The Insurance Sales Model is Anti-Competitive
It is Based on Exclusivity That Eliminates True Competition and Inflates Purchaser Costs
Commercial insurance products are over-priced, and coverage terms are not written in your favor – in fact they are to your peril.
True (multi-broker) competition is the lever by which insurance terms and conditions, and pricing, are negotiated.
Here is why that competition doesn’t exist, and what we need to do about it.
Brokers in Control
There are thousands of insurance companies and millions of brokers, so how is it that the broker is actually in control of the price and terms of the insurance that you purchase? The business model for insurance brokers is to eliminate competition and they are successful at it. They are relentless in the pursuit of this and leverage every angle to convince the CFO or General Counsel that their business model derives the most competitive price and the best terms.
An insurance broker positions himself as the advocate for your organization. The broker presumably validates this advocacy by securing multiple quotes from industry leading underwriters and then binding coverage on your behalf.
Able to Stifle Competition
This is where the perceived competition breaks down. The multiple bid process is traditionally performed within a pre-determined pool of underwriters – underwriters that the broker works with on a regular basis. Within that standard pool, some proposals are obtained. The larger underwriter market is not involved. And there is no competitive pressure on the broker, as he or she is the only broker bringing proposals to the table. The state of New York in its lawsuits against major brokers documented the broker / insurer deal-making going on. * Risk management practitioners are well aware of this behavior– brokers and underwriters are selling a product together.
Some quotes from lawsuits by the state of New York against the largest of the brokers in 2005:
The AG’s complaint describing the effect of broker/insurer deal-making:
“[broker’s] conduct had the purpose or effect…to …restrain trade and injure competition.”
In one of the complaints, a broker complaining about an insurance company not compensating the broker enough:
“They have gotten the lion’s share of our Environmental business PLUS they get an unfair ‘competitive advantage’ as our preferred insurance company.”
The broker positioning as your advocate is bundled together with a plethora of services (listed below) that are being offered in addition to the insurance product. Look at any broker website to see how they present their offering. You’ll find them selling “risk management.” You will have to fight your way through mentions of all the following before you get to the sense that they also sell insurance:
- risk identification
- loss control service
- claims administration
- contract management
- policy language negotiation
- compliance support
- additional “consulting services” etc., etc.
This bundling of services along with the sale of the insurance product is calculated behavior. This bundling is the technique brokers use to present themselves as one of a class of professionals you need for your business, and the way they compete is on service rather than insurance product. In fact brokers often complain that we, on behalf of our clients, treat the insurance as a “commodity” by forcing them to compete – that it can’t or shouldn’t be separated out (or “unbundled”) from the overall service offering. On the contrary, the insurance product is the opposite of a commodity – it is a highly complex, negotiable contract for which the leverage of competition is crucial.
What About Those Services?
The services mentioned are all important. They constitute important elements of risk management. The question is whether you should obtain them from a broker, or whether you should buy them elsewhere. Or if you would prefer a broker’s service, should the insurance product be purchased separately? The services are all available elsewhere, i.e. separate from the broker provision of the insurance itself. And they are available at better quality.
What’s the value of the services? For a company with an all-services-included insurance premium of say $1,000,000 a rough value breakdown would be something like this:
Services 5% – 10% (we’ll use 5 for illustration)
Insurance Premium 90%-95% (we’ll use 95 for illustration)
Given the breakdown, it’s obvious the greatest effort should be devoted to controlling the insurance premium. This is the cost of the actual risk transfer, the contract under which the insurer agrees to pay the loss.
If we were to fall under the spell of the broker marketing, the 5% would be controlling the 95% – and that would make no sense. The broker is selling on the basis of the service (5%) and then once chosen, the broker will face no competition as it works to place the insurance (95%). The client will have no pressure to apply to the pricing or– as important – the terms and conditions.
This is an example of the “anomaly” that business mogul Sam Zell referred to in his Autobiography, Am I Being Too Subtle. The anomaly is that somehow the normal competitive process is not functioning. When you figure that out, you can obtain extraordinary financial opportunities. From the book:
“I’m always on the lookout for anomalies or disruptions in an industry, in a market or in a particular company….Any event or pattern out of the ordinary is like a beacon telling me some new interesting opportunity may be emerging.”
In our current case here, the beacon comes from piercing the veil of the broker/underwriter world, and the opportunity is to create real competition for the first time.
Controlling the Relationship
To control the relationship, we need to arrange multi-broker competition. This means there are two or three brokers bidding on insurance specifications that have been provided to them, and the access by the brokers to the specific insurance companies is managed. This is the only way. One broker, picked via a “broker beauty contest,” who then approaches the underwriters, is not competition. And there is a perverse incentive for the broker which is contrary to the interests of the insured. That is in the form of both:
- Up-front commissions which are a percentage of the premium
- Contingent commissions which are annual profit-sharing with the insurer based on the profitability to the insurer of the broker’s book of business
The up-front commissions are commonly an extremely large 15 to 20% of the premium. Just do the math on this for your own insurance program.
And the contingent commissions are the definition of conflict of interest: the broker profits when premiums are high and paid claims are low! At one point when insurance broker Willis was trying to compete with other brokers by banning contingent commissions (they are now back), the CEO of Willis stated:
“it is a wake-up call to all risk managers and buyers of insurance to re-evaluate whether their broker really works for them, or the insurance carrier.”
Around the same time, this appeared in the Financial Times:
Brokers Developing their “Captive Clients”
The bundling of services with the insurance product blends the two together and makes it disruptive for you to leave your broker – this is the “lock-in” your broker is looking for. And to really bring it home, think of how many times a broker has asked you to actually just hand them the business via the ubiquitous scheme called the “broker-of-record letter.”
No Say on Policy Terms and Conditions
In the “anomaly,” the world of no competition, you may never even see the language of the policy you are paying all this money for. Insurance is sold on the basis of a five or ten-page proposal, and then months later, like magic, hundreds of pages of fine print show up. Is this ok? No! Not based on the multiple insured vs insurer lawsuits that come across our desk every day.
The Solution: Competition at the Broker Level
True (multi-broker) competition is the lever by which insurance terms and conditions are negotiated. Your broker is not an expert on the terms, and even if they were, how is it logical to think from a business sense that they can really critique the product they are selling? Unbundle the risk management service (5%) from the insurance product (95%).
- Hire a risk management firm to manage the process; the risk management fee is minimal in comparison to all other costs and especially to the huge premium savings you will generate via the competitive process.
- Through your risk manager, hire all the specific services (loss control, claims, etc.) from specialist firms, even sometimes from insurers (or even brokers) who offer the service separate from the insurance sale.
- Put multiple insurance brokers in competition for the 95% of cost – the insurance product. In this “competitive model” they win on the merits!!
- Negotiate the broker compensation and let the difference in that compensation drop to your bottom line.
In our risk management practice, we have a Broker Pact under which we outline the above business model. The broker’s main job is to bring to the table for our clients the best coverage at the best price. That is all they do and that is how they win.
The insurance industry operates in a cartel-like manner. We bust that up using the model described. This means going from stifled competition to true powerful competition. This model is how you can achieve monstrous improvements in the coverage terms and conditions, along with huge premium savings. This is not incremental stuff – it’s monumental stuff resulting from understanding and acting on the anomaly that is the insurance market.
* The People of the State of New York v Marsh & McLennan Companies; and The People of the State of New York v Aon Corporation;
(c ) Licata Risk & Insurance Advisors, Inc., 2019
Mar 22, 2019