Industry in the Bull’s Eye

November 8, 2004

In the days after New York Attorney General Eliot Spitzer filed a civil lawsuit against insurance broker Marsh & McLennan Companies Inc. for alleged commercial account steering and bid rigging, the insurance industry reeled with speculation about how far Spitzer would go with his probe of placement service agreements and other contingency commission arrangements between brokers and insurance companies.

Announcing the lawsuit, which was filed on Oct. 14, the New York AG’s office said: “In addition to steering business to its in-surance company partners, Marsh, at times, solicited fake bids, which deceived its customers into thinking that true competition had taken place. Marsh did this even as it claimed in public statements that its ‘guiding principle’ was to always consider its client’s best interests.”

The impact of the lawsuit on Marsh was swift and significant. In short order, Jeffrey W. Greenberg was out as Marsh & McLennan’s chairman and chief executive officer. The company’s board replaced Greenberg with Michael Cherkasky, who had been named to head the company’s risk and insurance services subsidiary, Marsh Inc., just the week before. Marsh also announced that it would conduct an internal investigation in response to the charges.

Reacting to Greenberg’s ouster, Spitzer commented that he would not proceed with a criminal prosecution of the company. Instead, he said removal of Greenberg “permits Marsh and this office to move forward toward a civil resolution of our lawsuit.” A favorable outcome of the investigation would “be better accomplished by criminal prosecution of individuals, adoption by the company of dramatically new business procedures, installation of new leadership, a full examination of prior wrongdoing and a pledge of restitution to those harmed,” he added.

Cherkasky, formerly with Marsh risk consulting subsidiary Marsh Kroll, has a background as a manager, prosecutor, investigator and trial attorney. Prior to joining Kroll, Cherkasky spent 16 years in the criminal justice system, including serving as chief of the Investigations Division for the New York County District Attorney’s Office.

Marsh quickly suspended all contingency fees of the type that are being investigated–fees that are over and above ordinary commissions, and paid by insurance companies to brokers, mainly for steering profitable clients the insurer’s way. The Associated Press reported that Marsh admitted to receiving $1.2 billion in such incentive payments over the past 18 months and that its decision to stop using such fees will reduce operating income.

Though not named in investigation, other large brokers, including Aon, Willis, Arthur J. Gallagher and Jardine Lloyd Thompson Group, reportedly followed Marsh’s lead in cutting off such fees.

At least two insurers named by Spitzer in his investigation, ACE and AIG, have said they will no longer pay them. The Hartford and Munich American RiskPartners (Munich), a division of American Reinsurance, were also named in the lawsuit.

In announcing that it is abolishing its contingency agreements, Willis Group Holdings commented that an internal investigation uncovered no evidence at Willis of bid rigging or tying of placements with insurers to sales of treaty reinsurance services. Joseph Plumeri, chairman and chief executive officer of Willis, said the company is cooperating with Spitzer’s investigation and denounced all bid rigging and tying activities. Plumeri noted that ending contingency agreements would cost Willis an estimated $80 million but he expressed confidence that company could make up the amount in new business.

Impact on independents
Many observers expect the impact to deepen as Spitzer expands to other companies and lines of insurance and as other courts and states get involved. Spitzer’s office has even suggested it could reach down to independent agents in their dealings with individual consumers.

“We are looking at the big insurance companies to see if there have been payments designed to influence small independent brokers,” David Brown, chief of Spitzer’s investment bureau told USA Today. “If brokers have been less than objective in giving their advice to [individual consumers], we think that is a problem.”

Independent agents see things differently. While not condoning bid rigging or any illegal activity, they note there is a fundamental difference between an independent agent and a broker that is not always understood by the public. Agents have a fiduciary responsibility to the insurance company they represent, while brokers do not–brokers work for their customers.

Robert Rusbuldt, CEO of the Independent Insurance Agents and Brokers of America (IIABA)–which the week before news of Spitzer’s investigation came out approved a new disclosure policy on contingency contracts–vigorously defended their place in the independent agency system. He said that contingency and profit sharing agreements are legal in the states and that such arrangements are central to sales organizations.

“The more you sell, the more incentives,” he told Insurance Journal. “It’s the American way.”

He acknowledged that even disclosure, however, is not ideal because the dollars involved are usually not known at the time of an individual sale. He said he does not think states will radically alter agencies’ compensation programs after the Marsh controversy fades.

