RIMS Executive Report

The Risk Perspective

A Practical Guide to

Insurance Broker

Compensation
and

Potential Conflicts
of Interest for the

Risk Manager

A Practical Guide to

Insurance Broker

Compensation
and

Potential Conflicts
of Interest for the

Risk Manager

Editor
William J. Kelly, President
WJK Advisory, LLC
(wjkadvisory.com)
RIMS President 1995-1996
Contributors
Deborah Luthi, Matheson, Inc.
RIMS External Affairs Committee
Kathy Doddridge, RIMS Government Affairs Director
Mary Roth, RIMS Executive Director
Art Director
Joseph Zwielich
2009 Risk and Insurance Management Society, Inc. (RIMS) All rights reserved. www.RIMS.org

Preface

It is the position of the Risk and Insurance

Management Society (RIMS) that insurance
brokers should at all times represent and act solely
in the interest of their client, the insured. In
keeping with this, RIMS believes that all
compensation to the broker should come from the
insured, and that any compensation to the broker
from insurers with whom the broker places client
business, represents a significant conflict of
interest that is potentially detrimental to the
interests of the insured.

Executive Summary

RIMS will continue to work with regulators and the

insurance brokerage industry to raise the required
and voluntary standards of business practice with
respect to compensation, disclosure, and complete
transparency. The ultimate goal is to create a
business model in which even the appearance of
potential conflicts of interest is eliminated.
Recognizing that risk managers* must deal
with the circumstances that currently exist, this
document is intended to provide guidance to the
risk manager on the current potential scope of
insurance broker compensation and to provide
assistance in identifying potential conflicts of
interest. It is also intended to encourage risk
managers to support regulation in their own states
that would require complete compensation
disclosure by brokers to insureds in every
transaction. It is not sufficient to require such
disclosure only at the request of the insured, which
may lack dedicated risk management personnel.
Complete disclosure should be required no later
than application for the insurance contract or
renewal. Risk managers can support such
regulation by contacting their State insurance
departments, and by working through their local
RIMS chapters, and RIMS headquarters in New
York.

Purpose

Importance

The purpose of this document is to provide

guidance to the risk manager on understanding
insurance broker compensation and identifying
potential conflicts of interest.

It is essential that the risk manager know how

much the employer is paying both for insurance
coverage and for related services.
It is critical that the risk manager know if the
insurance broker / advisor is receiving additional
compensation from any insurers relative to the
risk managers insurance program or for other
services provided by the broker to the insurers.

Goal

Risk managers can and should use their power in

the marketplace to raise the bar on standards of
independence and disclosure making complete
transparency a competitive issue and the
minimum acceptable standard for their
consideration of an insurance brokerage proposal.

Recognizing that the risk manager cannot regulate

the conduct of the insurance broker or require
consensus among intermediaries on standards of
conduct, the risk manager can and should make
conflicts of interest, disclosure, and transparency
key criteria in the broker selection process and
integral to every service level agreement. While
other financial service sectors seek to avoid even
the appearance of potential conflicts of interest,
in commercial insurance, the risk manager must
unfortunately seek to identify and assess the
materiality of the conflicts of interest that are
industry practice. It is hoped that, with the full
support of RIMS, risk managers will use their
power in the competitive marketplace to drive
a higher standard of conduct that will serve to
reduce and ultimately eliminate conflicts of
interest in the future.

*For the purposes of this document, the risk manager is the individual within the entity responsible for the entitys insurance program,
which, depending on the nature and size of the organization, may include the Chief Executive Officer or the Chief Financial Officer.

2009 Risk and Insurance Management Society, Inc. (RIMS) All rights reserved. www.RIMS.org

Recommendations

Issues

The risk manager should require the full disclosure of the nature of all compensation
earned by the insurance broker in connection with the coverage of the risk managers
entity both individually and when aggregated into a larger book of business with any
insurer. In addition, the broker should confirm that it is at all times acting solely in the
interest of the insured.

The risk manager should require that the broker disclose the nature of any other service
relationship or financial interest the broker may have with insurers recommended by the
broker to the insured.

