Monday, July 8, 2013

Commissions, Comp and Quantum Theory

A friend of mine, Bill Cobb asked about brokers and commissions in workers' compensation the other day.

Pointing to data from the Workers' Compensation Insurance Rating Bureau he noted that the rate of the commissions have varied greatly as well as the gross amount of commissions paid.

­Brokers were paid about $1.37 billion in 2004 and $941.6 million in 2012.

At the same time, the rate of commissions has varied widely as well – ranging from 7.9% in 1999, to a low of 5% in 2005, maxing out at 8.2% in 2011, and settling at 7.8% in 2012.

Bill had some questions. In a regulated market, where work comp insurance is mandated, why pay the brokers a commission at all? And, what does a broker do to earn the commission – what services do they provide? And why do the rates and gross amounts of commissions vary so much?

So I called up another friend, Don Chambers, CEO of brokerage Colonial Western Insurance Agency in Camarillo, CA (near WorkCompCentral luxuriously appointed world wide headquarters).

Don explained that virtually all carriers distribute their product, insurance, through brokers. The direct model doesn't seem to work for employers with more than just a couple of employees. So, in the first instance, brokers produce the market for carriers - they are a necessary market intermediary to enable the distribution of insurance product to the consumer, i.e. employers.

Brokers analyze the risk and exposure of an employer and then match up those characteristics to certain, appropriate carriers. Don explained that not all carriers will take just any business; the appetite for risk is different between different carriers with the carriers having different expertise in certain risk categories or having certain levels of comfort for expanding into new categories. The broker needs to know the employer's risk and be able to match that risk to the correct carrier.

The broker also analyzes an employer's losses, serving as the advocate for the employer in reviewing individual losses, claim activity, loss payments, return to work processes, etc. as against the carrier's claim management. It is the broker's oversight that helps to ensure a lower experience modification factor, if the broker is doing its job in advocating for the employer during reviews with the carrier claims staff.

The broker, in the same instance, provides an analysis of the flow of losses; i.e. safety controls and loss controls. This is different from what carriers do; while carriers may provide some safety consulting, their services are not focused on changing behavior at the employer level - i.e. analyzing and finding out and implementing strategies to correct the underlying reason for the safety/loss lapses.

Don also explained that brokers review unit statistical filings for employers. While carriers report what's on the books, the broker wants to know why a claim was not closed because the only true way to save an employer money in the long run is to control the experience modification factor.

How about the fluctuations in commissions? Don said that commissions depend heavily on the availability of coverage and the flow of the market. Look at the graphic above and you will note that during the "hard market" in the early 2000s, when California experience a shortage in capacity, commissions shrank in both rates and gross payments. When an insurance market constricts, as it dramatically did during that period of time (i.e. carriers not taking business) then commissions shrink as well - this is because carriers don't want brokers bring them business to write.

On the other side, though, when times are good and carriers want to write more business then commissions are more generous.

Bill noted that the almost $1 billion brokers were paid in 2012 is neutral to the economy. The carriers mark up the premiums to cover the commission. The employer rolls the cost of the premium into the cost of his goods and passes it on to the public. The brokers spend that money in the economy. So, in the long run it is just a re-distribution of wealth – take from one group, give it to another group, who eventually spends it on the first group.

Macro-economics aside, Bill said, it’s important for the public to understand that almost $1 billion (almost 8%) of the cost of work comp premiums are going to a group of people that service the employers as their representative to the insurance carriers.

Bill's take away from his foray into broker commissions are really applicable to nearly any business. They are:

1. Cannibalize your industry before someone else does. Rip out all the costs and return them to the customer – think Charles Schwab, Amazon, and Expedia.

2. Outsource to the customer. Let them perform all the administrative tasks. Not only does this cut administrative costs, it gives the customer more control and satisfaction.

3. Create learning interfaces. Show them how to manage their own accounts.

4. Give away as much information as possible. An educated client is, by far, much easier to handle and profitable to deal with.

So there you go - another little lesson in workers' compensation dynamics. And you thought quantum mechanics was interesting.


