S&P Says Insurance Brokers Have Resources to Manage Through Current Crisis

October 22, 2004

Standard & Poor’s said today it believes the three major brokers on which it has commented since bid-rigging and account steering charges have rocked the industry have the “resources to manage through these issues” and remain viable and profitable businesses.

Those comments came during a conference call with analysts after S&P announced it was downgrading the credit ratings of brokers Marsh and Aon, placing Willis on credit watch with negative implications, and revising its outlook for the property and casualty industry as a whole from stable to negative. (See separate stories.)

S&P credit analysts warned that the bid-rigging charges are most serious of the charges brought against certain brokers and insurers by New York Attorney General Eliot Spitzer and others. Other charges have centered on the receipt of contingent commissions by brokers and possible tying of placement of business with primary insurers in exchange for reinsurance contracts from those same insurers.

“Bid rigging is illegal,” the S&P analysts stressed, suggesting that contingent commissions and even tying may not be illegal. They said the bid rigging allegations “took everyone by surprise” and could have “fairly significant impact” on the industry.

S&P’s Steve Ader, Donovan Fraser, John Iten, Tom Upton were among the analysts who discussed the current controversies.

They attributed their downgrades for Aon and Marsh in part to short-term revenue reductions due to the expected loss of contingency commissions and questioning of any tying arrangements. Reduced revenues could affect the brokers’ revenues and cash flows.

Specifically they questioned whether the expected revenue hit could affect Marsh’s ability to rapidly pay down debt, including that related to its recent $1.9 billion purchase of Kroll.

Regarding Aon, they said they would be watching to see if its ability to sustain improvement in its financial profile is affected.

In the case of Willis, S&P found that any potential reduction in its revenues was not enough to trigger any rating downgrade at this time.

Ader referred to Spitzer as “one of the most powerful forces in America” whose moves are being take very seriously.

They noted that brokers and insurers would have to cover the high costs of complying with investigations and of potential fines and penalties, at a time when insurance rates are falling.

But they added that they believe the brokers named thus far are fundamentally sound and will emerge from this controversy without having to take “drastic” measures.

For the overall property and casualty industry, S&P revised its outlook to negative from stable to reflect the expectation that downgrades of insurers and brokers in this sector will exceed upgrades over the next 6 to 8 months. Factors other than the Spitzer allegations will factor into future downgrades, they predicted.

S&P said the “reputational risk” of bid rigging or price is very serious.

“In the long run, the damage to a broker’s reputation by any proven allegations of bid rigging could compromise its competitive position,” Upton observed.

However, S&P said it sees less chance for long term damage to reputations for “brokerages that depend heavily on contingent commissions or on tying.” It characterized them as “considerably lower” and more “short-lived.” It also noted that Marsh has announced it would “cease this practice with immediate effect,” as has Willis.

For the most part, insurance carriers will not be seriously hurt by the contingent commissions issue, they maintained.

S&P also sees some upside flowing from the current debacle. “Brokerages could replace the lost earnings from contingent commissions with other revenue streams,” said S&P in a bulletin.

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