Good Vibes Only: Intermediary Fee, Engineering Fee or Excessive Fee?

“The intermediary should recognize revenue only when it satisfies its performance obligations to its customer (the policyholder) under the service contract. At inception, the intermediary arguably has not satisfied any of its performance obligations under the contract, so no revenue (or income) is recognized.”

As times goes by, the real definition of the above has just vanished, as nowadays, the intermediary has recognized the revenue on the day one the insurance premium paid by the policyholder to the carrier and the revenue recognized without prior written contract. The question is, what would be the basis of the revenue recognition at the intermediary side? Does the market introduce ceiling to the acquisition cost? Do we vote for clarity over the hidden acquisition cost? Or we just have a new plan on introducing and defining the new term of “excessive cost” and let the market adopt without market guidelines? Whatever our industry stands for, we should educate and influence the industry with good industry vibes e.g. clarity on acquistion cost.

The acquisition procedure is a typically unwritten service contract with a success fee aiming for a promise of insurance coverage. The success fee is charged as part of the premiums of the subsequently agreed insurance contract if the acquisition procedure is successful. The initial performance obligation from the service contract is satisfied and consequently related revenue recognized by achieving the insurance promise for a specified duration. The insurance promise is an asset itself which is transferred at outset of the insurance contract.

Technically the acquisition process results in a permission to insert the individual risk into the insurance pool which means an advantage for the policyholder. The acquisition procedure is an integral part of the insurance production process, which ultimately means to pool risks. It is as well relevant, that the acquisition process is not a search for an acquirer of a pre-defined good but a process where a product is developed derived from the individuality of the customer. Hence, the acquisition process is in its entirety a part of the service already to the specific customer.

Insurance is not only transfer of risk, it is a permanent service of providing coverage capabilities and capacities by maintaining an insurance pool, which distinguishes insurance from a simple bet. An insurance pool of a sufficiently large number of sufficiently uncorrelated and homogeneous risks mitigates significantly the deviation risk of the individual risks. The basic form of insurance is a mutual company providing insurance at cost; although the mutual does not bear any risk itself, it organizes the insurance pool and the members share the residual risk after pooling mutually. Policyholders benefit from taking insurance by acquiring protection for a price which is lower than their own opportunity cost of their risk without insurance, since pooling reduces the deviation risk causing otherwise severe opportunity cost. The permission to transfer an own risk to an insurance pool is therefore already a benefit for the customer. Therefore, customers are willing to pay for that permission, as far as the charge for entering into the pool is lower than the reduction of opportunity cost by insurance.

At this stage, we learned that the role of intermediary is not simple nor easy but rather advisory in distributing good risk into the inurance pool and the intermediary entitled for the fee. From the policyholders point of view, the ability of the intermediary in choosing the right pool (or carrier) should be identified and by delivering the most effective insurance premium, the intermediary is entitled for a recognition of the service.

The acquisition steps from the insurers point of view contains the followings:

  • Potential customers (or risks) need to be found (market exploration).
  • The individual risk exposure of potential customers has to be investigated, including correlation to other risks already covered by the insurer (risk investigation).
  • The resulting coverage demands have to be brought in line with the coverage provided in the existing pool to maintain homogeneity (negotiation of risk exclusions or inclusions) and the specific coverage to be defined.
  • The resulting position has to be verified and confirmed by the underwriting department (acceptance).
  • The contractual position has to be documented (policy issuance).

The advisory activity before the contract is agreed is an integral part of the product. The product, i.e. the coverage of the specific risk of the customer, is tailor-made for the customer and that occurs in the advisory process. The product, the insurance contract is actually developed in that process rather than a given contract is simply forwarded. The customer does not choose within a range of available products. The customer’s own specific risk is made to the product, i.e. the product is directly derived from the individual customer.

Some might argue that this is similar to any sales activity. However, the difference is, that the acquisition activity in case of insurance (i.e. reflecting the individual risk of the customer) is part of the production process, while in other cases it is an own separate process. The acquisition process is not a pure sales process. Bringing customer and insurer together is only one aspect of the entire activity. The intermediary plays an important role in the production process of the insurer to maintain the pool of premium. Considering that importance, the undividable activity should be understood in its entirety as an activity directed to provide the service of gaining coverage.

If we clear enough in determining the role of intermediary and how the intermediary contributes positively to the insurers/ pool of risks & premiums then we could be clear enough in setting the intermediary fee without further confusing the policyholders.

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