Fees rising?

Studies are beginning to show a growing perception that brokers should be remunerated by fees rather than commission. This view is becoming widespread among both brokers themselves and the end consumer. So, what are the underlying reasons behind this shift in approach and what does the future hold for the long-established commission-based system?

When Professional Broking carried out its Sentiment Survey in July 2007, 41.3% of respondents who use fees said they now use them for SME business, with 38.1% using them for large corporate accounts. A quarter said they charged fees for more than 50% of their business. There were also signs that the trend towards more use of fees was likely to continue, with almost 12% saying they were likely to move toward fees for SME business in the proceeding six months and around 35% reporting that they were likely to do the same for large corporate accounts.

Few brokers appear surprised by reports of a shift towards fee-based remuneration. Eric Galbraith, chief executive of the British Insurance Brokers' Association, cites a number of reasons, particularly for the use of fees in smaller commercial business. He says: "Commission does not always pay the broker adequately for the work done on high-work, low-premium cases. Also, as we move to more formal terms of engagement with detailed services provided by the broker, clients will look to choose what services they require. Furthermore, regulation and competition have fuelled a move towards fee-based service."

Impact and influence

Many point to the influence of regulation and the need for greater transparency as an argument for fees over commission. The impact of the post-Spitzer era also continues to be influential. "It is all about treating the customer fairly and under TCF we have to be completely transparent in our charging," asserts Barry Wicks, marketing manager for broker RHG.

The market cycle also has a significant role to play in influencing a shift toward fees. Galbraith explains: "The soft market greatly impacts the intermediaries' remuneration and I believe there is a recognition in the intermediary channel that they need to ensure suitable remuneration for the services they provide and that they are not subject to the vagaries of the soft and hard market, or the soft and softer market. Therefore, knowing they will earn a minimum fee from each client helps their budget planning, making them less vulnerable to the market cycle."

Many point to the unpredictability of income when a commission-based system is combined with the highs and lows of the cycle. Wicks emphasises: "A soft market means prices drop, income drops and commission drops. Commission is not a healthy method on which to base our business because it is so variable."

There is a view that these issues have always been significant and that a shift toward fees in a soft market is not unusual. Cathie Bruce, distribution and customer services director for Groupama Insurances, explains: "I don't think there is more of a trend than there has been in previous years. In times of falling premiums brokers must look to ensure the stability of their income and fees is one way to do this."

Lyndon Wood, chairman at Moorhouse Group, agrees that the soft market has an impact but does not believe it is a deciding factor for brokers. "It is more to do with the realisation of the benefits associated with adopting a fee structure," he observes.

Again, there is a growing awareness among brokers about the benefits that can be gained by charging a fee. One broker sums up the advantages in three words: "Transparent, professional and fair." This issue of professionalism has been widely discussed and there is some consensus among brokers that charging a fee encourages the customer to perceive broking as a profession in line with accountants and lawyers, rather than as a product provider. It is important not to overplay the potential impact, however, as Sean Hicks, head of UK corporate risks at Oxygen Insurance Brokers, observes: "There's a lot more to being professional than just charging a fee. You've got to look at quality measurement and defining your service levels."

There are, of course, some notable disadvantages to take into account for those brokers looking to switch to fees. Galbraith comments: "One major disadvantage is that it is extremely difficult for the broker to charge for work that they do on behalf of the insurer and this area requires careful consideration. Many brokers improve the client offering by performing a variety of underwriting, claims and administrative functions for insurers, but they can't do it for free." Galbraith emphasises that the issue is complex as many services are provided by brokers for insurers and clients, though this does not mean the customers receive poor advice or service. "On the contrary. Many customers benefit from a superior and cost-effective service because of it," he adds.

Others point to the potential for clients to go direct or seek out a different broker if they are unhappy with the fee charged. "Clients that do not value what we do may decide to switch to direct sales," observes Wicks. This also raises the danger of brokers facing tough negotiation or even undercharging in order to retain a client. As Wood comments: "Certainly for the uneducated customer it may appear you are earning too much and it provides them with the ammunition to negotiate the premium or costs downwards, therefore disadvantaging the broker's ability to make a profit. After all, we are a business and we need to make a profit to stay compliant."

