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Where is compensation headed in post-Spitzer era? Aon and USI executives give their views at S&P conference panel By Phil Zinkewicz
Last June, Standard & Poor’s hosted its two-day insurance conference, titled “Insurance 2005: Under the Microscope.” Concurrent sessions centered on life insurance issues, property and casualty insurance issues and reinsurance issues, all with one overriding theme—that every sector of today’s insurance industry is becoming the subject of regulatory and legislative scrutiny, more than ever before. For example, New York Attorney General Eliot Spitzer’s recent investigations into the workings of the major brokers and their relationships with insurance companies in terms of alleged abuse of the contingent commission system and alleged bid rigging have set off a slew of similar investigations by state regulators and congressional legislators. Moreover, his investigations into allegedly improper accounting of a finite reinsurance agreement between General Reinsurance Corp. and American International Group (AIG) and a separate investigation into that matter by the Securities and Exchange Commission have raised serious questions as to whether that product will be allowed to be offered in the future. Led by Thomas Upton, managing director of S&P, panelists at one session of the S&P conference addressed those issues frankly and openly. Steven Ader, director of S&P; Patrick G. Ryan, executive chairman of Aon Corp.; and David Eslick, chairman of USI Holdings, offered opinions as to the future of contingent commissions as a means of further compensating brokers in complicated insurance contracts. Aon, Marsh & McLennan, Willis Group Holdings and Arthur J. Gallagher have all reached settlements to end contingent commissions. Panelist Ryan said that the end of contingent commissions is inevitable throughout the insurance broking system. Ryan argued that the employment of contingent commissions, long held acceptable by state insurance regulators, was a concept known to risk managers of major corporations but not necessarily to treasurers, corporate COOs and corporate CEOs. Furthermore, he said, the size of those contingent commissions was generally not known, and he pointed out that Marsh amassed some hundreds of millions of dollars on an annual basis in contingent commissions. Now that all the publicity surrounding contingent commissions has brought all these things to the forefront, Ryan said the end of contingent commissions is imminent, but he sees that as a good thing in the long run. “The elimination of contingent commissions will level the playing field among all brokers. There will now have to be full disclosure to the client of all fees collected by the broker, the work done for those fees and the value-added services. Secondly,” he said, “the disclosure requirements will take the mystery out of the insurance business.” Eslick, while agreeing that disclosure and transparency are desirable things, took a different view of the possible elimination of contingent commissions. “I don’t know if contingent commissions will disappear or not, but if the concept does disappear, it will be traumatic for regional and local brokers.” Eslick said that there are some 13,000 local and regional brokers competing with each other every day, and they depend upon contingent commissions to supplement their income when insurers cut regular commissions. But both Ryan and Eslick agreed that, whatever the future of contingent commissions, full disclosure of compensation arrangements to the client is essential. Also, both agreed that brokers will survive the possible sunset of the contingent commission era through a combination of higher premium commissions, a broader array of insurance products for their clients, and better alignment of costs and expenses. Director Ader agreed that insurance brokers have made progress in developing a new business model to replace lost contingent commission income. “Overall, the industry has done a good job changing its business model,” he said. Ryan said that higher premium commissions are almost certainly in store for clients as some brokers seek to make up for the lost contingent commission income. “Every broker is negotiating higher commissions, and we are disclosing that to our clients,” Ryan said. He said that carriers had lowered their commissions starting in early 2001 as much as 200 basis points, but with the market now softening, that would change. “And underwriters have generally agreed with us,” he added. Brokers will also have to match more carefully the cost to expenses in the lines they are brokering, the executives agreed. “The key is to segment the business and apply the costs to each segment,” said Ryan. S&P believes this will become increasingly important because there were few costs associated with contingent commissions. It was income that largely went directly to bottom line. “The key will be matching what clients want with the broker’s cost structure,” said Ader. Ader suggested other ways to improve the brokerage business model. In the past it had made sense for some big brokers to go after smaller clients because, in the aggregate, they would unlock volume-based contingent commissions, said Ader. “But now, the small client would be unprofitable, and big brokers might be forced to drop them. That would hurt the big brokers but open up possibilities for the regional brokers,” Ader said. Both Ryan and Eslick rejected outright as uncompetitive the idea of standard industry commissions, instead preferring competitive solutions achieved through fuller disclosure. They cited the end of fixed commissions on Wall Street as an example of how standard rates could distort the market and provide little incentive to meet customer demands. Despite the difficult year insurance brokers have had, both executives believed their positions would be strengthened because of adjustment to their business models and the increasing need for brokers. Risk management has become more complex than ever, Ryan and Eslick agreed; therefore, the need for brokers will intensify, they said. “The role of the advocate is growing,” said Ryan. S&P, at its conference, also addressed the current intense scrutiny of the insurance business in a survey of conference attendees conducted on site. Three-quarters of insurance executives and analysts believe Spitzer’s investigations will help the industry in the long run, according to the survey. “It’s becoming apparent that the costs of fines and settlements will be manageable, so survey respondents are likely looking past the near-term impact toward the benefits of better disclosure by chastened insurance executives,” said S&P’s Managing Director Steve Dreyer. He also said that “despite the distraction of investigations, our audience remains focused on the corrosive effects of weakening pricing and terms on the financial health of insurers.” Of those surveyed, 39% named increasing price competition as the issue that most concerns them. This was also the top issue at last year’s conference, when 33% of respondents named that issue as their top concern. Increasing regulatory risks, cited by 37% of those surveyed, was also a major concern, albeit somewhat contradictory to the overall view that investigations were a net positive. Only 18% of last year’s respondents cited regulatory risk as a concern. Last year’s conference took place before Spitzer’s civil action against Marsh in October. The other issues of concern were terrorism (10%), rapidly rising interest rates (9%) and expensive jury awards (4%). In another panel discussion on issues related to the property and casualty reinsurance industry, panelists Albert Benchimol, executive vice president and chief financial officer of Partner Re Ltd., and James R. Kroner, chief financial officer of Endurance Specialty Holdings Ltd., said that the reinsurance market is softening overall. Following 9/11, they said, reinsurers’ rate increases were in the double digits; by 2003 they were in the single digits; and last year rates flattened. However, they said there are some exceptions in volatiles lines of business such as directors and officers insurance. Without mentioning the controversy surrounding Spitzer’s investigation into the AIG-Gen Re finite reinsurance arrangement in particular, panelists said that there is nothing wrong with the finite reinsurance product. The problem has arisen because of the reporting of that product in specific transactions, the panelists said. However, they added, that if all the negative publicity over finite reinsurance results in the product being withdrawn from the market, it wouldn’t be a problem for primary insurers because they could always return to traditional reinsurance. What panelists feared most was that what they perceived as some “hasty reactions” from regulators towards finite reinsurance might result in other similar products withdrawn from the market. * |
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