Posted on 17 Nov 10
The news over the past year that the big insurance brokerages would again accept contingent commissions made plenty of headlines. And, looking at third-quarter numbers, the issue could be a needle mover, as the publicly traded brokerages struggle to maintain margin in what are very difficult times.
In its third-quarter financial results, released Oct. 26, Arthur J. Gallagher & Co. reported that contingent commissions have grown since its July 2009 settlement with Illinois Attorney General Lisa Madigan. As of the end of the third quarter of 2010, the company had received $33.7 million in contingent commissions, a 31.6 percent increase. Contingents as a percentage of the company's overall business have grown, even as brokerage receipts are being depressed (and have been for a long time due to the soft market and the recession) and the company's operating margin has fallen off only slightly in the first nine months compared with the year-ago period in 2009.
In a conference call with analysts on Oct. 27, J. Patrick Gallagher, the chairman and CEO of AJG, said that his company had received more contingent commissions than expected. He attributed that to the overall profitability of the business and referred to that revenue as "volatile."
For its part, Willis, which no longer accepts contingent commissions, reported 4 percent organic growth in total commissions and fees in the third quarter, with 2 percent growth in North America. Don Bailey, Willis' Chairman and CEO for its North American business, said that the company is retaining clients based on the company's policy banning contingent commission.
"I certainly would say we are getting this growth in part because of this stance," Bailey said. His philosophy is that his brokers can spend more time focusing on the client if they don't have the distraction of contingent commissions.
He also posits that a company that collects commissions from a carrier in a central payment system is bypassing individual brokers with that compensation, something that could lead to a talent drain for companies that accept contingents, according to Bailey.
"Our model is increasingly attractive to producers who currently exist in contingent models because they can have the same number of clients and the same amount of revenue and make more money than they make in other places because of our position on contingents," Bailey said.
In the third quarter of this year, Willis still took in $1 million in contingent commissions, half what it took in during the third quarter of 2009, according to third-quarter results, published on Oct. 27. The broker also reported that it had received $11 million in the first nine months of 2010 in legacy North American contingent commissions from its Hilb Rogal & Hobbs acquisition, a steep drop from the $26 million it received in such commissions though the first nine months of 2009.
Contingent commissions are fees paid to brokerages by insurance companies for the volume and profitability of business brought to carriers. Critics contend the commissions create a conflict of interest as brokers can't honestly represent the interest of buyers.
Others say carriers compensate brokers in numerous ways and to focus on contingent commissions in looking for conflicts of interest is overly simplistic. Since Gallagher reached its agreement with Illinois, New York-based Marsh said in March that it would accept the commissions in its middle market business, housed in a unit known as Marsh & McLennan Agency. Marsh is in a quiet period because it has earnings coming out this week and couldn't comment for this story.
Chicago-based Aon Corp. said in July that it would accept the commissions in its core brokerage business "where legally permissible." As of the end of September, Aon had yet to receive a penny of contingent commissions, according to a spokesman.
"We intend to be fully transparent with our clients on all forms of compensation," said David Prosperi. "The manner in which we describe revenues in our financial reporting will stay the same," Prosperi said, an e-mailed answers to questions from Risk & Insurance® on whether the company plans to break out contingent receipts in its financial filings when it does begin to receive them.
"As we have said on many occasions, contingent commissions were never an integral part of Aon's growth strategy before we stopped taking them, and we do not expect them to play an integral part going forward," Prosperi said.