A Fresh Take on Commission: Envisioning a System That Supports the Agent, Carrier and Consumer

I confess that for a guy who has made his living largely on commissions for decades, I don’t like the concept. It’s not that I don’t like getting paid — I do — but I find the commission system in our business has a number of flaws. It could be improved to the benefit of agents, carriers and consumers.

Insurance companies build their business models around a contracted distribution system. The contractual system allows insurers to estimate the costs of distributing their product as they plan and forecast results. Fixing those costs as a percent of sales, which is what commission does for them, is a simple and predictable means to do just that.

But this business model is problematic not just for the agent receiving the commissions, but for the companies paying them and the consumers buying the products and services.

Breaking Down a Broken System

The commission system fails to reflect the cost of doing business.

Agencies have both fixed and variable expenses. Accounts on the low end of the price spectrum may not cover costs on traditional commission structures. Often, I find carrier representatives in my office are looking for us to sell accounts that are marginally profitable or even loss producers. Occasionally, a carrier will offer incentive compensation to move these products, but those incentives are usually offered in a vacuum. The carrier does not take into account the financial picture of the agency.

In a true market economy, the agent could solve this problem by simply charging the client more money. Unfortunately, we don’t have a true market economy — certainly not in the insurance distribution system — and charging fees while collecting a commission is generally not legal. Another option for the agency would be to refuse commissions from the carrier and accept only fees paid by the carrier. While this approach does work for some larger organizations that focus on more complicated and highly priced accounts, it is an impractical solution for the vast majority of agencies who focus on personal insurance and small business.

We should view this as a system of distribution pricing, rather than distribution compensation. We need to change the mindset of how an agent should think not only about their carrier relationships, but their value proposition in the marketplace with respect to insurance consumers.

The lack of flexibility in terms of distribution pricing leaves compensation for agents largely fixed and anti-competitive. This concept is similar to problems reported in real estate sales. Fixed insurance company commissions to the agent are potentially as detrimental to the consumer as real estate commissions.

The commission system is anti-competitive and anti-consumer.

Perhaps my biggest problem with insurance company commissions is that they prevent the agent from truly competing on a value proposition for their services. While carriers offer essentially a commodity product, agents do not. Of course, I recognize carriers differ when it comes to claims service, loss control or other value-added services, but most policies are basically identical for a given class of risk. However, there is a wide variety of capability and quality related to delivery of services by agencies, but compensation doesn’t reflect that varying value. This is essentially anti-consumer. This practice disincentivizes agents from seeking to constantly improve their service offerings.

Consumers recognize this, which is why they view the entire insurance product, including agent service, as a commodity when it often isn’t. So, what is not good for the consumer — fixed commissions — is also not good for the agent.

Related to this are views by consumers which are unrealistic, potentially unfair, and certainly uninformed regarding who is responsible for the costs of insurance. Frankly, insureds don’t understand what agents actually make from an insurance sale. I believe this is particularly true in personal insurance, which is the bread and butter of the majority of independent agencies. This is a source of constant friction between consumers and agents and ultimately interferes with agents’ desire to be respected and viewed by their customers as a trusted advisor. This is particularly true in challenging markets like the one we have been experiencing for the last couple of years.

The commission system is also detrimental to carriers.

It’s true as I’ve said that commissions allow carriers to fix their costs with distribution. But it interferes with their ability to seek excellence in their distribution partners. Yes, carriers pay profit sharing, which gets at this issue indirectly. And it’s true they pay bonuses to some agents, but that’s generally for production, not quality of service. But in all, fixed commissions do nothing to ensure quality agent service which is, I would argue, the most controllable component of their retention.

Carriers, in the most recent decade or so, have recognized the critical value of policyholder retention where even one point can have huge margin implications. Yet, they don’t seem to understand that agent service quality, which is directly impacted by agent marginal profitability, is an area that could move policyholder retention significantly. I look at it in the same way distributors of tangible products look at last mile costs. They are often the ones with the most potential for moving the profitability needle. Unfortunately, in our industry, we ignore this.

A New Way Forward

So, is there a better way? I think there is and it’s one that has been brought up from time to time and then, rapidly discarded, out of fear. The better way is for carriers to strip out commissions and sell their products net. This way agents could compete in the marketplace based on their own value propositions and with full disclosure to consumers of how they are paid for their service.

This is not, and likely never will be, a popular idea because humans are always resistant to change. Change represents risk. And changing to a customer-paid fee-based system would potentially be a huge risk for some.

Those at risk would likely be those who only know how to sell insurance by being the cheapest. These agents represent some of the worst in our industry who fail to focus on understanding client needs.

A commission-based system is not focused on creating excellence in service and these systems continue to perpetuate the idea that insurance, as a part of either individual or corporate risk management, is nothing but a commodity, which it doesn’t have to be.

I believe, under a customer-paid fee-based system, good agents — those who sell based on client needs and provide exemplary and continually creative service to their customers, while also meeting the real needs of insurance company partners, would benefit tremendously. This is true, in my opinion, because consumers are smart and would rapidly see the difference that competitive differentiation based on service makes in bringing business their way.

Yes, there would be losers. But they would be those who deserve to lose. Those who don’t provide the quality service clients seek.

Good agents would win as would their carriers. And the biggest winners would be consumers, closing the value circle with agents and carriers in a virtuous, constantly improving loop.