Comparing Fees and Commissions: Fees Acknowledge the Demands of Clients Who Need Consulting Services as Well as Placement of Insurance
Perez, Jack R., Risk Management
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.
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 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. …