“To suggest that incentive compensation should be ended because a few bad actors abuse it is like saying we should ban college athletics because some programs may cheat,” Rusbult added in a statement released by the IIABA. “The goal of the investigation should be to prosecute those alleged to have committed crimes or engaged in illegal activities. That is exactly what Attorney General Spitzer is doing, and we applaud him. There is no place in the insurance industry for unlawful conduct, whether it is related to compensation issues or anything else. We want there to be responsible reforms to address real issues, not theoretical problems.”

In a statement issued by The Council of Insurance Agents & Brokers (CIAB), president Ken A. Crerar said, “The debate over proper compensation for the professional services brokers provide is far from over.” Calling contingency commissions “both legal and proper,” Crerar added, “however the compensation system for brokers evolves, it is imperative that there be transparency and disclosure.

“The Council has been on record since 1998 calling for full disclosure and transparency of contingency commission arrangements. The Risk Insurance Management Society, the largest association of commercial insurance buyers, also has looked at contingent commissions and concluded there is no problem as long as they are properly disclosed.”

While the impact of Spitzer’s investigation has spilled over into states like California and Connecticut, agents and brokers in the states covered by Insurance Journal-Texas/South Central–Arkansas, Louisiana, Oklahoma and Texas–may see little change as a result of the charges brought against Marsh.

As David VanDelinder, executive director of the Independent Insurance Agents of Texas, noted, “Independent agents in Texas don’t do business the way large New York brokers writing Fortune 500 accounts do business. We exist in a highly competitive environment writing small to middle-market accounts. This forces us to deliver the best quite for the best coverage to every customer. Otherwise, we don’t get the business–or keep it.

“Most agents have profit-sharing agreements with the major insurers in their offices,” he continued. “These agreements don’t pay agents for placement of individual accounts. They have as much to do with the loss ratio of the business as with the volume sent to the insurer, and they do not involve guaranteed income. I don’t know of an instance where an agent would deliver an inflated quote on the promise of non-guaranteed future income.”

The Texas Department of Insurance announced that it is “aware of the developments in New York alleging improper pricing and sales practices by some brokers and insurers and is actively looking into the matter. As always, we will vigorously enforce our laws and take whatever action is appropriate after our investigation is concluded.”

Louisiana Insurance Commissioner Robert Wooley said his state has laws in place that would both keep bid rigging out and stop any type of collusion between insurers and brokers. But, he added, “We really we don’t have any agencies or brokers big enough that would have that kind of clout, that could bring that amount of business to an insurer.” He concluded that since Louisiana has laws in place against bid rigging and collusion, further legislation is unnecessary. He noted, however, that his department would be monitoring the investigation and its possible impact on his state.

Arkansas Insurance Commissioner Mike Pickens added that his department, too, is looking into the matter and is working with the National Association of Insurance Commissioners (NAIC) on a coordinated response. He said while it is important not to overreact, there would likely be a push for legislation requiring more disclosure of fees and that the Arkansas Insurance Department would likely pass some type of regulation regarding uniform disclosure.

The Oklahoma Insurance Department is also monitoring the investigation, according to department spokesman David Meuser. He said Oklahoma, too, is working with the NAIC on a response to the allegations, adding that it will be interesting to see what comes out of a Nov. 11 meeting of a special committee formed by NAIC to address the issue.

Wall Street reacts
While the impact on independent agents remains unknown, the immediate effect of Spitzer’s charges on Wall Street were clear. Shares of Marsh fell 37 percent in just two days after Spitzer’s announcement. Shares of AIG, ACE and Hartford Financial Services Group–three carriers cited in the big rigging aspect of the complaint–all dropped as well. Even some companies not implicated by Spitzer–Aon and Willis–saw their shares take a nosedive. European insurance shares also took a tumble after news of the U.S. lawsuit was learned.

As of Nov. 1, shares of MMC hovered near the $28 mark, down significantly from a high of $46.61 before news of the lawsuit was released.

Editor’s note: Several Insurance Journal editors contributed to this report, notably, Andrew G. Simpson, Jr., managing editor of IJ-East. The full text of Spitzer’s complaint can be found online at http://www.oag.state.ny.us/press/2004/oct/oct14a_04.html.

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