How Insurance Agents and Brokers Make Money
Like most small business owners, you probably purchase your insurance policies through an insurance agent or broker. The functions performed by insurance agents are similar, but not identical, to those performed by brokers. This article will explain how they differ. It will also explain how agents and brokers make money from the premiums you pay your insurers. 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. Each has 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. An agent or broker must also 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, on the other hand, represents the insurance buyer.
Agents are either captive or independent. A captive agent represents a single insurer. Agents that represent Allstate or State Farm are captive agents. An independent agent represents multiple insurers.
To sell insurance products on behalf of a particular insurer, an agency must have an appointment with that insurer. An appointment is a contractual agreement that outlines the specific products the agency may sell. It also specifies the commissions the insurer will pay for each product. The contract usually describes the agency's binding authority, meaning its authority to initiate a policy on the insurer’s behalf. The agent may have permission to bind some types of coverage but not others.
Brokers are not appointed by insurers. They solicit insurance quotes and/or policies from insurers by submitting completed applications on behalf of buyers. Brokers don't have the authority to bind coverage. To initiate a policy, a broker must obtain a binder from the insurer. A binder is a legal document that serves as a temporary insurance policy. It usually applies for a short period, such as 30 or 60 days. A binder is not valid unless it has been signed by a representative of the insurer. A binder is replaced by a policy.
Brokers may be either retail or wholesale. A retail broker interacts directly with insurance buyers. If you visited a broker, who then obtained insurance coverages on your behalf, he or she is a retail broker. In some cases, your agent or broker may be unable to obtain insurance coverage on your behalf from a standard insurer. In that event, he or she may contact a wholesale broker. Wholesale brokers specialize in certain types of coverage. Many are surplus lines brokers, who arrange coverages for risks that are unusual or hazardous.
Examples are product liability insurance for a motorcycle manufacturer and 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 and contingent commissions.
Base commission is the “normal” commission earned on insurance policies. Base commission is expressed in terms of a percentage of premium and varies by type of coverage. For instance, an agent might earn say, a 10 percent commission on workers compensation policies and 15 percent on general liability policies. Suppose that you purchase a liability policy from the Elite Insurance Company through the Jones Agency, an independent agent. Jones earns a 15 percent commission on general liability policies.
If your annual liability premium is $2,000, Jones collects $2,000 from you and retains $300 in commission. Jones sends the remaining $1,700 to the insurer.
To encourage agents to write new business, some insurers pay a higher commission for new policies than for renewals. For instance, an insurer that pays 10 percent for a new workers compensation policy might pay only 9 percent when the policy is renewed.
Contingent or incentive commissions reward agents and brokers for achieving volume, profitability, growth or retention goals established by the insurer. For example, Elite Insurance promises to pay the Jones Agency an extra 3 percent commission if Jones writes $10 million in new property policies within a certain time frame. If Jones renews 90 percent of those policies when they expire, Elite will pay Jones an addition 2 percent commission.
Contingent commissions are controversial. For one thing, brokers represent insurance buyers. Some people contend that brokers shouldn't accept contingent commissions. Moreover, some brokers have collected contingent commissions without the knowledge of their clients. Another problem is that contingent commissions may give brokers (and agents) an incentive to steer insurance buyers into policies that are particularly lucrative for the broker. If agents and brokers accept contingent commissions, they should disclose this fact to policyholders.
Some brokers now refuse such commissions.
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.
Some insurers sell policies directly to insurance buyers without using agents or brokers as intermediaries. These insurers are called direct writers. Many direct writers focus on personal coverages like homeowners and personal auto policies. However, some also offer commercial coverages to small businesses
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 may be 70 percent to 120 percent of the premium in the first year, but 4 percent to 6 percent of the premium for a renewal.