Some of the buyers think that this will ultimately be viewed as a major “train wreck” for the insurance industry. The loss of credibility will be difficult to overcome. As one put it, “Trust is going to be a problem.”
SPECIAL REPORT
ON THE HORNS OF A DILEMMA II
Risk managers see workload growing as they seek competitive bids from numerous brokers
By Michael J. Moody, MBA, ARM
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Some of the buyers think that this will ultimately be viewed as a major “train wreck” for the insurance industry. The loss of credibility will be difficult to overcome. As one put it, “Trust is going to be a problem.” |
In the October issue of Rough Notes, I wrote an article titled, “On the horns of a dilemma.” The article discussed the utilization of contingent commissions in the property/casualty business. It highlighted the issues involved, the problems associated with it, and provided a number of reasons for abandoning the practice of contingent commissions. It ended by noting that the insurance industry had a choice to make, thus finding itself on the horns of a dilemma. Due to the rash of activity subsequent to New York Attorney General Eliot Spitzer’s filing suit against Marsh & McLennan Companies (Marsh) on October 14, 2004, there is certainly more to talk about on the subject and thus the need for this follow-up to that earlier article.
Recent events have indicated, however, that the time for choice may have passed. Where things go from here is anyone’s guess. But the risk manager’s role will be critical.
Background
Contingent commissions have been a bone of contention within the risk management community several times over the past 10 or 15 years. However, the insurance industry chose to just ride out the storm and continued to use the controversial compensation plans. To be certain, most states did not view contingent commission as illegal. It was typically the lack of disclosure that was in question both by regulators and insurance buyers. Many felt that the practice also represented a potential conflict of interest for the brokers who were expected to work in the insured’s best interest.
Early in 2004, the New York Attorney General began issuing subpoenas to most of the insurance industry biggies. In addition to New York, Connecticut and California also began similar investigation work. Then came Spitzer’s October 14th bombshell. The New York AG accused Marsh of bid rigging and using contingent commissions to manipulate the sale of property and casualty insurance. The complaint was directed at Marsh; however, it also specifically noted the involvement of four carriers: AIG, ACE, The Hartford, and Munich American Risk Partners. And, if that was not enough to get everyone’s attention, Spitzer announced that two executives of AIG had already pleaded guilty to criminal charges in connection with the suits. Subsequent to the original complaint, an ACE employee also pleaded guilty to similar charges.
The next several days saw a whirlwind of activity from all affected parties. There were a number of early casualties. Among the earliest casualties was Ray J. Groves, Marsh’s chairman and chief executive officer of its insurance brokerage unit, who was fired. Then Marsh Chairman and CEO Jeffrey W. Greenberg resigned.
The practice of collecting and/or receiving contingent commission within Marsh, ACE and AIG were also early casualties as it was at the Willis Group shortly after that. But Willis went a step further by introducing a nine-point “Client Bill of Rights” which outlines its responsibility to serve as a client advocate by providing full disclosure of their dealings with carriers. Within days, it also became obvious that the shareholders of Marsh, as well as most insurance brokers and carriers, were in for a difficult time. Marsh stock lost about 50% of its value within a couple of days of the announcement. As with any significant drop in stock price, it is expected that shareholder lawsuits will also follow.
Since the original suit, additional involvement has occurred on a variety of fronts. Most of the national brokers have now also received subpoenas from New York. In addition, many property and casualty carriers have been notified of potential involvement. A number of life and health carriers were also on the receiving end of additional subpoenas. Ditto for pension consultants. As of late October, even insurers of personal lines were being reviewed, as well as several reinsurance practices. While most of the activity emanated from the New York Attorney General, both Connecticut and California have been busy with similar actions. A number of other states have also begun to respond with legal action of their own.
Contingent commissions at the core
Contingent commissions are not illegal. The biggest issue has been the failure to properly disclose information about contingent commissions to the buyer. But of equal concern is the potential for conflict of interest that could be driven by the desire for additional contingent revenue. As the current activity has confirmed, contingent commissions can certainly be a driving force and are ripe for abuse. By rigging bids and promoting insurance coverage that may not be in the best interest of the buyers, some brokers and insurers have used contingent commissions to the detriment of the consumer. The one big question as of this writing is just how widespread is this practice.