  1. Susan Piha , Manager of Research and Education, Illinois Workers' Compensation Commission, provided the following comment to me via email and consented to posting here:

    "Bill noted that the almost $1 billion brokers were paid in 2012 is neutral to the economy. The carriers mark up the premiums to cover the commission. The employer rolls the cost of the premium into the cost of his goods and passes it on to the public. The brokers spend that money in the economy. So, in the long run it is just a re-distribution of wealth – take from one group, give it to another group, who eventually spends it on the first group."

    I think the logic is faulty. Who isn't in that "redistribution" loop? Consumers who pay higher prices, and workers whose wages are constrained by higher benefit costs. Money is going from them to others. It's not neutral to them.

    It would be helpful to know how broker fees vary among states. Do you have info on that? And how can states limit excesses?

  2. The response to Susan is that 'some of the consumers who pay higher prices are also the beneficiary of the brokers spending the money. And, some of the workers whose wages are constrained ......' are also beneficiaries because the broker's money is spent on the goods and services they and their employer provide. Other market forces (as much as the cost of workers' comp - average just 3.2% of payroll costs) are a greater constraint.'

    Notice, in both cases I used the word 'some'. This isn't a perfect and balanced re-distribution system. Not everyone benefits equally - some are better off than others. But then, I don't think anyone would agree that any of the re-distribution systems are perfectly balanced and fair - think income tax payers and recipients of entitlement payments; think corporate income taxes and the stock holders that receive a lower (or no) dividend; think WalMart paying minimum wages and the single mother of two that can buy diapers and milk cheaper than anywhere else where the employees make a 'living wage' (what ever that is).

    Here's the important thing to focus on - in a $12 billion system, brokers are getting paid almost $1 billion for placing coverage in a 'closed system'. The employers have to buy the insurance. The carriers get to 'cherry pick' the employers they want to deal with - everyone else gets dumped on SCIF. Every underwriter prices the policy based on a single criteria - they think the policy will bring them a profit. Trust me, no underwriter says, 'I'm sure this account will have $500K in losses, but I want the business so I'll price it at $400K.'

    As to what Don claims the brokers do for the clients - no they don't. They don't oversee claims - they don't follow up with the claims adjusters, medical providers, and defense/applicant attorneys - they don't review unit stats - they don't analyze the X-MODs - they don't call the WCIRB to argue on behalf of the employer. It just doesn't happen - it's supposed to, but it doesn't.

    Broker's commissions aren't the single ill that plagues work comp. Commissions are a significant expense line item. Like every other system, no one argues that the costs exist and are necessary. The question is, 'Am I getting the value for the money I'm spending?'

  3. There a number of items that could be argued in terms of what Mr Cobb asserts, but the one nearest and dearest to my heart, which is probably where Mr Cobb's passion and bailiwick lies as well, is claims and claims servicing.

    While I can’t speak to Mr. Cobb’s personal experiences, I do agree and can echo that there are a ton of brokers who promise the world but can’t deliver diddly squat; and that is for many reasons, least of which is the relatively complicated combination of dynamics going on.

    Nonetheless, when it comes to claims experience mitigation. Whether that be EMR audits, claim audits, claim reviews prior to the critical value dates for the 1st thru 3rd Unit Stat Report submissions, and a number of other items that he speaks to i.e. it does take someone special to expertly navigate and manage the burdensome CA WC system, which is then compounded by our Unit Stat/Exp. Rating plans and the horrendous WCIRB.

    But I certainly take umbrage by being lumped in with “all the other brokers.” I’m proud to say as the manager of my firms’ Claims/Risk Mgmt. dept (Cost Containment Unit <-- our fancy yet accurate name) we do the things he mentions and more, and have great success at it. And these are services are “value added”, our stance is "hey, you’re our client and we’re going to take care of you” and by following-thru, by having the success, by delivering on the promises, we have a high retention rate. Sure we lose clients to pricing once in a while, but they often see “it’s not always greener“ and if you get super low rates, but have any decent amount of frequency coupled with a crappy claims administrator, they more than pay for it down the road once that experience starts to develop.

    But I sure do think Mr. Cobb’s last statement/question of ‘Where’s the value’ is a cogent and succinct one that any good Risk Manager/CFO/ins. policy purchaser should be asking,