How Insurance Agents and Brokers Make Money
Many small business owners purchase business insurance policies through an insurance agent or broker. While insurance agents and brokers perform similar functions, there are some differences between the two. Except where noted, the following discussion applies to agents and brokers selling property/casualty insurance.
Agent Versus Broker
Agents and brokers act as intermediaries between you (the insurance buyer) and your insurers. Both have a legal duty to help you obtain appropriate coverage at a reasonable price. Each must have a license to distribute the type of insurance he or she is selling. Each must adhere to the regulations enforced by your state insurance department.
The main difference between a broker and an agent has to do with whom they represent. An agent represents one or more insurance companies. He or she acts as an extension of the insurer. A broker represents the insurance buyer.
Agents serve as representatives of insurance companies and may be captive or independent. A captive agent represents a single insurer. Agents that represent Farmers Insurance or State Farm are captive agents. An independent agent represents multiple insurers.
An insurance agency sells policies on behalf of insurers that have granted it an appointment. An appointment is a contractual agreement that specifies the types of products the agency may sell and the commission the insurer will pay for each. The contract usually describes the agency's binding authority, meaning its authority to initiate a policy. An agent may have permission to bind some types of coverage but not others.
Brokers represent their clients. They are not appointed by insurers and do not have the authority to bind coverage. They solicit insurance quotes and/or policies from insurers by submitting completed applications on behalf of buyers. To initiate a policy, a broker must obtain a binder signed by an underwriter at the insurer.
Brokers may be retail or wholesale. A retail broker interacts directly with insurance buyers. If a retail broker (or agent) is unable to obtain insurance coverage the customer needs from a standard insurer, he or she may contact a wholesale broker. Wholesale brokers are intermediaries between retail brokers and insurers. Many are surplus lines brokers, who arrange coverages for unusual or hazardous risks. For instance, a surplus lines broker might help secure product liability insurance for a motorcycle manufacturer or auto liability coverage for a long-haul trucker.
While some captive agents are salaried, most agents and brokers rely on commissions for income.
Commissions are paid out of premiums charged to policyholders by insurers. These may include base commissions as well as supplemental commissions or contingent commissions.
Base commission is the “normal” commission earned on insurance policies. It is expressed as a percentage of premium and varies by type of coverage. For instance, your agent might earn a 15% commission on general liability policies and a 10% commission on workers compensation policies. If you purchase a liability policy for a $2,000 premium, your agent will collect $2,000 from you, retain $300 in commission, and send the remaining $1,700 to your insurer.
Some insurers try to encourage agents and brokers to write new policies by paying a higher base commission for new policies than for renewals. For instance, an insurer might pay a 10% commission for a new workers compensation policy but only 9% when the policy is renewed.
In addition to base commissions, many insurers pay supplemental or contingent commissions. These are intended to reward agents and brokers who achieve volume, profitability, growth or retention goals established by the insurer. Supplemental commissions are usually a fixed percentage of the premium. The percentage is set at the beginning of the year and is communicated to the agent. It reflects the agent's performance in the previous calendar year.
Contingent commissions are calculated after the year has ended. For example, Elite Insurance promises to pay the Jones Agency a two percent contingent commission if Jones writes $10 million in new property policies in 2020. Elite waits until early 2021 to determine whether the Jones Agency has met its goal. If it has, Jones receives the commission.
Both supplemental and contingent commissions are controversial, especially for brokers. Brokers represent insurance buyers and profit-based commissions can create a conflict of interest. They can motivate brokers to steer customers to insurers that pay the highest fees but are not necessarily the best option for the client. Some brokers don't accept incentive commissions. A number of states have passed disclosure laws requiring brokers to notify policyholders of the types of payments they receive from insurers.
Your agent or broker should provide you with a compensation disclosure statement that outlines the types of commissions the agency or brokerage receives from its insurers. This document should state whether the agency or brokerage receives base commissions only, or if it also receives contingent commissions.
Agents and brokers that sell life insurance also earn commissions. However, a life agent earns most of the commission he or she makes during the first year of the policy. The commission might be up to 120% of the premium in the first year, but around 7.5% of the premium for a renewal.