It is essential that the risk manager know how much the employer is paying both
for insurance coverage and for related services.
In paying an insurance premium, the insured needs to know the amount of the premium
that is going to the insurer to cover risk, and the amount that is going to the broker for
negotiating the transaction and related services. This information is essential to evaluating
competing proposals and managing the components of the overall cost of risk. It is also
necessary to identify potential conflicts of interest. If a broker is receiving compensation
from certain insurers, it is in the brokers interest to place business with those insurers, an
interest that may be in conflict with the insureds.
It is critical that the risk manager know if its insurance broker / advisor is
receiving additional compensation from any insurers relative to the risk
managers insurance program or for other services provided by the broker
to the insurer.
As discussed below, insurance broker compensation can take many forms, some of which
the risk manager may not be a party and which he or she has no direct knowledge. In
addition, exclusive of the placement of coverage on behalf of the insured, the broker may
provide services of various types to insurers as clients of the broker. This too can create a
potential conflict of interest. In addition, such services may be duplicative of services being
charged to the insured. The risk manager should be aware of all compensation, any service
relationships, and any common financial interest between the broker and an insurer.

2009 Risk and Insurance Management Society, Inc. (RIMS) All rights reserved. www.RIMS.org

Insurance Broker
Compensation

Insurance brokers derive their compensation in a variety of ways and from different sources.
Compensation may be directly associated with a specific insureds coverage. It may result from the
aggregation of an insureds program with others in a book of business with an insurer.
Compensation may also arise from placements with excess and surplus lines insurers, carriers
based overseas, and reinsurance markets. In addition, exclusive of any particular insurance program,
a broker may earn income directly from an insurer to which it provides services, with the insurer
being the client of the broker.
Types of insurance broker compensation include:
Commission this is the traditional means of compensation in which a percentage of the
premium is retained by the broker with the agreement of the insurer and insured.
Fees this type of compensation constitutes an agreed upon fee for services, best defined in a
service level agreement. Fee based compensation in commercial insurance began to become
popular in the mid-1980s when insurance premiums increased significantly due to market
conditions. Risk managers realized that although a new annual premium may have become a
multiple of the expiring, the brokers compensation should not similarly increase. In fact, although
negotiation may be more difficult in such a market, the ability of the broker to influence terms and
conditions is usually significantly diminished. In such arrangements, the risk manager would ask the
broker to have the insurer quote net of commission, with the understanding that the brokers total
compensation would be the fee.
Contingent Commissions this is additional compensation paid to the broker by the insurer
based on some performance criterion relative to the performance of a book of business or individual
contracts.
Enhanced or Supplemental Commissions negotiated by the broker with the insurer in
addition to customary commissions and fees.
Excess and Surplus Line and Reinsurance Commissions generated in these markets
whose participation is often necessary to fill out a program. Brokers have specialized subsidiaries to
ensure that such compensation remains in-house, however, compensation is sometimes received
by sub-brokers.
Profit Sharing compensation based on a percentage of profits.
Volume Over-Rides increased compensation is triggered when pre-defined thresholds are
achieved.
Work Transfer Payments compensation paid by the insurer for policy related services performed
by the broker. The risk manager needs to ensure that such compensation is not duplicative.
Service Income for services provided by the broker to the insurer not specific to any insured.
Fiduciary Funds Income interest earned solely by the broker on the insureds funds held by the
broker in the form of premiums intended for insurers and claims payments going to insureds.
Other- Advanced Commissions / Loans / Marketing and IT Payments / Sales Incentives / Gifts and
Corporate Entertainment.

