VideoLike many risk managers, Dave Hennes eagerly awaited notification about his company's financial slice of the $850 million settlement that insurance broker Marsh reached last January 31 with New York Attorney General Eliot Spitzer. When Hennes, director of risk management at The Toro Co., learned the amount in late May, his jaw dropped. "The number astonished me," he says.
Marsh offered Toro, a Minneapolis-based manufacturer of landscape products with $1.7 billion in 2004 revenue, several hundred thousand dollars. While Hennes declined to divulge the exact amount, the offer far exceeded his expectations. "It tells me that the contingent commissions Marsh received from our insurers had a much bigger influence on how business was being done than we'd ever imagined," he explains.
Other risk managers opening correspondence from Marsh in late May had similar reactions. Janice Chamberlain, senior director of risk management at Costco Wholesale Corp., says she was "pleasantly surprised" to learn that the Issaquah, Washington-based superstore chain with $47.1 billion in 2004 sales, had received a $661,000 offer from Marsh.
But risk managers shouldn't be too happy about refunds of contingent commissions. These are the additional commissions that Marsh, Aon, Willis North America, and other insurance brokers received from insurance companies based on the amount or the profitability of the business the brokers referred to them. Risk managers like to portray themselves as skillful architects who shape coverage based on their organization's appetite for risk. When insurance is too dear or unavailable, they take pride in helping their companies do quite well without it, thank you, by means of self-insurance or captive-insurance subsidiaries.
However, it appears that a fair number of risk managers weren't as independent of the insurance industry — of insurance brokers, in particular — as they should have been. Given the opportunity to have their brokers disclose contingency-fee arrangements with insurers, many risk managers failed to do so.
Unwittingly or not, at least some corporate insurance buyers enabled abuse of their employers by brokers. Risk managers' lack of vigilance gave their brokers a free pass to steer corporate business to insurers who were guided by the fees insurers paid rather than by their clients' needs. At the very least, some risk managers lacked important knowledge of how the coverage they bought for their companies was being priced. All this means CFOs, particularly those of small and midsize companies, may have to review their charges' performance with additional rigor.
Easily Deceived
The contingency-fee controversy came to a head last October, when Eliot Spitzer sued Marsh, the biggest insurance brokerage in the industry, for bid rigging. While contingency fees aren't illegal in themselves, in his complaint Spitzer charged that they "created an improper incentive" for Marsh to maximize profits, sometimes moving brokers to get "fictitious high quotes from insurance companies in order to deceive its clients into believing that true competition had taken place." Without admitting guilt, Marsh settled, issued an apology, and undertook governance changes. Later, Spitzer reached similar settlements with the other two largest brokers, Aon and Willis, for $190 million and $50 million, respectively. In May, another big broker, Arthur J. Gallagher & Co., settled a contingency-fee case with the Illinois Attorney General and the state's director of insurance for $27 million.
Long before the Spitzer investigation, leaders of the Risk and Insurance Management Society (RIMS) had warned members about the fees. In 1998, the prominent trade group already worried about the effect of fees on a broker's motivation for recommending or placing business with particular insurers. It supported the disclosure of all broker compensation arrangements before insurance is bought. In 1999, RIMS struck a deal with Marsh in which the broker would identify — at the client company's request — the client's insurers with which the broker had contingency deals. The risk manager could then estimate the contingency revenue generated by those agreements.
But the risk managers did very little requesting, so they were left in the dark. "Marsh explained to me five years ago what contingent commissions were, and said that they were fairly insignificant," says Toro's Hennes. "So I wasn't too concerned. I figured maybe they were getting less than 5 percent of my premium from insurers as a contingency. I was stunned to find out that in some cases it was nearly as much as full compensation."
Dick Schmidt, director of risk management at Illinois Tool Works, a Glenview, Illinois-based diversified manufacturer of industrial products with $11.7 billion in 2004 revenues, was also taken aback by the number of contingent commissions Marsh received. Its $200,000 settlement offer covered 253 items dating from 2001 through 2004. Says Schmidt, "This was much deeper than I'd imagined, in amounts more than I expected." Adds Costco's Chamberlain: "I never had the feeling we'd been duped, and yet apparently we were."
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