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To The Point Collateral Chaos Bid rigging scandal threatens legitimate contingent commission practice By Emanuel Levy The turmoil triggered by the 2004 investigation by New York Attorney General (now Governor) Eliot Spitzer of the allegedly fraudulent machinations within the nation’s four mega insurance brokerage firms, with the complicity of some insurers, is not going away anytime soon. Unfortunately, the multi-state fallout is endangering the vital services offered to insureds and the legitimate income of Main Street (and beyond) insurance brokers and agents. It must be viewed as a serious threat. The irony is that those engaged in the scam that involved deliberate falsification of rates covering excess liability coverages appear to have been absolved, although the cost was high. For example, Marsh & McLennan, seemingly the most prolific actor in the complex scheme described as “bid rigging,” escaped any formal criminal involvement by agreeing to set aside $850 million as restitution for insureds deprived of lower rates. The other brokerage firms and some insurance companies entered their own agreements earmarking designated restitution funds so that the total well exceeds $1 billion. Despite specific language in the agreements between the attorneys general, it is less than clear how these amounts were calculated and it is not clear, either, at this time, how, when and if they were distributed to the aggrieved customers. In a 47-page agreement dated December 21, 2006, entered by the Chubb Corporation and the attorneys general of New York, Connecticut and Illinois, Chubb was required to calculate by February 15, 2007, using a formula set out in the agreement, the amount to which each excess casualty policyholder was entitled. This covered purchases (including renewals) of insurance from January 1, 2000, through September 30, 2004. The calculations, including details about the policyholders, had to be certified to the attorneys general. Bid rigging mystery Even more mystifying is the technique of “bid rigging.” Many employees of each of the insurers had to be involved so that each of the participating conspirators got their “fair” share of the higher bids. But while the investigators uncovered various documents revealing a variety of deceptions, apparently there was no evidence of how sharing records were kept. There is also evidence about other types of manipulation. Puzzlement is the name of the game. In the July 18, 2005, issue of IndustryFocus, a supplement to Business Insurance, writer Rodd Zolkos reported a comment by Thomas Player, partner and chairman of the insurance group at the Atlanta law firm of Morris Manning & Martin L.L.P. Player, observing that “bid rigging is a problem,” added: “I’ve been in the business a long time, and I can’t imagine large brokerage firms and large insurers doing that.” One thing appears to be certain: that in the “bid rigging” instances, the risks had to be a single class of business, and in this instance it was evidently excess casualty. The American Insurance Association, in its publication AIA Advocate, dated June 7, 2005, referencing the “abusive brokering practices,” said that the public interest was heightened in how insurance coverage is found for highly complex risks, such as large commercial lines customers, and that this has raised questions about the process. The AIA Advocate cites the observation of two “renowned scholars” from the Wharton School (of the University of Pennsylvania), Professor J. David Cummins and Neal A. Doherty, who in their book The Economics of Insurance Intermediaries, emphasize the critical role intermediaries play “in making certain areas of the insurance marketplace workable and efficient.” All this is hardly news to readers of Rough Notes. But the complexity of the process creates a high degree of dismay as to how the “bid rigging” scam could be carried out with so many players, over such a relatively protracted period and involving so many dollars. Here is a quotation from the AIA Advocate that makes the scam so confounding. “Buyers [insureds] must determine the full range of risks their businesses face and the coverage that is needed to address those risks. The buyers must then compare policies of disparate price and coverage from insurers of varying credit risks and reputation in the face of the overwhelming array of options; even the most experienced risk managers look to commercial insurance brokers and independent agents for assistance.” Under these circumstances, how was it possible for the “bid rigging” and other anti-competitive devices to go undetected by so many risk managers? If the “bid rigging” scandal was the be-all and end-all of this disaster, it would by now be settling into the industry lore; and life in the insurance business would go on with the punishment and preventive measures closing the chapter. Unfortunately, Spitzer and the other officials opened floodgates through either inadvertence or mindless regulatory convenience, by describing the money (tribute) paid to the brokerage firms by the insurers as “contingent commissions.” In truth they were nothing of the sort, not even close, because they were evidently quid pro quo and had nothing to do with annual calculations of insurer profit sharing based on designated services. What’s more, these mega brokers were working on fee arrangements with their clients while double dealing with company kickbacks, to the financial detriment of their clients. Overreaction? But attorneys general as well as some regulators and legislators have now questioned and even condemned the time-honored contingent commission concept and are attempting to outlaw its use or burden it with unwarranted limitations. In some instances, as has been widely reported, attorneys general are demanding that insurance companies cease payment of such commissions and even to agree to support legislation that would restrict or outlaw such arrangements. This is really beyond the authority of these officials and an abridgement of the freedom of contract. In virtually every instance, insurers describe the requirements that must be met by their brokers or agents in order to earn added income on their overall accounts and not on individual sales. Here, too, the agents and brokers have either contracts or agreements with their insurers, calling for specific