VideoFirst came investment banking; then mutual funds; now the insurance industry is mired in scandal, the latest target of Eliot Spitzer, New York's formidable attorney general. On October 14th he filed civil charges against Marsh & McLennan, the world's biggest insurance broker, and announced settlements of criminal charges with two employees at AIG, the world's biggest insurer, and one at ACE, a big property-casualty insurer. The charges are part of an ongoing investigation into industry practices that suggest insurers and brokers have acted collectively (and secretly) to betray customers. An added twist is that the three main companies so far involved are led by members of the Greenberg family: Hank Greenberg is the legendary boss of AIG; his eldest son Jeffrey runs Marsh; and his younger son Evan is in charge at ACE. A business often thought to lack personality and drama is now suffering from an abundance of both.
Mr. Spitzer's civil complaint against Marsh, filed in New York state's Supreme Court, alleges much misbehavior, including fake bids, collusion, improper steering of business, payments by insurers to avoid solicitation of competing quotes, and outright threats against those resisting participation in the fraudulent schemes. Marsh acted, in short, less like a broker with a fiduciary obligation to its clients than as the linchpin of a racket. Proof for the existing charges, Mr. Spitzer contends, is "rock solid". Given the strength of the evidence and the seriousness of the infractions, the main legal conundrum he faced was whether he should file criminal rather than civil charges.
His leniency will be of only marginal solace for the industry. Mr. Spitzer says his investigation into insurance continues to expand, with the only certainty being that he will bring more charges against more people and more companies. So far only two segments of the vast insurance industry have been implicated — the mid-sized sector and so-called excess liability insurance (i.e., the umbrella policies companies buy to top off their core coverage), both prime territory for brokers.
But that looks certain to change. Mr. Spitzer is said to like cases that champion the average person, and he is going after general insurers too. Subpoenas from his office demanding information were reported to have been received this week by Aetna and Cigna (health insurance), MetLife (life insurance), and UnumProvident (disability). Shortly after the complaint against Marsh was disclosed, Aon, the second-largest brokerage firm, put out a statement that only a lawyer could find reassuring: the actions described in the complaint would have violated its own policies and "to the best of our knowledge" were not present at Aon. Mr. Spitzer's office quickly indicated that Aon is being examined with particular interest.
And Mr. Spitzer is not the industry's only legal threat. On October 19th and 20th Connecticut's attorney general sent out dozens of subpoenas to insurers operating in the state in the health, auto and employee-benefit sectors. In May he began investigating claims of widespread price-rigging and kick-backs. California began its own investigation of insurers and insurance brokers this spring. John Garamendi, the state's insurance commissioner, says he will soon bring civil charges against a number of companies, as well as introducing new rules to improve disclosure. Meanwhile, a barrage of private lawsuits has been filed in New York's federal district court, most of them against Marsh for misleading investors.
The embarrassment felt by the insurance industry is acute. But how did the problems arise? Few people outside the industry understand either its structure or how it has evolved in recent years. Essentially brokers are classic middlemen. They stand between companies that want to buy insurance and the insurers that sell it, taking a commission for services rendered. But the broker's job is no longer one of simply finding the lowest price. These days brokers help companies to prepare complex evaluations of their insurance needs, often in many different countries. That task requires knowledge of the insurance providers in each local market, but also a good understanding of local risks. Companies' proposals and risk assessments are used by insurers in making their bids; indeed, without the help of a broker many large companies would be unable to solicit meaningful offers from the big insurers. In effect, brokers serve as corporate advisers and form an important distribution channel for insurers. Since the brokers work for both sides, they have, increasingly, been paid commissions by both.
In their defense, brokers say these arrangements are disclosed to clients, and that, with adequate disclosure, the system can work. Yet disclosure is often vague, at best, and the potential conflicts are glaring. Indeed, Mr. Spitzer has revealed what amounts to gross abuse of the pricing system. Insurers have been offering incentives to brokers in the form of so-called "contingent commissions" — money paid only if the broker places a certain amount of business with a particular insurer.
Contingent Conflicts
Such commissions are generally calculated by the volume of business sent by a broker to an insurer — the more the better, regardless of whether it is in clients' interests. Less commonly, the commissions are based on the insurer's profits. But that can also harm customers, because a broker might choose not to push for a legitimate claim that will reduce the insurer's profits.
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