COLLATERAL CHAOS

Rough Notes, Mar 2007 by Levy, Emanuel

Bid rigging scandal threatens legitimate contingent commission practice

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.