AGENTS BEING SWEPT INTO THE SCANDAL

Rough Notes, Dec 2004 by Zinkewicz, Phil

Contingent commissions may very well be a casualty of the investigation

Some years ago, a young journalism trainee on a New York daily newspaper, anxious to move ahead, asked her editor if she could cover a particular panel discussion at an insurance industry annual meeting taking place in Manhattan. The editor felt that the young reporter was not yet ready for such an assignment, but she persisted and finally he agreed, but on one condition. "Cover the panel discussion, then come back and report on what they said," ordered the editor. "But, if the audience is invited to ask questions, don't get up and ask anything. Just listen to what others ask and make notes." The young reporter promised.

When the young reporter returned, she was visibly upset. Her editor asked her what was wrong. "Well," she answered, "the panel discussion was on the soft insurance market. The insurers on the panel all agreed that excessive competition in the marketplace had driven rates too low for them to make a profit. I know you said not to ask a question, but I couldn't help myself. I got up, went to the microphone and asked why, if they all agreed rates were too low, didn't they get together and agree on the proper prices to charge?" Rolling his eyes to the ceiling, the editor asked what happened next, knowing all too well what the answer would be. "The audience began to laugh," she said. "Small titters at first, but it grew until the entire ballroom was in hysterics."

Obviously, in her haste to demonstrate her newfound self-importance, this young trainee had forgotten for the moment that there were such things as antitrust laws and that price fixing was illegal. A funny story at the time, albeit not for the embarrassed editor.

However, probably very few in the insurance industry would find that story funny today.

The fear and panic that engulfed the entire insurance industry in October when New York Attorney General Eliot Spitzer filed a lawsuit against Marsh & McLennan alleging price-fixing in its business dealings with corporate insurance clients is not going to go away any time soon. Also named in the lawsuit as participants in the alleged price-fixing activities were American International Group, the Bermuda-based ACE Ltd. and The Hartford-industry giants all. In announcing the lawsuit, Spitzer promised that more brokers and insurers would be dragged into his price-fixing scenario, which he called bid-rigging. Basically, Spitzer charged that employees at Marsh would take a corporate account to a "favored" insurer and get an insurance quote. Then, they would go to another insurer and intentionally ask for a quote that was higher than that being offered by the favored insurer to assure that the favored insurer would get the business, with the promise that they would return the favor in the future, according to Spitzer. This would make the client believe that they were enjoying a competitive bid when, in fact, the cost of the coverage had been pre-determined.

Immediately following these allegations, hysteria mounted and industry uncertainty prevailed. Four employees of American Home, a subsidiary of AIG, resigned and pled guilty to "misdemeanors" with the promise that they would become witnesses for Spitzer in the future. Some employees at Marsh were ousted, including the head of its brokerage unit; then Marsh CEO Jeffrey W. Greenberg resigned.

Insurance stock prices dropped and Marsh & McLennan Companies itself suffered a one-day stock decline of 25%. Speculation began to grow that if Spitzer was able to prove his price-fixing allegations, it would be the end of the insurance industry's long-cherished McCarran-Ferguson antitrust exemption, limited though it is. But allegations of price-fixing were only part of the worries that were facing the insurance brokerage industry.

According to Spitzer, in addition to the price-fixing scheme, another alleged broker-insurer abuse was the industry's contingent commission system, a long-held tradition of insurers and brokers, where insurers paid brokers a special commission based on either volume and/or profitability of the brokers' book of business.

It is important to make a clear distinction between bidrigging and contingent commissions, according to Standard & Poor's, one of the rating organizations that is keeping a close eye on the matter. Said Thomas S. Upton, property/casualty ratings team leader at S&P: "It is possible that our current review will reveal that these issues-contingent commissions and bid-rigging-were indeed linked, however loosely, in the operations of some of the affected companies. But, in the first instance, it is essential that they be recognized as distinct issues with entirely different implications."

Upton pointed out that contingent commissions is a practice that has been criticized as compromising a broker's obligation to deliver the best value in insurance to the customer. However, it is not illegal, as is bid-rigging, says Upton. "Indeed, it is well established in insurance broking as a means of rewarding brokers for the qualityand not just the quantity-of the business they bring in. This practice is also known as a placement service agreement (PSA) or market service agreement (MSA)."