What Are Insurance Commission Clawbacks and How Can You Avoid Them?

– Ellen Lichtenstein

Insurance commission clawbacks: The phrase alone invokes some unsettling imagery, even if you aren’t well-versed in the concept. Do you envision a bony, skeletal hand emerging from its earthly grave to claw its way back to the surface, or is that just me? While my imagination may be overactive, a commission clawback isn’t all that different from a ghostly hand reaching out from the past to pull back what was once given. 

In this case, what’s being clawed back is an insurance agent’s or securities broker’s commission. If a policyholder cancels a policy shortly after purchasing it, insurance carriers often have the contractual right to take back some or all of the commission they paid the selling agent. It becomes an even more serious issue when a clawback is required because the commission shouldn’t have been paid in the first place. For example, if a producer sold a policy without the legal authority to do so. 

In this article, we’ll cover the basics of insurance commission clawbacks and the circumstances in which they occur, along with some of the best ways to prevent experiencing one, regardless of which side of the clawback you’re on. 

What is an insurance commission clawback? 

A commission clawback is when an insurance agent or financial services broker makes a sale, thus earning a commission, which they later have to repay to the insurance carrier or financial institution that issued it. In a world of endless acronyms and industry jargon, there’s hardly a better example of something being named as literally and accurately as a commission clawback. 

The reasons someone might be subject to an insurance commission clawback vary, but the bottom line is the person needs to pay back all or part of the money they previously earned. Since no one likes to give back money, the term “clawback” denotes the mandatory nature of this action. Whether it’s based solely on contractual agreements between insurance carriers, agencies, and producers, or based on legally binding insurance regulations, an insurance agent or variable lines broker who’s subject to a commission clawback doesn’t have a choice in the matter. 

Why do commission clawbacks happen? 

At the most basic level, a commission clawback happens because an insurance agent or variable lines broker received a commission that they didn’t or shouldn’t have earned. This can happen for a variety of reasons, ranging from completely innocent and outside the insurance agent’s control to unintentional mishaps to downright nefarious shenanigans. 

Depending on the type of insurance policy and the agreements between carriers, agencies, and agents, a commission clawback may only be possible if a policy’s canceled within a specific period of time, for example, the first two years after purchase.  

Policy cancellations: The most common cause of commission clawbacks

By far the most common reason for an insurance carrier to reclaim the commission it paid out is because the policyholder stopped paying for, or outright canceled/surrendered their policy. This can happen for any number of reasons, including a consumer changing their mind or experiencing a change in financial circumstances. It can also be the result of a poorly educated consumer or pressure from an insurance agent or variable lines broker to buy a product that wasn’t suitable. 

Whatever the reason for the cancellation, insurance carrier contracts usually include a clawback clause for when a policy’s canceled “early.” What exactly “early” means depends on the type of insurance and how long the policy period is. This is because carriers normally pay commissions at the start of a policy term with the assumption that the policy will be in effect for the entire period. 

For auto and home insurance policies with one-year terms, a producer can face a commission clawback if the insured cancels the policy before its renewal date. Life insurance policies tend to have the potential for much larger commission clawbacks if they’re canceled within the first two years because carriers expect to receive premium payments on that life insurance policy for years and decades to come. So, they pay a very large commission to their agents and brokers at the start, and then only a small fraction of the initial commission as the years go on. As a sidenote, this front-loaded commission structure is one of the reasons unscrupulous life insurance agents may find it tempting to twist or churn business.

Innocent and accidental mishaps

Somewhere between a consumer just changing their mind about a policy and an insurance producer doing something blatantly wrong are a few (mostly) innocent and accidental reasons a carrier may take back the commissions they’ve paid. 

  • An expired, lapsed, or late-renewed license: We’ll give the agent, agency, or broker the benefit of the doubt here and separate this out from more intentional wrongdoings below. Sometimes, due to the complex nature of insurance and variable lines licensing, someone can fully intend to complete their renewal and still miss it. Regardless of the reason, if someone sells a policy without an active license, the sale isn’t valid and the carrier will take back the commission. 
  • A carrier appointment that falls through the cracks: Keeping up with which producers are appointed with each carrier, and in each state, is no easy task. Despite everyone’s best intentions, a producer may accidentally sell a policy to a client without the right appointment in place. Even if it’s an accident, this is still not legal and doesn’t count as a valid sale. The agent and their agency will be lucky if the only penalty they face is a commission clawback. 
  • Advanced commissions on a deal that never closes: Sometimes an insurance carrier will pay an agent or broker a commission on a deal that appears very likely to close but hasn’t quite yet. In this case, no one should be surprised that the carrier wants their money back if the sale doesn’t actually go through. 
  • Quitting or being fired before vesting in a firm’s commission structure: This is one instance where an insurance agency or brokerage firm has some ability to decide how nice it’s going to be to its producers. There’s no true standard or law that dictates how long an agent needs to be at an agency before they get to keep 100 percent of their commissions, even if they leave the company. Unlike when a policyholder cancels their policy, neither the carrier nor the agency are losing money if a producer leaves the firm. Still, perhaps to incentivize longer tenure, many agencies have a period of two to five years during which a producer would have to repay a portion of their earned commissions if they leave – whether voluntarily or involuntarily. 

Nefarious shenanigans: Selling outside legal or ethical standards

Moving from the realm of innocent and accidental to the not-at-all-gray area of wrongdoing, there are a few common reasons a carrier will enforce a commission clawback clause. 