2009 Risk and Insurance Management Society, Inc. (RIMS) All rights reserved. www.RIMS.org

Compensation
Disclosure and
Conflict Identification

The Request for Proposal (RFP)

The RFP sets forth exactly what is expected from any broker who would offer a proposal. It
establishes the rules to be followed: permissible length of proposal, timeline etc. It details the
specifications of the coverage to be addressed, the required qualifications and references of the
broker, and the compensation disclosure.
The risk managers expectations relative to disclosure and transparency should be clearly set forth
in the initial RFP. The respondent should be required to explain the basis and projected amount of all
anticipated compensation to be received by itself, any affiliated entities throughout the world, and any
financial or service relationship with insurers to be contacted on behalf of the client. In addition, it
should require that any recommended insurer will disclose all commissions, assessments, taxes, and
surcharges.
The RFP should also reflect that the respondents independence and lack of potential conflicts of
interest will be one of the important criteria in evaluating each respondent. (Appendix A)
The Service Level Agreement (SLA)
Unlike other service providers, insurance brokers often operated in the past without written service
level agreements. The use of SLAs has now become accepted best practice. The SLA delineates all
of the services to be provided, the associated charges, and identifies any services falling outside the
scope of the agreement.

Conclusion

The SLA should require ongoing full disclosure of compensation and any changes in financial or
service relationship between the broker and any insurer participating in the clients insurance
program. (Appendix B)

Insurance brokers provide valuable services and are relied upon extensively by risk managers. The
insurance broker is the critical conduit between the insured and the commercial insurance market.
The risk manager must be able to rely on the objectivity and independence of the broker in the
marketing of the risk managers coverage and in the advisory services being provided by the broker.
Until the point is reached at which the insurance broker is paid only by the insured and in all cases
represents the sole interest of the insured, commercial insurance will continue to be fraught with
conflicts of interest for the broker. Will a broker market coverage to an insurer with which it does not
have a contingency or other compensation agreement? Will a broker steer business to those insurers
with which the broker has growth, profit sharing or other incentive arrangements?
Werent such arrangements created in manufacturing specifically as an incentive for steering
business? Whether or not the individual negotiating the contingency arrangement is different from the
placing broker, doesnt everyone in the brokerage become aware of preferred markets?
Contingent compensation arrangements do not fit in the financial services context. Financial advice
relative to coverage and market selection is not a commodity, and should not even be potentially
influenced by self-interest.
The call for demonstrated independence is not unique to commercial insurance. Other areas of
financial service have well established and extensive independence requirements with strict
compliance controls. Insurance is only just recognizing the problem, and risk managers can
accelerate its resolution through their power in the marketplace, by demanding competition that
imposes higher standards.

2009 Risk and Insurance Management Society, Inc. (RIMS) All rights reserved. www.RIMS.org

Appendix A

Examples of provisions to be included in the Request for Proposal (RFP)

For inclusion in the section on Proposal Evaluation Criteria:
The respondents demonstrated independence and lack of potential conflicts of interest relative to
insurers will be an important consideration in evaluating the proposal.
For inclusion in the Compensation Section:
Indicate the anticipated basis and projected amount of all compensation to be received from the
insured or any insurer, by the respondent, as well as any affiliated or other broker entity throughout
the world, such compensation to include without limitation: commissions, fees, contingent
commissions, enhanced or supplemental commissions, excess surplus lines and reinsurance
commissions, profit sharing, volume overrides, work transfer payments, service income, and
compensation of any other type.
Work transfer payments and service income represent compensation paid to the broker from any
insurer for services provided in a service relationship.
Indicate any financial or service relationship that the respondent or any of its affiliates has with any
insurer that the respondent included in its proposal.
For inclusion in the specifications section:
Participating insurers will be required to disclose all commissions, assessments, taxes, and
surcharges.
For inclusion in the Services Section:
The respondent will expressly and specifically indicate any circumstances in which it will not be acting
solely in the interest of the insured.

Appendix B

Examples of provisions to be included in the Service Level Agreement (SLA)

For inclusion in the compensation section:
Any additional compensation, beyond that set forth in this compensation provision, received by the
broker, any of its affiliates or any other broker during the term of this agreement, shall be promptly
reported to the insured as a potential offset against the agreed amount of total annual compensation.
For inclusion in the independence section:
Any change in affiliation with any participating insurer by the broker or any of its affiliates, whether in
financial interest or with respect to service relationships, will be promptly reported to the insured and
evaluated relative to potential conflict of interest.

2009 Risk and Insurance Management Society, Inc. (RIMS) All rights reserved. www.RIMS.org