Sales Commissions And Health Insurance Exchanges

As Al Franken's Stuart Smalley character was known to say, "Denial is not just a river in Egypt."

Insurance agents and brokers are apoplectic about a recent recommendation to the Obama Administration by the National Association of Insurance Commissioners, stating that sales commissions should be considered as administrative expenses under the new health insurance reform law.

This is significant because beginning as early as January 1st, 2011, insurers are under a federal mandate to spend at least 80 percent of collected premiums on medical expenses. This caps insurer administrative expenses at 20 percent of premiums for small group insurance coverage, and at 25 percent of premiums for individual (non-group) coverage.

Response from the insurance industry and lobbying associations representing agents and brokers has been predictable: they have blamed everybody else (hospitals, doctors, lawyers, pharmaceutical companies) for health insurance cost inflation; they've railed against government interference in health insurance pricing; they've predicted that many insurers may be forced to leave the market if they can't compete in a more efficient world; and they've made dire pronouncements about declining customer service if agents must abandon their roles as "educators and advocates" for their small business clients.

All of which conveniently overlooks some important objective realities.

Health insurance coverage costs an average of 18-20 percent more for small employers than larger companies pay for comparable coverage. The principal reason for the cost differential is administrative costs, which average 25-27 percent of premiums for small groups and 30-40 percent of premiums for individuals.

The largest components of those cost differences are related to marketing, sales, and underwriting. Easily half of the difference is related to commissions and overrides paid both to general agents ("wholesalers")and selling agents ("retailers.")

Despite the onslaught of information technology, small group coverage remains heavily dependent on paper forms, complicated business processes, and a lot of administrative inefficiency, as technology solutions which have permeated other niches of the industry have not touched the small group market.

Why not? Because insurers are almost solely dependent on third-party agents to sell their products. And business processes which might simplify shopping for coverage threaten to "disintermediate" third-party salespeople, who have a lot of power with insurers.

Back in the late 1980's and early 1990's a few small business organizations (including my COSE alma mater) were able to produce genuine cost savings for their members by using the power of large numbers to reduce administrative costs through more efficient marketing and sales, and through the use of management information to negotiate more cost-effective rates from participating insurers.

The growing leverage of these purchasing groups produced a backlash among smaller insurers and agents, which resulted in many states enacting laws which prohibited insurers from "discounting" administrative costs for such groups. This protected agents' income, even as it created a disincentive to develop any cost-related efficiencies in health insurance marketing and administration.

Health costs (hospital, physician, and pharmaceutical among them) being equal, the only way to have a meaningful impact on small business' health insurance costs is to attack these administrative expenses...including sales commissions.

Certainly, a key differentiator for new statewide health insurance exchanges ought to be the ability to use administrative efficiencies...in the form of plan standardization, simplification, and reduced marketing, sales, and underwriting costs...to affect the price of health insurance coverage. A small business owner purchasing coverage directly through an exchange on-line should not have to pay the same cost as a business owner who buys through an agent, whose paperwork is processed by a general agent.

Administrative efficiency can also be a differentiator for insurers who, because of their size or market position, cannot obtain the kind of discounts from provider groups that the big Blues or dominant local insurers can obtain.

There's no doubt that agents are going to be subject to a squeeze in the brave new world of health insurance reform, just as middlemen have been squeezed in virtually every service industry. Many of the protests raised by insurance agents in this instance mirror those of travel agents in the infant stages of Priceline.com.

In the long run, just as with travel services, customers will flock to purchase health coverage in the easiest most transparent and cost-efficient manner...and if that means sacrificing their relationships with agents for a lower-cost, better deal through an exchange, that's what's going to happen.

Insurer and agent fears about exchanges aren't based on fear that they won't work; it's based on fear that they WILL work. Much of agents' business success is based on managing the complexity of the status quo, and insurers use the complexity and pain involved in shopping for coverage as a defensive business strategy. Neither party sees itself benefiting from a system which encourages transparency and simplicity.

That's why, instead of trying to find ways to game the regulatory process, agents should be pressuring insurers to do everything they can to increase simplicity and efficiency, and reduce their costs...even though, since their commissions are largely calculated as a percentage of premium, lower costs may lead to reduced commission income.

And they should start collaborating to develop the means to compete with exchanges through faster, simpler, and more customer-friendly experiences, rather than hoping that the system will continue to reward complexity and lack of transparency.

In a world where shopping for health coverage is easy, efficient, and transparent, the only beneficiaries are the small businesses that pay the bill. And that's what health insurance "reform" is supposed to be about.