S&P Conference: With End of Contingent Commissions, Brokers Find Ways to Plug the Hole

June 14, 2005

Insurance brokerage executives at Standard & Poor’s insurance conference, “Insurance 2005: Under the Microscope,” expressed confidence Tuesday that brokers would survive the sunset of the contingent-commission era through a combination of higher premium commissions, a broader array of insurance products for their clients, and better alignment of costs and expenses.

Despite the negative outlooks on the brokers–a result of probes into the practice of contingent commissions and bid-rigging by New York State Attorney General Eliot Spitzer – Standard & Poor’s Director Steve Ader agreed that insurance brokers have made progress in developing a new business model to replace lost contingent-commission income. “Overall, the industry has done a good job changing its business model,” he said.

The two brokerage executives on the panel – David Eslick, chairman of USI Holdings Corp., and Patrick Ryan, executive chairman of Aon Corp. – both agreed that although settlements to end contingent commissions by the four large national brokers (Marsh & McLennan Cos., Aon, Willis Group Holdings Ltd., and Gallagher) will hurt the industry in the short run because of lost income, brokers will benefit over the long term because of the more transparent environment that has been created. “These were difficult times,” said Ryan, “but we saw them as an opportunity to level the playing field with full disclosure. We liked taking the mystery out of the business.” As a result of the Spitzer probes and the subsequent settlements, clients are now more likely to be informed on the bidding process and methods of broker compensation and to reevaluate their broker relationships.

Higher premium commissions are almost certainly in store for clients as some brokers seek to make up for the lost contingent-commission income. “Every broker is negotiating higher commissions, and we are disclosing that to our clients,” said Aon’s Ryan. He said that carriers had lowered their commissions starting in early 2001, as much as 200 basis points, but with the market now softening, that would change. “And underwriters have generally agreed with us,” he added.

Another adaptation to the new environment will likely be a greater emphasis on the diversity of product offerings. Instead of focusing on just property insurance, for example, the brokers will make more of offering their other lines as well, such as life or health. That’s a model particularly attractive to the smaller and mid-market companies USI works with and will help strengthen the broker/client relationship, according to Eslick.

Brokers will also have to match more carefully the costs to expenses in the lines they are brokering, the executives agreed. “The key is to segment the business and apply the costs to each segment,” said Ryan. Standard & Poor’s believes that this will become increasingly important because there were few costs associated with contingent commissions. It was income that largely went directly to the bottom line. “The key will be matching what clients want with the broker’s cost structure,” said Ader.

Ader suggested other ways to improve the brokerage business model. In the past, it had made sense for some big brokers to go after smaller clients because in the aggregate, they would unlock volume-based contingent commissions. But now, the small client would be unprofitable, and big brokers might be forced to drop them. That would hurt the big brokers but open up possibilities for the regional brokers.

Both insurance executives also rejected as uncompetitive the idea of standard industry commissions, instead preferring competitive solutions achieved through fuller disclosure. They cited the end of fixed commissions on Wall Street as an example of how standard rates could distort the market and provide little incentive to meet customer demands.

Despite the tough year insurance brokers have had, both executives felt that their position would be strengthened going forward because of adjustment to their business models and the increasing need for brokers. Risk management has become more complex than ever and business owners, they felt, need brokers. “The market is so complex,” added Ryan. “The role of the advocate is growing.”

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