A Matter of Trust

Marcus Wagner


September 1, 2010

Although insurance agents have a duty to act with reasonable care towards their clients, they have no obligation to advise clients in regard to policy terms and conditions. Nor are they obligated to ensure that their clients have the most appropriate coverage. In fact, there are several federal U.S. court cases proving the importance of ensuring that your insurance broker is actually acting as your fiduciary. 

In 2008, a U.S. federal court determined that a company's agent did not have a duty to advise its client on the most appropriate insurance coverage. The judge in Sewall v. Great Northern Insurance ruled that the broker, Professional Lines Insurance Brokerage Inc., had no fiduciary duty to its client because the broker was, in reality, the agent of the insurer. No client/broker relationship existed beyond those of an "ordinary, reasonable prudential agent." 

Another judge agreed. Insurance agents do not have any duty to identify their clients' needs, tell them when they are underinsured or inform them of additional coverage that may be available from different insurers, according to a 1998 ruling in Cameron School Board v. State Farm Fire and Casualty Co.

Given this, every risk manager should question his or her broker relationship.  If a trust does not exist, you may be paying more for coverage and receiving less.

While many businesses are now more aware of the need for transparency, disclosure and the conflicts of interest that exist in the commercial insurance market, they still misunderstand the need to establish a fiduciary duty from their insurance advisor. Most companies feel comfortable with their current insurance arrangements because they have a good relationship with their broker and have received prompt service in the past. Unfortunately, most companies discover that they were inadequately insured only after it is too late -- when a major, uninsured event occurs.

Many insurance buyers also underestimate the power of fees in their broker relationship. "There should be total clarity about whether the intermediary is acting on behalf of the buyer or the insurer and that it is no longer acceptable for brokers to work for both parties during the same transaction," according to the London-based Association of Insurance and Risk Managers (AIRMIC).  

But in most countries -- especially the United States, Australia and New Zealand -- brokers continue to believe that it is acceptable to work for the insurer and client. Some insurers claim they have difficulty understanding the potential for conflict of interest. Skeptics often claim that this inability to understand is blurred by money.

Brokers typically receive a 15% to 20% commission for their services. In Europe, some brokers also want insurers to pay an additional 2.5% commission, which will eventually be passed on to clients. In addition, brokers sometimes charge their clients a fee. In some countries, including the United States and New Zealand, these fees can be camouflaged into the premium so the client is not aware what is being charged above the actual premium. In one example of broker exploitation, this add-on fee was $1.4 million on top of a $2.6 million actual premium. 

Dirk Verbeek, UK chairman and CEO of Aon Risk Services International, said the 2.5% additional commission is justified for the services a broker provides in a changing marketplace heavily dependent on expensive technology. Critics of the 2.5% commission, disagree, claiming it is an effort for brokers to buy time to sort out business models that were previously dependent on contingent commissions at the expense of clients and carriers.

The Risk and Insurance Management Society (RIMS), a nonprofit advocacy group for risk managers and publisher of this magazine, once again spoke out against contingents in July. "RIMS reaffirms its position that contingent fees for insurance producers should be prohibited, and that in the absence of prohibition, all compensation arrangements should be fully disclosed to the client," stated RIMS. This statement came in response to Aon's announcement that it has "decided to accept various forms of compensation available, which may include supplemental and/or contingent commissions."

While the highly contentious issue of contingent commissions has resurfaced of late, the most important thing for insurance buyers to understand is that all commissions paid to brokers come out of the insurer's profits. If the insurer is not prepared to absorb that cost, it is passed along to the client in the form of higher premiums.
Marcus Wagner, CPA, is a partner and the advisory practice leader of Calvetti, Ferguson & Wagner, a Houston-based CPA firm.