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Like most small businesses, you probably purchase your insurance policies through an insurance agent or broker. Agents and brokers perform very similar functions. Both act as intermediaries between you, the insurance buyer, and insurers. Both have a legal duty to help you obtain the coverage you need at a reasonable price. Both an agent and a broker must have the proper license to sell insurance. He or she must also adhere to the regulations enforced by your state insurance department. Yet, the functions of insurance agents and brokers are not identical. This article will explain how they differ. It will also explain how agents and brokers make money from the premiums you pay your insurers. Except where noted, the following discussion applies to agents and brokers selling property/casualty coverages.

The differences between a broker and an agent may vary somewhat from one state to another. Generally, an agent represents one or more insurance companies. He or she acts as an extension of the insurance company. A broker, on the other hand, represents the insurance buyer.

An insurance agency cannot sell insurance products on behalf of a specific insurer unless the agency has been appointed by that insurer. An appointment is a contractual agreement that specifies what products the agency may sell and what commissions the insurer will pay for each product. The contract usually spells out the agency's binding authority, meaning its authority to initiate a policy on the insurer’s behalf. The agent may have permission to bind some types of coverage but not others.

Agents are either captive or independent. A captive agent represents a single insurer. For example, agents that represent Allstate or State Farm are captive agents. An independent agent represents multiple insurers.

Brokers are not appointed by insurers. They submit insurance applications to insurers on behalf of their clients, but they do not have the authority to bind coverage. To initiate a policy, a broker must obtain a binder from the insurer. A binder is a legal document that serves as a temporary insurance policy. It usually applies for a short period, such as 30 or 60 days, and must be signed by a representative of the insurer. A binder is replaced by a policy.

Brokers may be either retail or wholesale. A retail broker interacts directly with policyholders. If you have purchased commercial policies through a broker, your broker is a retail broker. If your agent or broker is unable to obtain a particular coverage you need, he or she may contact a wholesale broker. Wholesale brokers handle specialized coverages that are not readily available to retail brokers and agents. Examples are product liability insurance for a motorcycle manufacturer and auto liability coverage for a long-haul trucker.

Some insurers sell policies directly to insurance buyers without using agents or brokers as intermediaries. Such insurers are called direct writers. Direct writers tend to focus on personal coverages like homeowners and personal auto policies. However, some also offer commercial coverages to small businesses.

Agents and brokers that sell life insurance also earn commissions. However, a life agent earns most of the commission he or she makes on a policy in the policy’s first year. The commission on may be 70 to 120% of the premium in the first year, but 4 to 6% of the premium for a renewal.

Some captive agents are salaried. However, most brokers and agents rely on commissions for income. Commissions are paid out of premiums charged to policyholders by insurers. These may include base commissions and contingent commissions.

Base commission is the “normal” commission earned on insurance policies. Base commission is expressed in terms of a percentage of premium and varies by type of coverage. For instance, an agent might earn say, a 10% commission on workers compensation policies and 15% on general liability policies. Suppose that you purchase a liability policy from the Elite Insurance Company through the Jones Agency, an independent agent. Jones earns a 15% commission on general liability policies. If your annual liability premium is $2000, Jones collects $2000 from you and retains $300 in commission. Jones sends the remaining $1700 to the insurer.

Some insurers pay a higher commission for new policies than for renewals to encourage agents to write new business. For instance, if the insurer pays 10% for a new workers compensation policy, it might pay only 9% when the policy is renewed.

Contingent or incentive commissions reward agents and brokers for achieving volume, profitability, growth or retention goals established by the insurer. For example, Elite Insurance promises to pay the Jones Agency an extra 3% commission if Jones writes $10 million in new property policies in 2013. If Jones renews 90% of those policies when they expire, Elite will pay Jones an addition 2% commission.

Contingent commissions are controversial, particularly for brokers, who are supposed to represent insurance buyers. In the past, some brokers collected these commissions without the knowledge of their clients. Also, contingent commissions may give brokers (and agents) an incentive to steer insurance buyers into policies that are particularly lucrative for the broker. If agents and brokers accept contingent commissions, they should disclose this fact to policyholders. Some brokers no longer accept such commissions.

Your agent or broker should provide you with a compensation disclosure statement that outlines the types of commissions the agency or brokerage receives from its insurers. This document should state whether the agency or brokerage receives base commissions only or if it also receives contingent commissions.