CFO Magazine

Busting the Brokers

Eliot Spitzer's latest investigation has companies taking a hard look at their insurance programs.

Randy Myers
CFO Magazine

December 1, 2004

New York State Attorney General Eliot Spitzer has already changed the way insurance brokers and companies conduct business with each other. Chances are, his burgeoning investigation of the insurance industry will change the way you do business with them, too.

Insurance has long been a chummy game. Deals may not have been cemented on golf courses as often as they were hammered out across a table, but no one ever argued that insurance wasn't a relationship business. When Spitzer unveiled a civil suit against Marsh & McLennan Cos. on October 14, alleging that the world's largest insurance broker had been cheating clients through bid-rigging and kickback arrangements with insurance companies, he threw a lot of comfortable relationships into question. Now corporate policyholders are being forced to ask hard questions about whether their broker was upholding its legal responsibility to act in their best interest, and whether their insurance program might have been overpriced.

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"You can't ignore this if you're a CFO or law department," says Ann Kramer, a partner in the insurance-recovery group at Anderson Kill & Olick PC in New York. "If a risk manager says, 'I know, love, and trust my broker,' that's not really enough. You have an obligation, whether under the Sarbanes-Oxley Act or your own ethical guidelines, to look into what happened with your account."

Fortune Brands, a $7 billion maker of consumer products, was described as a potential victim in Spitzer's complaint against Marsh, and is among the many companies taking a fresh look at its insurance program. "Fortune Brands works hard to keep insurance costs and all expenses as low as possible, so we're obviously concerned by what we learned," a company spokesman said in October. "We immediately began investigating the matter, and will take the appropriate course of action after we establish the facts."

Spitzer's civil suit spotlighted two types of potentially fraudulent behavior. One was bid-rigging, in which Marsh allegedly solicited or fabricated false, high bids from some insurance companies to ensure that a favored insurer's bid would win a particular piece of business. The other was the practice of accepting "contingent commissions" from insurance companies based not on the underwriting profitability of their book of business (a long-standing practice), but rather on the volume of business the broker was steering their way. The latter practice took root in the 1990s, and is one that Spitzer argues created a conflict of interest for brokers by giving them an incentive to place business with the insurance company paying the largest commission, rather than the one offering the best policy. Within weeks of Spitzer's lawsuit, most of the major insurance brokers had promised to stop accepting contingent commissions entirely. (Marsh, among other actions, replaced the chairman and CEO of its insurance brokerage unit, launched an internal investigation, and promised to implement reforms by January.)

While no one knows yet how widespread bid-rigging might have been — and it was by far the most serious of Spitzer's allegations — volume-based contingent commissions, also known as placement service agreements or market service agreements, were hardly an industry secret. The New York State Insurance Department even reviewed the practice in 1998 and issued a rule requiring the disclosure of such commissions to clients when received in connection with their account. That didn't always happen, though. Surveyed in May by Advisen Ltd., 56 percent of commercial insurance buyers said they did not believe their brokers were disclosing those commissions in all cases, and 69 percent said the commissions were creating a conflict of interest for their brokers.

Second Opinions
Indeed, it's a measure of just how skeptical Corporate America was becoming of the insurance industry that, even prior to Spitzer's lawsuit against Marsh, some large clients of major brokerage firms had begun to hire a second insurance broker to assess the performance of their primary broker. Veteran broker Andrew Marks, president and CEO of MLW Services, says his New York firm has been retained by a number of companies in the past year to perform what he's calling "risk-management forensic audits." In one such case, he says, his firm was able to save the client $400,000 when it discovered that the client's primary broker was seeking to place coverage for a worldwide risk with the London office of a U.S. insurer — in order to earn a commission that it wouldn't have received placing the coverage domestically.

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