Conflicts of Interest and Rebating

Time flies but history repeats. Enough time has passed that many people working in insurance today have no experience relative to the disruption, fear and frustration generated by the inquires of various state attorneys general (AG) into contingency contracts more than 10 years ago. The AG’s positions were that contingency contracts created a conflict of interest whereby agents would steer business to companies paying the highest contingency bonuses even if their clients’ coverages/rates were inferior.

I recently saw a headline regarding the new Department of Labor (DOL) fiduciary rules that read, “DOL’s fiduciary target is Wall Street culture, not commissions.” That headline was like an immediate flashback to the contingency investigations. I do not know much about these new DOL rules but I understand the message: The DOL wants to eliminate conflicts of interest. That is an admirable goal, assuming the conflicts are real and the “solution” does more good than harm.

The contingency investigations may have had a point specific to certain bad apples, although whether any bad apples actually existed still is not clear to me. Regardless, the overarching investigations were designed on purpose, or in ignorance, to throw the baby out with the bath water. The majority of the contingency contracts used by companies, agencies, and brokers, were used in ways that benefited all the players and consumers.

In other cases, mostly due to not paying attention to the contracts to the point of not even reading the contracts and therefore, not being able to cognitively and intelligently steer business even if the agents tried, the effects the contracts had were completely nonfactors.

This headline regarding the DOL’s new regulations makes me wonder if something is not lurking to light a fire in the P&C investigations again because the DOL proposal involves financial insurance products. Politicians and regulators often go after perceptions rather than reality, damaging those they investigate for imaginary harm and then causing more harm by not pursing real misdeeds.

Rebating

A possible example is rebating. Rebating, defined generally as giving a policyholder material consideration in return for buying insurance, has been illegal to extremely varying extents in at least 49 states (California is, at least, the partial exception) for decades. The basis for outlawing rebating makes sense.

First, rates for admitted carriers are filed based on the company having an expense rate of X percent. That expense rate includes commissions. If agents give away their commissions or give away gifts/services in lieu of giving away commissions, the expense rate in the filing is not necessarily correct. If agents do not need commissions, an argument some people might make is that lower rates should be filed.

A second twist is that rebates are not usually offered to all consumers. Insurance is supposed to be sold without discrimination (underwriting is discrimination but of the reasonable kind, thereby avoiding the oxymoronic situation nondiscriminatory underwriting otherwise creates). This is why redlining neighborhoods was banned 30, 40 or 50 years ago. If some consumers get a lower price through rebates, this means discrimination, not of an accepted underwriting nature, arguably occurs. The difference today is likely to be that customers paying larger premiums will get rebates rather than discrimination based on race, creed, religion, political party, etc.

Whether the rebate is cash, gifts or services makes a key difference in many peoples’ and some regulators’ minds. Cash is too crass. Cash back is too much like a bribe. Gifts of significance are slightly removed and are a gray area because clients are also often good friends. The definition of “significance” is interesting. Some states have quite precise definitions and the amounts involved are sometimes tiny. Additionally, to the chagrin of some commercial producers, some state laws use absolute amounts. The gift limit is the same regardless whether the client spends $500 or $100,000. This limitation makes no sense to some. Maybe if limits exist, the limits should be scaled by account size.

Value-Added Service Rebates

The gray area, the most important area in my mind, involves value-added services. Agents and brokers have been offering value-added services such as loss control, MVRs, training and other similar services for decades without raising the ire of many competitors, much less catching the attention of regulators. One reason these kinds of rebates have not caused a problem is many agents offering these services did not really bring anything to the table. It was just talk to help make a sale. However, since the last hard market, the true value and the quality of these services have been increasing and improving.

For example, if an agency offers a wellness program, loss control service, payroll service, compliance, time/attendance tracking, benefits administration or PEO outsourcing that is available for the client to otherwise purchase from a third party for, say $5,000, and that service is of true value making the difference between who the consumer chooses as their agent, is this a rebate?

If two agents use the same admitted carrier and the same filed rate, but one offers a service worth $1,000 and the other offers a cash back rebate of $1,000, is the filing still valid in either case? The answer is important in so many ways.

First, if some agents can afford rebated services, then do companies need to file rates including the cost of these rebates or should companies reduce rates for all?

Second, if rebates are here to stay and likely grow, agents better find a way to reduce their cost of sales without reducing quality to remain competitive.

Third, how do regulators assure fairness? Some agencies/brokers have access to considerable capital, more than likely ever envisioned when state regulations were originally written. These firms can use their capital to offer services at huge discounts to build market share.

Such capital burns are part of the high tech model, not the insurance model. Insurance laws are designed to insure insurance companies set actuarially sound rates, thereby minimizing using loss-leader prices to capture a market and in turn protect the public from carrier insolvency. The laws may not adequately address an agent/broker doing the same. Insolvency would not necessarily be the result (but it is not excluded either if alternative markets are involved, which in itself is an entirely different issue, at times, with vertical integration). I’m not sure regulators are fully informed related to these cash burns at the broker level. Loss of competition is an issue, as is using an E&O term, invariable practice. It potentially opens the door to treating customers differently.

The industry might want to get in front of this rebating issue before the regulators again throw the baby out with the bathwater, and definitely before new entrants with millions, and even hundreds of millions, to burn put a lot of traditional agencies out of business.