Canadian risk managers weigh in on U.S. approval of using contingent commissions

The debate over the appropriateness of contingent commissions has been reopened due to a recent Illinois decision that will allow a major insurance brokerage to resume the practice.

Amendments to Arthur J Gallagher & Co.’s (AJG) agreements with the Illinois Attorney General and the Illinois Department of Insurance will allow it to resume accepting retail contingent commissions starting October 1, 2009—the decision will boost AJG’s bottom line and is drawing strong reactions from others in the insurance industry.

The announcement was made as a part of AJG’s second quarter 2009 earnings release on July 28, 2009. AJG expects the contingent commissions to generate approximately $10 million  (USD) a year in revenue by 2011.

The news was quickly criticized by the Risk and Insurance Management Society (RIMS), which issued a press release on July 29, 2009 stating that “contingent commission should be broadly prohibited as they represent an inherent conflict of interest.”

In the their statement, RIMS also urged AJG to continue using the compensation disclosure requirements that were part of the original 2005 agreement.

“You want to make sure that you understand what you are getting into” added Stephen Pottle, vice chair of the communication and external affairs subcommittee at RIMS Canada. “There has to be full disclosure. Otherwise, am I compensating the broker for what really is fair?” He adds, “If you only direct business to a certain insurer because they would pay [contingent] commission that can smell a little fishy.”

Dan Danyluk, chief executive officer of the Insurance Brokers Association of Canada (IBAC), countered Pottle’s concern.

“There is no insurance broker who would place business on the basis of contingent profit commissions,” said Danyluk.

Danyluk emphasized that regular commissions form the bulk of a broker’s income and that “no well run brokerage counts on contingent commissions to make sure they operate.” He adds, “Our view is that contingent commission is a valuable part of the insurance process. They are designed so that there is a reward for brokers doing front line underwriting.” Danyluk continued by saying, "My experience as a broker is that Canadians are pretty smart. They look to their broker to do a good job for them. If [a broker]  tries to play the system, take shortcuts and give bad advice, that broker  will not gain business. It’s that simple.”

Both Pottle and Danyluk agree that compensation disclosure issues are best managed through industry self-regulation as opposed to government intervention.

AJG signed the original agreements on May 18, 2005 after Illinois regulators expressed concerns regarding contingent commissions, which are paid out on top of the usual commission fees when a broker achieves a certain sales or quality target set by an insurer.
 
In late 2004 and early 2005, officials from Illinois and a few other states worried that brokers were steering clients towards certain insurers in an attempt to earn these contingent commissions rather than acting in the client’s best interests.

AJG was one of four large insurance brokerage firms that signed agreements with Illinois in 2005. In addition to eliminating contingent commissions, the agreements required Gallagher to create a $27 million (USD) restitution fund to compensate policyholders and clearly disclose its compensation details to clients.

Smaller brokerages were not required to sign agreements and were not subject to any restriction regarding the collection of contingent fees.

Similar concerns were raised in Canada and prompted the Canadian Council of Insurance Regulators (CCIR) and the Canadian Insurance Services Regulatory Organization (CSRO) to launch an Industry Practices Review Committee focusing on the relationships between insurers and sales intermediaries.

The review culminated in a consultation paper that was published in June 2005. The report noted that more than two-thirds of P&C insurers offer contingent commissions to their agents/brokers and that “some current business practices may contribute to a perception of or actual conflicts of interest in the marketplace,” but concluded that, “no evidence of any illegal insurance related activity was found.”

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