What does 2009 hold for the
insurance industry?

Contingent commissions victory and continuing
Fed regulation of insurance industry shape the markets

By Phil Zinkewicz

While last year was not a red letter one for the investment community or for the overall economy, the insurance industry fared pretty well, at least in the eyes of agency groups. Okay, American International Group (AIG) had to be bailed out by the federal government for a few [billion] dollars; but that had nothing to do with its insurance subsidiaries, which have been performing fairly well, according to the various rating organizations. Moreover, agents have won some significant legislative victories over the year. One, in particular, stands out.

In June 2008, the 1st Appellate Division of the New York Supreme Court found that contingent commission agreements are not illegal. Calling the decision a “resounding victory” for Main Street insurance agents, Kenneth R. Auerbach, Esq., president of the National Association of Professional Insurance Agents (PIA National), says it was also a vindication of the actions taken by PIA to turn back the attacks on a compensation system that has always been legal and ethical, despite former New York State Governor Eliot Spitzer’s assertions to the contrary.

The court’s action—throwing out all claims relating to contingent commission agreements—came in a case that stemmed from a May 2006 fraud and bid-rigging suit originally filed against Liberty Mutual by Spitzer when he was New York state attorney general. While other insurers and mega-brokers faced investigations of similar allegations since 2004 and opted to settle with Spitzer, Liberty Mutual vowed to fight the allegations in court. Some of the settlements banned the payment of contingent commissions, while others mandated the use of a disclosure form that was “legally flawed” and would place agents at risk of errors and omissions claims, according to Auerbach.

“Contingent commission agreements between brokers and insurers are not illegal and, in the absence of a special relationship between the parties, defendants had no duty to disclose the existence of the contingent commission agreement,” the court said in its ruling. Several other court decisions in 2007 also found to be baseless allegations that carriers’ contingent compensation programs constituted a conflict of interest and are illegal.

“This marks the end of the Spitzer era,” says Auerbach. “Common sense is finally beginning to prevail. The court has stated unequivocally that being compensated with commission, contingent or otherwise, is neither illegal nor unethical and has thrown out as baseless all claims to the contrary. We are hopeful that the certainty of this ruling will serve to deter any further attempts by ambitious and misguided state attorneys general from targeting the legal compensation of those who never engaged in wrongdoing.”

Auerbach says that PIA National will work diligently this year to educate policymakers in other district attorneys’ offices as to the legality of contingent commissions.

Meanwhile, agents associations also see the new year as one in which the attempts on the part of some to bring about federal supremacy over states in the regulation of insurance will continue. Furthermore, Auerbach believes that proponents of federal regulation of insurance are using the current financial services crisis to further their cause.

“The advocates of federal regulation of insurance are perversely pointing to the one financial services sector that has largely been insulated from the worst of the financial carnage—insurance—and saying that the market meltdown proves that insurance should be federally regulated,” says Auerbach.

“In fact, this economic crisis proves that insurance should not be brought into the federal system that has failed so miserably in its supervision of banking and securities,” he continues. “As our friends at the National Conference of Insurance Legislators (NCOIL) aptly suggest, the state insurance regulatory system should serve as a model for reforms to the federal regulatory system for banks and securities, not vice-versa.”

Charles Symington, senior vice president of government affairs for the Independent Insurance Agents and Brokers of America (IIABA), believes that those in favor of federal regulation of insurance in the form of the optional charter approach will lose ground in the coming year. “We want to maintain the state regulatory structure,” he says.

That, however, doesn’t mean that there isn’t a role for the federal government in insurance, Symington maintains. “We have supported uniform guidelines for agents’ licensing in the surplus lines arena,” he says. “The flood insurance program expires in early March. We would like to see some reforms in this program, but there isn’t really time. Right now we have to push for an extension. In addition, we’d like to see some sort of federal backstop for insurers following natural disasters. Finally, we’re hoping for some tax relief for small business owners in the year ahead.”

Chris Suchar, executive vice president of professional services North America at DFA Capital Management, says the AIG situation demonstrates the need for companies to practice enterprise risk manage-ment (ERM). “Not only AIG, but look at companies such as XL and The Hartford,” says Suchar. “The property and casualty side of those businesses are doing well, but they’ve been hurt by other elements of the organizations. P-C companies are being hurt by risks they’re not even aware of. Diversification is not necessarily a good thing if management is not aware of how different elements of a corporation affect each other.”

Bart Hedges, president and chief underwriting officer of Greenlight Re, based in the Cayman Islands, discussed the current soft market, saying that there could be a turnaround in 2009. “The crisis in the financial services market has grabbed all the headlines, but we have to remember that Hurricanes Ike and Gustav were pretty big events. Ike was the third largest insurance event ever, after Hurricanes Andrew and Katrina. I think that the property market will harden considerably in 2009.”

Global insurance broker Lockton recently released a market update taking a more cautious view, albeit positive, of potential market changes. “While it is not clear that prices will harden, pressures are looming in the property and casualty insurance market,” says the update. “In the first half of 2008, insurer profits declined 57%; the industry posted its worst first-half year underwriting performance since 2002; investment returns declined by 18% and net written premiums for the industry as a whole were stagnant. Catastrophe losses were double the average of the past decade.”

Highlights of the Lockton market update include:

• Executive Risks—Rodger Laurite, Lockton senior vice president in Atlanta, says that securities lawsuits are on the rise once more. “Continued volatility in the financial markets could mean that litigation levels will continue to rise,” he says. “Even though the D&O market has been soft for most buyers, we recommend that clients use this time to prepare for their upcoming renewals. It is important that clients take steps to differentiate themselves so that they avoid being lumped in unfairly with their peers.”

• Energy—“The energy insurance market, offshore and onshore, continues in a soft phase although there are signs that rating levels are flattening out,” says Peter Leahy, Lockton managing director of global risks in London. “Other indicators point towards the first signs of a tightening market in specific areas.”

• Property—“The repercussions from the big hurricane losses and the meltdown in the financial markets are just beginning to be felt in the property insurance market,” says Jim Rubel, Lockton executive vice president in the property insurance market. “Insurance buyers should prepare themselves for a period of uncertainty and volatility in the property insurance market,” he says.