  • An agent or variable lines broker sells a policy without being licensed: While accidents do happen (as mentioned above), there are also instances when a bad actor may simply decide to sell a product for which they have no license, or to sell something they’ve got a license for in a state they aren’t licensed in. In the case of dually licensed broker-dealers, this might include selling variable lines of insurance without both the necessary insurance and securities licenses. These are serious violations and among the reasons a producer can lose their license entirely. 
  • Selling insurance without an active carrier appointment: Appointment requirements vary by state, but for those that require every producer to be appointed by the carrier before selling, doing so without the appointment is a big no-no. 
  • Selling to friends and family just to get a commission: A common, yet ill-thought-out scheme is to sell insurance policies to friends and family with the understanding that they can cancel the policy a few months later. Specifically for permanent life insurance policies, where producers earn a very large commission at the start of the policy, this can seem like a great way to make money. The truth is, it’s not! This practice is a surefire way to get every bit of commission you earn clawed back when your friends cancel their policies. When done repeatedly and intentionally, it also may jeopardize a producer’s license. 

Who do commission clawbacks impact?

Most obviously, a commission clawback affects the insurance producer or securities broker whose income relies on selling products and receiving commissions. In the case of a clawback, the producer has to repay money they previously considered part of their earnings. If they can’t immediately repay the commission, it becomes a debt they owe, which can even make another firm less likely to hire or contract them. But individual agents and brokers aren’t the only ones impacted. 

How commission clawbacks affect insurance agencies and brokerage firms 

It’s not just individual agents who lose money when a carrier takes back a commission they’ve paid out. Insurance agencies, MGAs, MGUs, and other types of firms and intermediaries take a portion of the carrier’s commission as part of their role in the insurance distribution channel. That means they’re on the hook to pay back their own part of any monies a carrier reclaims. 

On top of impacting the company’s bottom line, commission clawbacks can negatively impact an agency’s relationship with both its upstream carrier partners and downstream producers. While everyone involved should understand the risks that come along with selling insurance and variable lines policies, that doesn’t mean they love what happens when the rubber meets the road. 

If an insurance agency is aggressive about taking back commissions from producers who’ve done nothing wrong, it can sour the relationship. By the same token, if a particular agency has a string of canceled policies resulting in commission clawbacks from a particular carrier, the carrier may suspect something fishy and prefer not to do business with that agency at all. 

How commission clawbacks affect insurance carriers 

At the top of the distribution pipeline are the insurance carriers that underwrite products. The more policies they sell, the more money they can make. As part of their partnership with producers and agents who sell their products, carriers pay a commission. So, it only makes sense to take that commission back when a policy is sold and quickly canceled – not to mention other instances when a policy may have been sold out of compliance with laws.

While the ability to recoup the commissions they’ve paid out can help a carrier not lose additional money, the carrier isn’t exactly coming out ahead by selling policies that don’t last. In fact, clawback clauses in carriers’ contracts with their agency and agent partners are intended to disincentivize selling policies that aren’t a good long-term fit for the end insured. 

Avoiding commission clawbacks 

In yet another instance of “an ounce of prevention is worth a pound of cure,” the very best way to avoid a commission clawback is to prevent it from happening to begin with. Because, once the circumstances for a clawback exist, you’re probably not escaping that money going back from whence it came. 

How producers and broker-dealers can avoid commission clawbacks 

The first thing to understand is that no one bats 1,000. Even the best insurance salespeople will end up with a client who cancels a policy before the term is up, which means some of your commissions will get taken back at some point. The best thing you can do to protect yourself from financial impact is to set aside a percentage of your commission earnings in a separate account that you can draw from when (not if) this happens. 

However, there are things an insurance producer or variable lines broker can do to lower the chances of this happening. 

  • Build relationships with your clients based on trust and a deep understanding of their needs. When you don’t sell clients superfluous policies, they’re less likely to cancel them. 
  • Read your contracts with agencies and carriers carefully to determine when you might be subject to a commission clawback. Knowing these timeframes ahead of time will shield you from surprises, like finding out you have to pay back commissions if you leave an agency within five years. 
  • Stay on top of your insurance licenses, carrier appointments, and securities licenses (as applicable). If you’re not sure who’s handling your compliance, it might be time to suggest your organization invest in some technology like AgentSync. 

How insurance carriers, agencies, and brokerage firms can avoid commission clawbacks

Larger organizations managing multiple producers and broker-dealers have even more incentive to avoid commission clawbacks. For carriers, although they’re the ones taking the money back, doing so still costs time and resources, and may even cost money if they have to engage a collection agency to recoup their improperly paid commissions. For agencies and brokerages, a clawback situation can sour the relationship between vital sales staff and the agency, on top of simply reducing the firm’s revenue.

While no carrier or agency can entirely prevent its producers from behaving badly, or stop  clients from canceling policies, they can take steps to cut the risk of improperly paid commissions to virtually zero. The easiest way to do this is with technology. 

First, implementing a producer compliance management solution (may we suggest checking out AgentSync?) is a huge step. Technology like AgentSync makes it fast and easy to stay on top of hundreds, even thousands, of licensed producers, adjusters, and variable lines brokers. You’ll get an up-to-the-day look at who’s licensed in which lines of business, across all jurisdictions, plus an accurate picture of active carrier appointments. 

There’s even the ability for carriers to use Just-in-Time (JIT) appointments, which automatically starts the state appointment process once a producer sells their first policy. This gives carriers the best of both worlds: the cost savings of not appointing producers who don’t sell, and the peace of mind that no producer is selling without a valid appointment. 

With a system like that in place, the next step is to integrate compliance checks across the producer lifecycle to make sure no producer gets paid a commission they shouldn’t. Thankfully, this can also be automated using built-in integrations or API technology

With the right systems in place, you can put your time and attention into areas that add revenue, not into trying to make sure insurance producers are ready to sell. If you’re ready to take the next step and see how compliance can be a key part of your business’s growth, contact us today.

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