Tsunami Warning: Spitzer is Coming

This is not a tsunami “watch.” This is a tsunami warning. The waves have already swept over the closest beaches, so we know they are coming. It’s too soon for casualty reports, but some mighty big places were hit very hard.

Your beach is further away, but the wave is coming. It might weaken by the time it gets to you, but there is very little doubt. A very big wave is coming.

As you may have guessed, this wave includes the loss of your contingent bonuses. It includes disclosure requirements only an attorney could love. If that was all, it would be a very big wave. But the wave is even bigger than that, and you need to know the details.

It all started with a big earthquake warning in October 2004. Another earthquake was predicted along the famous Spitzer fault. That’s the fault line that starts in the heart of the financial district in New York City, and heads towards the Governor’s mansion in Albany.

The earthquake warning was issued by New York Attorney General Eliot Spitzer at a press conference. He announced he was filing civil fraud charges against Marsh & McLennan Companies Inc., the world’s largest insurance brokerage firm. He emphasized this could be a big one. Criminal charges could very possibly be filed, and he called for the ouster of Marsh’s CEO. He warned the company, “You should think long and hard, very long and very hard, about the leadership of your company.”

The predicted earthquake finally came at the end of January 2005. It was a 9.5 on the Settlement Scale, the biggest financial settlement ever agreed to.

The Marsh earthquake was followed shortly thereafter by the Aon settlement in early March, a $190 million aftershock. For a while it looked like that might be the end, but in early April a $51 million aftershock hit Willis Group too.

A.J. Gallagher has not settled, but had previously announced it would no longer take contingent bonuses. The CEO of Gallagher, J. Patrick Gallagher Jr., went even further at a press conference on April 27. He announced Gallagher was setting aside $35 million as a reserve, and made his intentions clear regarding a possible settlement with the Attorney General of New York. “If we can find a way to put this behind us we will do so.” He further noted that Gallagher is currently subject to 22 state inquiries, 12 class action lawsuits, and one shareholder suit.

Counting Gallagher, the Spitzer earthquakes of 2005 have now claimed the top four publicly-traded insurance brokerage firms in the U.S.

A lot of money has been shaken loose, but the monetary damage for brokers this big will be easy to repair. The real damage is below the surface. A giant underwater landslide occurred in the form of identical business “reforms” the brokers agreed to when they settled. The landslide started a “reform” tsunami that is heading for the rest of the insurance distribution system.

Can the tsunami be stopped?
The industry is used to regulation, and generally expects any major change to come from regulators. If this was a big wave from the regulators, we would have a chance to make our voices heard. It would not be perfect, but we would have a chance to identify problems before solutions were applied. But regulators are reacting to this wave, not creating it.

Substantial change has already come without any regulatory input whatsoever. The clients of Marsh and Aon, alone, pay over half the P/C premium in the United States. Add Willis and Gallagher to the mix, and we are looking at far more than half the total premium in the United States.

Companies interested in keeping their largest brokers happy may choose to change the way they do business even if regulators do not require them to do so. All the national carriers will be hard pressed to justify more restrictive rules for the biggest brokers than for the rest of the industry.

All companies, plus the brokers who have not (yet?) settled with Spitzer, have to assess their legal risk. Regardless of the actual merits of various forms of “contingent” compensation, the fact remains that the Attorney General of New York has been able to force the four largest brokers in the country to denounce them. They have been declared at least unethical, and arguably illegal.

No insurance company wants the kind of legal trouble that hit the big brokers. If brokers receiving contingents can get hammered, it is easy to see how the companies that pay them could too. Given the damage to the big brokers, what insurance company will take that chance?

It is even easier to see how every large broker will see potential risk if they continue to take contingents. When the top four brokers have all surrendered, what broker will risk being next?

To sum up:

So … can the big wave be stopped?

If the tsunami cannot be stopped, what is coming? Here are the key “reforms” the top brokers have agreed to:

No more contingent bonuses, as very broadly defined: Commissions may not vary based on the: number of policies placed; dollar value of premium; growth in number of policies or premium volume; retention or renewal rate; loss ratio or any measure of profitability.

Although current contracts are likely to be honored, contingent bonuses after these contracts expire are probably gone. It is too soon to say if companies will raise commissions to compensate agents and brokers for the lost revenue.

The definition of “contingent” is so broad that companies will lose a lot of their flexibility when dealing with smaller agencies. Some companies will cancel contracts with smaller agencies as a result.

Disclose everything: Prior to new or renewal binding, consultation, or servicing, disclose in writing, and obtain client consent in writing, on:

The disclosure requirement is so broad that it is probably unworkable. For instance, a homeowner would have to consent, in writing, prior to renewal of homeowners insurance. The same would apply for a person’s car.

Exactly what is meant by the rest of the disclosure requirements is unclear. Taken to an extreme, it would mean every conversation with a company would have to be disclosed, and the entire policy for each quote would have to be provided, prior to binding coverage. (If this were football, the provisions on trust account interest would be flagged for piling on …)

Disclose a second time: At the end of each year, further disclose what was actually received, and what is contemplated to be received, even if it has not yet occurred.

Given the complete prohibition of contingents, this would seem to be redundant. However, it is a perfect way to solve the disclosure issue for an agency which might receive a contingent bonus based on results during the year. Since Spitzer described the settlement terms as a possible template for the entire industry, perhaps he added this second disclosure requirement as a way to cover agencies that might somehow escape the ban on contingents.

These are not hypothetical requirements. The nation’s largest publicly traded brokers have already agreed to them. Although parts of them will require “clarification” because they are unclear and/or unworkable, the agreements are “done deals.”

There comes a time when immense change is almost unstoppable, even though that change has not yet occurred. All the evidence says that time has come. The sea may look calm, but a tsunami is coming.

Donald L. (Larry) Morrison is president of Bellevue, Wash.-based Business Transition Network Inc., a consulting firm specializing in agency mergers and acquisitions, business succession planning, and business appraisal. He can be reached at (425) 957-4754 or via e-mail at btnmorrison@qwest.net.

Topics Catastrophe USA Natural Disasters New York Agencies A.J. Gallagher