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Comparing fees and commissions: fees acknowledge the demands of clients who need consulting services as well as placement of insurance.

When comparing fees and commissions, it is important to remember that one form of remuneration is not automatically better or less expensive than the other. Selecting the best compensation method, or combination of methods, will generally depend on the client's needs and the amount of broker expertise needed to service the account. The broker's remuneration should reflect the service provided and should not be dictated by the price of insurance.

Commissions are defined as a percentage of gross premium paid to the producer for services rendered. Fees are periodic payments for risk management services rendered to a client. Each approach has advantages and disadvantages for brokers and clients.

Selecting a compensation structure that satisfies both parties is very important, because if the parties continually debate compensation questions, the quality of the work performed can suffer. Clients looking to reduce costs and enhance productivity have to determine their compensation goals before meeting with the broker.

COMMISSIONS

To generalize, paying a commission is probably the simplest method of compensating a broker. Commissions are generally used for the small to average-sized client with basic needs, for whom the broker's ability to select the best market is the most important requirement. Under the commission approach, brokers spread their service costs among all clients without directing individual expenses to specific clients. Each client pays the insurance company a premium that includes the broker's compensation.

One of the advantages of a commission arrangement is that the risk manager receives all services without having to negotiate separate fees. Commissions are easier for the risk manager to administer because they do not involve additional costs and do not require special approval from senior management. For simple accounts, commissions may be less expensive than a negotiated fee.

On the other hand, the disadvantages of a commission approach stem from the fact that part of the cost of the insurance package includes the broker's remuneration. The commission payment therefore becomes subject to the whims of the insurance cycle, and the commission amount can rise or fall regardless of the services rendered. A commission arrangement could also be considered a potential conflict of interest because the client may wonder if the broker has sufficient incentive to select the least expensive premium. Finally, commission payments may not reflect the amount of work performed by the broker.

FEES

Fees are generally requested by and offered to larger clients with more complex risks. Fees provide a reflection and acknowledgment of the professionalism demanded by clients who need risk management and technical consulting services as well as placement of insurance policies. What are the advantages of fees? Fees allow risk managers to select and purchase only the specific services they need at a negotiated cost that will not fluctuate with market cycles. Paying a fee acknowledges the expertise (instead of the sales ability) of the broker and demonstrates the value the broker adds to the insurance package. A fee structure also removes potential price-related conflicts of interest and encourages the broker to explore noninsurance approaches to financing the client's risks.

What are the disadvantages of fees? One disadvantage comes from the potential difficulty risk managers may have in defining the services they need. If the scope of services is not spelled out clearly at the start of negotiations, the client may face additional costs if the program turns out to be more complex than it first appeared. Accordingly, negotiating the fee and service agreement can become complicated. A fee arrangement usually requires approval from the client's senior level management. Finally, there could be problems if it appears that the broker's staff is more concerned with justifying time spent on the account than in providing service to the client.

WHERE ARE WE HEADING?

Many risk managers are considering whether they should move from a commission to a fee basis with their brokers. Clients with more complex accounts are increasingly using brokers as risk management consultants and are generally shifting from commissions toward fees. As the trend toward fees continues, a higher level of professionalism should be demanded from brokers.

Risk managers who only need to select the proper insurance coverage at the best possible price are generally better off staying on a commission basis with their broker. Clients with circumstances that dictate a fee approach should remember fees should cover costs for work actually done. A successful fee agreement requires creating a service contract that spells out what the broker is expected to do; how he or she will do it; how performance will be measured; and how much the client will pay for the broker's services. As much detail as possible should be articulated at the start of the arrangement to prevent misunderstandings.

If either remuneration method is not appropriate by itself, a combination of commission and fees could be considered. After a broker proffers his or her cost to service a client's account and an agreement is reached on the total amount of fees payable to the broker, the commission allowed on the insurance package could be offset against the total fee and the balance could be paid by the client. Similarly, a negotiated commission could accomplish the same result as a fee. The client would determine the agreed-upon costs to service the account, and this cost could be converted into a percentage of the total premium.

Whatever agreement is reached, it is important for clients and brokers to remain flexible. No matter how well the program is structured, it is impossible to anticipate every variable that can affect the final results. If problems arise therefore, both parties must be willing to work together to solve them.

As globalization of the insurance and industrial markets continues, the complexity of risks requires brokers to offer clients the state of the art in services. For brokers, the ultimate goal is to provide the best product and service available while expecting the compensation, whether a fee, commission or a combination thereof, to cover fixed costs and a profit. We as brokers and consultants are looking for a long-term relationship, and clients should consider this point along with the costs when making their selection. Does the remuneration justify the work you are requesting? Look out for the low bid. After all, you get what you pay for!

RELATED ARTICLE: Broker Services Commonly Compensated by Fees:

* Placement of insurance using global marketing expertise

* Alternative funding techniques

* Captive management

* Engineering services

* Legal, accounting and actuarial services

* Loss control

* Policy service

* Risk management services and reports

* Safety engineering and loss prevention

* Security issues

* Intangible qualities such as the broker's skill, reputation, financial integrity, creativity and innovation.
COPYRIGHT 1995 Risk Management Society Publishing, Inc.
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Copyright 1995 Gale, Cengage Learning. All rights reserved.

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Author:Perez, Jack R.
Publication:Risk Management
Date:Jun 1, 1995
Words:1095
Previous Article:Insurance broker as risk consultant.
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