Insurers tend to remain largely neutral over the question of whether or not brokers should choose the fee or commission route, but are insurers enthusiastic about a movement towards fees? Chris Garrett, broker partnership manager for Allianz Commercial, responds: "Neither for nor against. Providing the end customer is well served, the broker is remunerated fairly and the insurer is able to carry the right technical rate and price for the risk then either system is fine."

Before switching to a fee-based system it is vital to do your homework and that also means investing in staff training. Hicks says: "It has to be accepted that you need to have disciplines in place in terms of having a pragmatic and fair time-cost system. You've got to train the staff to use it and it's got to be used. They have to understand the links between using it and the revenue so it's not just some dissociated process." Hicks adds that it is important to ensure when collating fee rates that brokers establish what the costs of business are so they are charging rates that will allow them to recover those costs and make a margin. "It's not rocket science, but all of those things can bite you painfully if you don't get them right," asserts Hicks.

Galbraith advises brokers to fully research what their competitors charge before they decide to convert their client base. "We recommend thoroughly that brokers perform an 'income test' first to see exactly how they would need to calculate the fees charged so that they don't take a sudden drop in income."

What the customer thinks

While the debate over fees continues to develop in the broker community, it appears customers are beginning to favour a fee-based approach. In a survey carried out among risk managers at this year's Airmic conference, 78% of delegates questioned believed that brokers' remuneration should be fee rather than commission-based. The survey, conducted by Oxygen Insurance Brokers, also showed a high level of interest in the issue on the part of risk managers, with 85% of respondents saying how brokers are paid is important.

It is worth bearing in mind that many customers would have encountered fee-based systems elsewhere, for example when working with lawyers or accountants. As Garrett observes: "Most commercial clients understand that professions charge fees, for example solicitors and accountants, hence there should not be any difficulty in them accepting a change from commission to fee."

Oxygen Insurance Brokers has built a reputation for being exclusively fee-based and Hicks asserts that clients welcome this feature. "We make it very clear that the only income we earn is from the fee we charge and I think that is a message clients want," remarks Hicks.

Many brokers are beginning to report positive responses from clients to fee-based systems. As one broker concludes: "The vast majority see the absolute sense in the proposition." There are, however, varying degrees of understanding regarding the issue. According to Wicks: "As a rule, the larger the client the more commercially aware they are. The smaller client that may not fully understand what the broker delivers, may just see it as a cost, so there is an issue there in ensuring the customer knows what the broker does."

The good news is that there is a growing awareness of the methodology both among brokers and their customers. Mike Lamborn, executive director of UK Broking at Heath Lambert, asserts: "Increasingly, new business is being transacted using a fee-based structure. Commissions are limited to volume desktop services these days, where the process can be standardised and the client requirements and insurances sought are less complex and are typically more 'out of the box' solutions."

When asked about predictions for the future, many brokers foresee that the momentum will gather pace. "I don't think we have a choice," says Wicks: "We have to treat the customer fairly and we have to be out there showing we do a good job and that means charging fees." Wood welcomes the predicted changes, observing: "With change comes opportunity and I certainly see it as just that."

But despite a rising acceptance of fees from brokers and customers, there are still inherent challenges ahead for a purely fee-based system. According to one broker, what stops fees being ubiquitous is client inertia: "If they have been with the same broker for many years and this is often the case, then they have not necessarily been exposed to the argument for fee-based remuneration. This is compounded by intra-broker competition, with brokers that are commission-based not competing on a fee basis."

FEES V BROKERAGE

The British Insurance Brokers' Association chief executive, Eric Galbraith, summarises some of the pros and cons of the brokerage-based system:

For Brokerage:

Well understood by all parties;

- Brokers and clients don't have to negotiate over the fee, meaning it is painless for the client;

- Brokers earn more when premiums rise;

- Links brokers' incomes to economic growth;

- Pays brokers for work done for the client and insurer;

- Broker doesn't have to keep the clock running every time he speaks to a client.

Against Brokerage:

- Makes budgeting difficult;

- Earnings are not linked to actual work done but instead are linked to premiums;

- Limits scope to make charges for additional services such as risk management;

- Not as transparent on fees.

- Fees are more certain;

- Fees align brokers with other professionals such as solicitors.