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By DAN REYNOLDS, senior editor of Risk & Insurance®

The news over the past year that the big insurance brokerages would again accept contingent commissions made headlines. And, looking at third-quarter numbers, generating revenues from contingent commissions could be a needle mover, as the publicly traded brokerages struggle to maintain margin in what are very difficult times.

Contingents as a percentage of the company's overall business have grown, too, even as the soft market takes a toll on brokerage receipts. 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 Oct. 27, J. Patrick Gallagher Jr., chairman, president 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 Group Holdings, 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' former chairman and CEO for its North American business, said he believes the broker 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, in an interview with Risk & Insurance® before the company last month said he was leaving to join Allstate Corp. 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.

"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, 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.

But that revenue was part of $11 million in the first nine months of 2010 in contingent commissions from its Hilb Rogal & Hobbs acquisition. It is 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. The commissions create a conflict of interest as brokers can't honestly represent the interest of buyers if they are paid on volume by carriers, critics contend. 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.

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, vice president, global public relations, with Aon Corp. "The manner in which we describe revenues in our financial reporting will stay the same," Prosperi said, in 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.

Third quarter revenue at New York-based Marsh jumped 9 percent to $1.08 billion compared to $989 million in the year-ago quarter.

The increase was due mainly to growth from acquisitions (7 percent), and organic growth (3 percent). Exposure to currency exchanges contributed to a drop of 1 percent in revenue, Marsh said.

Brian Duperreault, the president and CEO of Marsh's parent company, Marsh & McLennan Companies Inc., said in a prepared statement accompanying Marsh's earnings that the company's substantial organic revenue growth in all four of its units--Guy Carpenter, Mercer, Marsh and Oliver Wyman--was the first time all those units had achieved such growth in the same quarter since 2007. What may have been particularly impressive about Marsh's numbers was the 3 percent organic growth the company achieved in the third quarter in the U.S. and Canada, a landscape where organic growth has been particularly hard to achieve in the last couple of years. Latin America, which has seen more substantial growth for brokers, barely outstripped North America for Marsh with 4 percent organic growth in the quarter.

The battle to retain margin in this extended soft market was clearly delineated in the Marsh segment of MMC's earnings statement. Although the company recorded that 9 percent overall revenue increase in the third quarter, its operating margin through nine months of 2010 remained relatively flat.

Through nine months of 2009, the brokerage registered an adjusted operating margin of 19.6 percent. Through the first nine months of 2010, that margin, despite a perceptible revenue increase, dipped slightly to 19.3 percent.

From the sounds of things, Aon and Marsh are looking at contingent commissions as insubstantial pieces of their future revenue stream. But these are tough enough times. Continued low prices for commercial property/casualty insurance means that even with organic revenue growth maintaining margin is going to be difficult and is going to call for some scrappy management. And contingent commissions do help the bottom line.

But Willis' Bailey said he thinks they are ultimately counterproductive.

"If you think taking contingents is a recipe for top-line revenue growth and margin expansion you are wrong," Bailey said.

"We have proven that you don't have to take contingents, you don't have to compromise your position with your clients you don't have to compromise your position with your producers in order to run a successful business. I firmly believe that if I was getting five percent or so of my revenues from contingents I would spend a lot of time with carriers trying to figure out how to maximize contingent income, and that is time that I would not be spending with my clients thinking about value proposition, thinking about differentiation, thinking about claims, thinking about placement solutions," Bailey said.

December 1, 2010

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