Broker monitoring of premium adequacy: the role of contingent commissions

Contingent commissions, which are payments made by an insurer to brokers based on the volume and profitability of insurance placed with the insurer, have been criticized as damaging to the relationship between the insured and its broker. The argument is made that contingent commission payments encourage brokers to select insurers for their clients based on the potential to earn contingent commissions, rather than on the needs of the insured. We argue that contingent commission payments, which while directly paid by the insurer are ultimately paid by the insured through higher premiums, are beneficial to insureds because they provide an incentive for the broker to place their coverage with an insurer that is charging an adequate premium. We contend that although inadequate premiums are perhaps good for the insured in the short term, in the longer term, inadequate premiums will result in price hikes or coverage restrictions that are harmful to the insureds. Our empirical analysis demonstrates that insurers who pay contingent commissions experience less price fluctuation over the underwriting cycle than insurers who do not pay contingent commissions in the US property and casualty insurance industry.