Predicting better distribution: carriers have a wealth of information about the market and the likely behavior of insureds, but fail to use this information effectively to help agents distribute products and to compensate them for their work.
What hasn't kept pace, however, is the commission-based business relationship with agents for distribution of personal-lines products. In fact, these relationships need to be overhauled to better support the quality and profitability of each carrier's business.
Back in the 1980s, personal-lines agency writers paid 15% commissions on private-passenger auto business and 20% on homeowners business. These percentages were paid by carriers across all types of these lines of business. If an agent produced profitable business, additional contingent commissions were paid. The definition of "profitable" varied by carrier, and could be based on one line of business, or several lines combined. These contingent commissions were after the fact--that is, if an agent produced business according to a carrier's guidelines in 1985, a contingent commission amount would be paid in early 1986. The measures of profitability tended to be based on loss ratios, and in some cases also included growth or retention factors, mix of business factors, and other items.
Over the past couple of decades, personal-lines commissions have changed somewhat, but most carriers still pay a flat percentage up from, and a contingent commission after the close of a year, with the amounts depending on some quantification of results.
Better Information and Decisions
By contrast, over the past 20 years, pricing for personal lines has become significantly more refined. Risk segmentation has transformed the private-passenger auto business, replacing the old class plans with a grand total of 161 or 202 classes with class plans for some insurers that have thousands, or tens of thousands, of pricing points.
For homeowners, the old rating plan that considered only the building itself has been replaced with rating plans that reflect multiple characteristics of the owner or tenant. These new plans are based on predictive modeling, where complex statistical models are applied to large amounts of information from a carrier's databases, combined with external information, such as insurance scoring.
The upshot is that property/casualty companies have powerful predictive models that give them enormous amounts of data that can be of great value. These models project the frequency of claims and the amounts of losses that their insureds are expected to produce based on a large number of characteristics that go far beyond the historical data based on age, sex and marital status for private passenger auto, or construction type and protection class for homeowners.
In addition, many carriers now have sophisticated models of the expected purchasing behavior of different types of insureds, again based on a wide range of characteristics. These purchasing behaviors can be related to:
* Whether an insured will purchase any coverage from a carrier;
* How long the insured is expected to renew his or her policy with the company; and
* How likely the insured is to buy additional coverages beyond private passenger auto and homeowners (for example, umbrella, boat, or inland marine).
Changing the Rules
With carriers' expectations of conversion/retention and loss experience so refined, the price they are willing to pay to acquire different types of business also should vary. Carriers, given their predictive modeling, can project with much greater certainty than in the past which types of insureds will be most profitable, how long they are expected to renew with the carrier, and whether there are any cross-selling opportunities. Therefore, they could pay commissions that vary according to these projections. If commissions are in essence the purchase price that a carrier pays to obtain business from an agency, that price should reflect the attractiveness (or lifetime value) of the individual insured.
Additionally, from the perspective of the producer, if commissions reflect the market rate charged to an insurer by an agency to produce and service a personal-lines policy for a year, that "produce-and-service" fee should vary by type of insured.
Variable Commissions, Flat Fees
Historically, commissions have been set at a percentage of premiums for personal lines. But in some cases, the costs to the agency to perform certain tasks related to producing and servicing a piece of business do not vary by premium size. For example, completing a private-passenger auto application and uploading the information to carriers to receive quotes and bind coverage for a senior citizen should not take any less time than to perform the same task for a teenager. But if an agency is paid 12% of premiums to produce this business, the payment is significantly higher for the teen.
Other categories of work performed by an agency that might be considered for flat fees are inspections for vehicles just added to a private-passenger auto policy, new homeowners policies or looking up an insured's driving history on the state's registry system. From the carrier's perspective, paying a flat fee that covers this type of work would more closely align costs to an agency with its compensation.
For other types of work within an agency, which vary by type of insured, a variable commission could be paid. Examples of these types of tasks include claim handling, endorsement activities and billing. The relative percentages to be paid across the various types of insureds could be determined from a range of predictive models (related to frequency of loss, endorsement activity, or probability of notice-of-cancellation for nonpayment of premium).