accomplishments and results over a stated period, for which they will receive added income. The arrangement is not dependent solely on volume of business but usually includes a variety of client services, operating methods and the profitability of the account. The state officials should be aware of the history and procedures of the business before putting the practice of contingent commissions into jeopardy. The extent of the challenge is not theoretical. A significant number of newspaper stories make that clear. For example, an AP report in mid-January gave some details of the action by Connecticut Attorney General Richard Blumenthal, who ordered insurance companies to stop paying “contingent commissions” to brokers and agents for steering business to them. He was reflecting the overall pact entered by St. Paul Travelers, ACE of Bermuda, American International Group (AIG) and Zurich, with the attorney general of his state as well as those of New York and Illinois. The insurers bent over backward to accept the restraints and Blumenthal said, according to the AP story, that “contingent fees will eventually disappear as Travelers and other insurers abandon the practice.” This constitutes broad interference with the operation of the insurance business from state agencies that are not regulators or legislators. AGs in at least 10 other states have acted similarly without examining the subject, holding hearings to understand the issue, or examining the impact on the business or the buying public. They failed to clearly distinguish the “bid rigging” customer allocation (steering) of risks, a quid pro quo device by mega producers who were double dipping, from the profit-sharing contracts that have never before been challenged by regulators, other agencies of government or the public. The demand for this action of the AGs introduces a new element of oversight, and its success may enable the intrusion of this extra-regulatory process into legitimate business enterprises without the color of law. The AGs, of course, have all the authority and obligation to investigate and punish fraud and other improprieties, but not to go beyond and upset legitimate business practices. That was clearly stated in the midst of the debate by Len Brevik, executive vice president and CEO of the National Association of Professional Insurance Agents. Referring to one of the strong-armed settlements by New York, Connecticut and Illinois involving Zurich American, Brevik said: “Regrettably, this settlement agreement, and others like it, attempts to create a remedy for alleged wrongdoing and then impose it on those who were not involved in any wrongdoing.” Transparency required The remedy proposes mandating that all brokers and agents adopt transparency procedures to disclose to their customers the details of their contractual arrangements and goals and go as far as the banning of contingency commissions entirely. Some if not all of the mega brokers have already agreed to end acceptance of contingent commissions. That’s simplistic, however, because Marsh’s agreement relating to the placement, renewal or servicing of its insureds’ risks states that it will accept a specific fee from the insured or a specific commission from the insurance company or both but only after binding is completed, except where there is advance written approval by the parties. Individual agreements were made with each of the mega firms. But whatever the mega brokers work out with the authorities, it should not invade the rights of other brokers and agents. The National Association of Insurance Commissioners early in 2005 adopted amendments to its Producer Licensing Model Act to address transparency and producer disclosure of compensation. If these amendments are to have any effect, they will have to be enacted by individual states. And here is where the industry as a whole must stand firmly against the attempt to limit the legal rights to engage in sound business practices, which already include a large degree of transparency. At least one state insurance commissioner has already made it clear that the position expressed by the attorneys general is not acceptable. As of the beginning of 2007, legislation was pending in about a half dozen states, but not much progress had been made. One insurance commissioner, Susan Cogswell of Connecticut, warned independent agents and brokers of pending legislation. She also was critical of the agreements among the attorneys general and the insurers, asserting that they infringed on public policy. She also said that the majority of state insurance commissioners are opposed to the actions of NAIC in seeking further disclosure. On the positive side is the solidarity of the independent agents and brokers in preparing to preserve the rights of legitimate compensation. Here are a few examples: Robert A. Rusbuldt, CEO of the Independent Insurance Agents and Brokers Association, said: “Insurance companies recognize that agents and brokers must invest substantial time to identify consumers’ wants and needs; understand the complex terms of policies available; assess the products to present; offer choices about coverage, price, service and financial strength of carriers and remain available to assist insureds with questions and policy changes, as needed.” Ellen D. Kiehl, Ph.D., CAE, assistant executive director of the PIA of New York, New Jersey, Connecticut and New Hampshire, in a special report released in January 2007, pledged that PIA would “work to defend legal compensation arrangements and prevent unreasonable demands from being placed on members.” The American Insurance Association (AIA) refuting a 2005 report issued by the Consumer Federation of America, said: “Put simply, there is no evidence to support CFA’s illogical leap to the conclusion that personal lines consumers have been significantly affected, much less harmed, by the use of contingent commissions. The CFA report fails to appreciate the self-regulating nature of competitive dynamics that have built-in checks on marketplace conduct.” AIA also noted that periodic surveys by the Insurance Research Council confirm that 97% of homeowners insurance customers and 96% of auto insurance customers are satisfied with their insurers. The independent insurance agents and brokers industry must stand firm to protect the integrity of its compensation. * |
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