We need to talk about Broker Commissions
Amid falling rates and rising costs, Atticus DQ Pro’s Nick Mair broaches the delicate matter of brokers’ fees
Mistrust and scepticism about broker commissions the world over never really go away. But whether it’s the regulator, your clients, or your own firm that comes asking, keeping close track of the fees charged by insurance intermediaries will give your business an edge.
Let’s acknowledge that broker commissions are a critical cost component for insurers struggling to reduce their expenses. It is agreed and accepted that commissions are part of the broker’s business model. However some carriers view them with an understanding that they are the trade-off, the broker’s tip, for directing higher quality specialty business to the underwriter.
Of course I’m not suggestion that the brokers are operating unfairly, but there are certain historical hangovers that make commissions a touchy subject.
Here are granular three points you might want to consider.
- Do discriminate
Commissions vary considerably across specialty classes, as well as by timings, volumes, and the scarcity and quality of business. Considering all these variables, and their direct bearing on the insurer’s expense ratio, it’s surprising how many insurers don’t monitor them as closely as they ought to.
Timings are an important consideration, which cascade into other variables. There should be an annual planning process in place at the start of the year, to decide what to underwrite, what to avoid, and to estimate the cost of commissions.
But, as any weather watcher knows, forecasting is different to tracking the way the wind really blows. It’s vital to revisit and adjust those estimates during the twelve months between annual plans. This is because commissions can change throughout the year, not all business renews on January 1, and market events can change their dynamics.
Taking nuclear power business as a specialty market example, a nuclear accident leading to a market loss would not only lead to an immediate impact on premium, but also to the commissions payable for access to scarce, high-quality risks.
Broker consolidation represents a second instance. A mid-year merger between two of the larger brokers would shift the power dynamics behind an intermediary’s commissions, depending on how much market share a broker controls for a particular line of business, before and after a merger.
Real-time monitoring of broker commissions is something with which DQPro can assist, initially by checking that commissions fall within a range of estimates. Then, if underwriting teams are notified early when commissions fall outside estimates, they can track them more easily, and question why broker A has higher commissions than broker B for any given market niche.
- Avoid compliance headaches
The legal and regulatory risks associated with commissions have never gone away.
Lloyd’s faces a class action in Hawaii, an allegation that brokers received kickbacks through increased commissions for channelling surplus lines policies with artificially inflated limits, but rendered useless by lava risk exemptions.
Spin the globe and Australian insurers are seeking clarity on what products and commissions payments would be included in a ban being considered by a Royal Commission.
Commissions can of course be used as subterfuge for bribes and money laundering, and this puts added onus on monitoring. It can happen anywhere, but there are increased financial crime risks waiting for premium-hungry insurers that are seeking to underwrite new emerging markets business such as Latin America and Asia.
All of this puts added responsibility on the role of monitoring and scrutiny, as part of the audit trail in the event of Lloyd’s, supervisors or lawyers knocking on doors investigating commissions. If payments fall outside of the expected range or patterns you can investigate further, and demonstrate that your organisation was acting responsibly with the right systems and controls in place.
- Commissions are rising fast
Rising commissions are a symptom of the squeeze on the broker business model during the past two decades. Excess capacity and a soft market have created the underwriting conditions for broker commissions to flourish. Demand for good risks has risen, and carriers are prepared to pay.
This would not be a problem if expense ratios were healthy, or if premium income was flourishing. However, neither of those things are happening. This means that if commissions continue to rise, they will drive business away towards leaner, more efficient corners of the market. London’s loss will be Bermuda and Singapore’s gain resulting in a well-worn underwriting crisis that fuels demand for so-called third party capital alternative re/insurance.
These are big problems to face. But any solution starts with small steps. Adopting a healthy daily routine for monitoring commissions and having the right controls in place is a good place to start. DQPro allows carriers to flexibly deploy the custom controls and checks they need, at scale and across classes and jurisdictions, to give a real-time view when estimates and controls are breached.
Brokers are an intricate and vital part of the global market’s risk flow, bringing niche business to specialist capacity. The commissions agreed at the outset of the policy are, in essence, just a cost carriers should keep close track of – but it is slightly shocking to me that they some don’t do this at a granular level across individual policies, programmes and classes.