What Is a Contingent Commission?
A contingent commission is a commission paid to an intermediary by an insurance or reinsurance company with a value dependent on the occurrence of an event. The amount of a contingent commission may, for example, depend on how profitable the policyholder is to the insurer or reinsurer. Contingent commissions are higher when the insurer or reinsurer doesn't suffer losses from claims, and they are lower when policyholders are riskier.
- A contingent commission is a commission paid to an intermediary broker by an insurance or reinsurance company.
- The value of the contingent commission is based on a variety of factors, such as the riskiness of the policyholder and if a claim is paid out.
- Contingent commissions differ from traditional commissions in that they are only paid out on an event occurring rather than when a policy is sold to a customer.
- Contingent commissions have fallen out of favor because it creates an incentive for an intermediary broker to push its clients to certain insurers or reinsurers, based on compensation, creating a conflict of interest.
Understanding a Contingent Commission
Contingent commissions differ from more traditional commission structures because the commission is not collected in the event that the policy is sold. The event that the compensation is contingent on may vary, according to the needs of the insurer or reinsurer, and it may include the profitability of the policy or the amount of business that the client brings in. This type of commission may be paid in addition to a sales commission based on the amount of premium.
Insurance regulators have targeted contingent commissions for review and possible elimination because it creates an incentive for an intermediary broker to push its clients to certain insurers or reinsurers, based on compensation.
An insurance broker has a duty to the individual or business that is purchasing a policy. An incentive structure that pushes a broker to choose a policy that may not be in the best interest of the client causes a conflict of interest.
This can especially be the case if the commission is contingent on profitability since the insurance broker has a financial incentive to discourage or disrupt any claims that a client may wish to make. Preventing successful claims increases the broker’s compensation.
This type of compensation has fallen out of favor for brokers. Though contingent commissions are not as popular as they once were, they are legal to use and are considered ethical if brokers are upfront about the agreement they have with an insurer or reinsurer.
An independent agent or sales agent of an insurance or reinsurance company represents the financial interests of the insurance company, which reduces the conflict of interest that a contingent commission brings. This type of commission is still used as a compensation method for individual insurance agents.
History of Contingent Commissions
Contingent commissions first appeared in the 1960s when claims were rising much faster than the rate of inflation and insurance companies cut agent commissions on premiums. To make up for this loss of revenue, carriers offered agents contingent commissions of a certain percentage of premiums if the agents could meet certain volume and profitability goals. These first contingent commissions were paid on personal lines.
Despite the controversy surrounding the practice, it is still possible to use contingent commissions ethically. There is some consensus that three rules should apply in such cases:
- Buyers must be informed of the arrangement
- The agreement can't create bias in brokers as to which carriers to recommend
- All false or friendly bids should be eliminated from any offers to the client
Many companies that used to implement a contingent commission scheme with intermediary brokers stopped the practice because the perception that it created for the insurer as an honest, truthful company was believed to better business and a longstanding relationship with clients.
For example, two of the top insurance companies in New York, Illinois, and Connecticut, in the early 2000s, were legally prevented from utilizing contingent commissions. When they were once again given the go-ahead a few years later, they declined, based on the fact that their businesses were performing better without them and that it improved client retention.