Canadian Brokers understand that Contingent Profit Commissions (CPC) are a device that insurance companies use to reward good front-line underwriting, volume of premium business placed and some good claims luck. In simple terms, the better your loss experience and the larger the premiums placed, the higher the CPC.
While the amount of CPC paid out each year varies by insurance company, Canadian underwriters, as a whole, return approximately 1.5% of total written premiums to brokers in the form of CPC payments. This can translate to between 6% and 8% of commission income for a broker, which is not an insignificant amount considering the average brokerage operating income margin is 26%.
While the calculation of CPC varies from company to company, most standard contracts ultimately base the CPC payment on the profitability of the book after allocating certain costs which allow for a reasonable return to the insurance company. Though it is unlikely you will see a calculation exactly as we have shown below, this depicts the basics of a CPC calculation.
On an industry wide basis, it is our view that standard CPC contracts are equitable for both brokerages and insurance companies. Having said that, it is incumbent that brokers understand how their CPC contract is structured as there are a number of factors that can have material impact on the ultimate CPC payout, regardless of the books profitability to the underwriter. Here are some of the more common factors:
- Brokerage profitability is generally reflected as a percentage of earned premiums. In some cases, the CPC factor remains constant over a wide range of profitability, effectively paying a smaller share of the profit to those brokers at the high-end of the profitability range;
- There can be a significant difference in the CPC factor depending on the amount of premiums written;
- Contracts often have retention requirements based on policies in force. For example, in these cases it would not be uncommon for the CPC factor to be zero if policy count fell more than, say 10%. One policy can make the difference.
- Insurance companies may have an option to lock in the CPC at a point of time by paying a percentage of the CPC otherwise payable as a form of insurance. Care must be taken when determining what circumstances this option is appropriate for.
While no one is suggesting that brokers should place business with one market or another based on CPC agreements, it is relatively easy for our team at Smythe Advisory to develop a sensitivity analysis to compare potential CPCs between companies. If all things are equal, this knowledge can help a broker ensure they are maximizing their potential CPCs.
Large brokers that place significant amounts of business with a specific market, or those brokers who have specialized lines of business that tend to be very profitable, likely have the ability to negotiate what we will refer to as non-standard CPC agreements. This might take the form of a guaranteed commission override or a special arrangement that recognizes both the profitability and related costs associated with the book of business.
In these cases, the broker has to understand the real long-term profitability of their book to the insurance company and then negotiate an agreement that is fair to both parties. The broker also has to look beyond their own book and consider the overall profitability of the underwriter.
At the same time, the underwriter has to reward those high-performing brokers who deliver significant and profitable premium volume. There is an abundance of information that brokers can use to support their negotiation, including insurance company financial metrics readily available through their Annual Report and MSA Research Inc.
Time invested by both the underwriter and the broker can result in CPC agreements that create a stronger broker distribution channel.
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