Most brokers have tried to minimize concerns about this being a pervasive practice by saying that it occurs only in isolated cases and does not affect the majority of honest brokers. However, Eliot Spitzer notes in a press release that “The damages are vast, the corruption is remarkable.” He goes on to say, “There will be numerous criminal and civil cases. Trust me, this is Day One.” John Garamendi, California’s Insurance Commissioner, also thinks this is a significant problem, calling contingent commissions “secret broker commissions” that are “a serious problem that betrays the public’s trust.”
Risk managers concerned
Conversations with several risk managers who wished to remain anonymous have illustrated their frustration with this situation. Principal among the frustrations was the amount of contingent commissions involved. While most were aware of the existence of these forms of commissions, they were taken aback by Marsh’s statement that its 2003 contingent commissions amounted to $845 million, an amount that represented almost half of Marsh’s net income for 2003. One noted that “I was always told by my broker that these numbers were not available on an individual account basis and were not that big of a deal anyway.” Most buyers did not have any idea as to the actual commission allocated to their account.
Some of the buyers think that this will ultimately be viewed as a major “train wreck” for the insurance industry. The loss of credibility will be difficult to overcome. As one put it, “Trust is going to be a problem.” Another noted, “The insurance industry has held itself out to be better than other financial service sectors, and now it is just one of the pack. And it is not a pack you want to run with.” Another said, “It is sad when the industry you work in begins showing up on the front page of the Wall Street Journal.”
It appears that much of the evidence that Spitzer has accumulated is in the form of e-mails, and several people commented on how dumb it was to leave incriminating material on computers. But as one person observed: “It may be that they never considered it as incriminating evidence, but rather just standard operating procedure, so why would you get rid of it?”
Buyers also noted that this is a wake-up call to risk managers. “While what has happened is certainly bad, it is now more incumbent on those of us buying the service to make sure we know what we are getting.” Another said, “Too often the clients never find out what they are buying or ask the questions they should.” They go on to say, “It is now time for risk managers to take things into their own hands.” They realize the additional administrative burden this will bring. However, they feel “we have no other choice now.”
A number of risk mangers had previously moved to a “fee-for-service” approach, rather than the traditional commission structure, and they felt that this may have lessened the probability of contingent commission abuse with their account.
Most risk managers who responded said they believed they would be required to do much more competitive bidding utilizing several brokers rather than depending on one broker to obtain several carrier bids on their behalf. This was particularly true for public entity risk managers. However, all of the risk managers felt that their office would have to do significantly more administrative work, just to assure the competitiveness of future purchases. “I can no longer trust quotes obtained from a single broker,” one commented. Most also felt that the competitive bidding process which uses several brokers will become the norm. As another risk manager put it, “Even though it means more work for us, I cannot assure my management that we have the best deal without competitive bids.”
Conclusion
It is still early in this evolving story. Despite that, some things even now are crystal clear. Certainly, you can expect to see a musical chair activity within the various brokerage houses as employees try to find greener pastures. Additionally, management at both insurers and brokers will be preoccupied with trying to comply with state regulators while defending their companies from shareholder suits. And all this will occur while they are trying to maintain their competitive industry position. This will prove to be a difficult, costly, time-consuming task.
And then there are the contingent fees themselves. It is going to be difficult for any broker to continue in its current form without contingent commissions. If the $845 million that Marsh made is any indication, contingent commissions apparently are a major part of brokers’ bottom lines. Yet regulatory reform may force a change and that will result in basic structural changes within the industry.
In the final analysis, regardless of how widespread the bid rigging has been, the insurance industry has already lost the trust of the buyers. A policy statement issued early in 2004 by The Risk and Insurance Management Society reads in part, “Because of the complex nature of insurance transactions, a special trust relationship built on a foundation of truth and honesty must exist between broker and client.” In light of recent events, how badly has this foundation crumbled?
The author
Michael J. Moody, MBA, ARM, is a former corporate risk manager with a Fortune 500 company and has experience with a national broker as well. He is the managing director of Strategic Risk Financing, Inc. (SuRF), an independent consulting firm that advances the practice of enterprise risk management. He can be reached at mmoody1222@yahoo.com.