere are often understandable reasons for calls for increased commissions in a softening market. But the need to maintain broker earnings cannot be funded via this route; it again masks inefficiency. During times when volume is reducing, insurers and brokers both have to cut costs and find new ways of achieving more with less.So what's the conclusion to all this:

  • Most additional payments to brokers are based on volume and spurious measures of profitability. This is an insurer failing: with subjectivity prevalent and little true value measurement
  • Excessive commission levels and payments are not sustainable - they will be exposed by lower cost insurer/broker combinations. Greed will lead to bleed
  • The industry has a real integrity question if insurers continue to make year-end payments to brokers that cannot be directly related and relayed to an individual customer
  • And the big one: when our industry becomes more efficient, changes its shape, goes through cycles, it must be to improve our offer to the customer. Not to profiteer or mask our own shortcomings.
  • At Zurich UK Commercial our ethos is one of integrity, value creation for all parties, transparency and, most importantly, sustainability. And we will be supporting independent regionals, international brokers, networks, aggregators and marketing groups that share these values. The current profitability within the industry is sustainable - provided we keep customer benefit at the forefront of our minds and don't upset the remuneration balance.
  • David Smith is Zurich UK Commercial head of market management