New Business versus Renewal
In general, the work an agent must perform for new business is greater than for renewal policies. In addition, the losses related to new business tend to be higher than losses for renewal business; to the extent that the agent is involved in claim handling, more work is expended on new business policies.
A carrier that wants to grow its business may be willing to pay a higher purchase price for new business. The expenses related to obtaining a new piece of business also may vary by how long that business is expected to remain with the company. For example, nonstandard private-passenger auto risks tend to move from carrier to carrier significantly more often than preferred business. A carrier may assume that for nonstandard risks, all of the agency's costs of placing those risks should be borne in the first year, while for the preferred business, the original placement costs could be amortized over several years. The number of years that costs are amortized across could vary by type of insured, based on the expected number of years' tenure as estimated by a retention predictive model.
In general, carriers view customers who purchase multiple types of policies to be more desirable, or preferred risks. They tend to move less often, and their underwriting results tend to be more favorable than monoline insureds. For cross-selling a second type of policy to an insured, an agency could receive a higher commission percentage (in addition to any fixed and variable fees related to placing the new policy). For example, an insured with a private passenger auto and homeowners policy with the same carrier, which then adds an umbrella policy, may generate a new business commission on the umbrella, and also increase the percentage commission on the private passenger auto and homeowners accounts.
Different carriers have different target markets and underwriting philosophies. If carriers' marketing departments were explicit in what their target markets were, and what the growth opportunities were, then agencies could focus on providing the risks to each carrier that were best aligned with the carriers' plans.
Commission schedules could then be explicit purchase prices related to a company's appetite for specific types of insureds, which would be integrated with the insurers' pricing based on predictive models. An agency might then refine its own marketing plans to align with its carriers' growth appetites, and could look to partner with new carriers that might be focused in markets that are off-target for their current insurers.
The simple fact is that carriers have a wealth of information about the market and have created strategic plans for improving their competitive position, but they fail to put this information to better use in determining how they pay agencies to distribute their products.
This is especially true with respect to contingent commission plans. Typically, these start with a comparison of an agency's loss ratio to an expected or break-even loss ratio, to determine the profitability of the agency's book of business placed with an insurer. Various other considerations are then included into a formula that determines the contingent commissions paid. These typically include volume of business with a carrier, growth in new business or retention of policies, and mix of business (for example, a desired balance between private passenger auto and homeowners).
Carriers usually estimate the expected loss ratio on a line-of-business basis, by state. However, a significantly more refined view of the actual profitability versus the expected profitability could also incorporate all of the factors underlying the carrier's pricing predictive models. Applying the modeled effects of each of these variables to agencies' books of business can produce expected loss (or retention or cross-selling) results. Then, the contingent commission calculations can align directly with the carriers' pricing and marketing decisions.
Catching Up, Moving Forward
Clearly, property/casualty companies have some opportunities to put into place more effective--and potentially more profitable--relationships with their agents, if they are willing to explore some new distribution approaches that take greater advantage of their own resources and capabilities. In essence, they can make better use of existing information to access selected markets. To do this, however, companies have to come forward with explicit proposals that carry advantages to agencies as well. If this happens, both carriers and agencies can have a more successful partnership that serves their own interests.
* Property/casualty insurers have predictive models that give them large amounts of data, including frequency of claims, losses that their insureds are expected to produce, and the likelihood of retention and cross-selling.
* Carders should pay agents commissions that vary according to these projections about specific business.
* Commission schedules also could be related to a company's appetite for specific types of insureds.
Contributor Katharine Barnes is a principal for the Tillinghast practice of Towers Perrin. She can be reached at Kathy.Barnes@towersperrin.com.
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|Title Annotation:||Agent/Broker: Personal Lines|
|Comment:||Predicting better distribution: carriers have a wealth of information about the market and the likely behavior of insureds, but fail to use this information effectively to help agents distribute products and to compensate them for their work.(Agent/Broker: Personal Lines)|
|Date:||Feb 1, 2007|
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