Your insurance broker doesn't set your price

Your small business insurance bill jumps 15% this year. Your broker hands you quotes from five of the largest and most respected insurers, and all five say about the same thing. You shop around anyway.

That restless moment explains an odd business, says Aaron Cohen, an investor with private equity firm GTCR who focuses on insurance. In most industries, customers shop the seller's price. In insurance brokerage, he says, the broker does not set the price, and the customer does not shop the broker's price.

For the small and midsize companies where private equity has made much of its money, the broker typically earns a commission, a percentage of the premium paid by the insurer back to the broker. When premiums rise, the broker's revenue rises too, without asking the client for a raise. Very large companies work differently and often pay the big brokerage houses a flat fee for advice, using their own insurance experts to decide what to buy.

Those premiums move in cycles with plain names. A hard market means rising rates and rising premiums, while a soft market means rates are coming down.

What moves prices is not always the broader economy, but whether insurers themselves are making money. Cohen says soft markets have sometimes lined up with soft economic times, but not always. The gauge he watches is insurer cash flow and profits. When insurers have positive cash flow, they are happy and generating returns. When they slide toward losing money, the market hardens because they push rates to restore returns.

That is why insurance prices can have a life of their own. Two costly natural disasters could harden the market even in a weak economy, and brokers would earn more because they take a cut of the higher premium.

It also explains the part that frustrates brokers. The price increase is outside their control, the stack of quotes often means no cheaper deal exists, and clients still leave. Attrition often rises when premiums are rising.