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Eliot Spitzer's investigation of bid-rigging in the insurance industry could dig up deeper questions about whether there's any need for intermediaries in the first place.
David M. Katz, CFO.com | US
November 11, 2004
Do corporate finance executives really need an insurance broker to stand between them and their companies' insurers?
Amid the hubbub surrounding New York Attorney General Eliot Spitzer's probe of bid-rigging and business-steering in the insurance industry, that basic question isn't being asked much — yet.
If the tremors rippling through the insurance-buying community are any indication, however, it soon will be. The cries for disintermediation heard so widely during the go-go '90s are likely to be directed at insurance brokers soon.
The notion that risk managers, who have known about brokers' "contingency fees" for decades, seem genuinely stunned by Spitzer's charges suggests that changes in the way commercial insurance is bought and sold may soon be at hand.
The fees — payments made to brokers by insurers for steering copious amounts of business or very low-risk accounts their way — were already irking corporate insurance buyers in the late 1990s. By then, a wave of mergers had reduced a bevy of brokerage firms into the currently dominant Big Three: Marsh Inc., Aon Corp., and Willis Group Holdings.
That concentration of power spawned fears that a lack of competition would keep the costs of using brokers high. With their increased market clout, the mega-brokers could offer an insurer an impressively big book of business and expect hefty contingency fees in return.
Thus, while brokers protested that getting their corporate clients the cheapest and best coverage was their only reason for being, corporate buyers began to suspect otherwise.
Enter Eliot Spitzer. His charge last month that Marsh got insurers to submit phony bids that "deceived its customers into thinking that true competition had taken place," according to a release issued by his office, went far beyond most risk managers' darkest suspicions.
What's more, the recent disclosure by Marsh's parent company, Marsh & McLennan Cos. (MMC), of how much its business relies on contingency fees was a revelation: In 2003, Marsh's contingency-fee revenue hit $845 million, or 12 percent of MMC's risk and insurance services revenue of $6.9 billion and 7 percent of its total consolidated revenue of $11.6 billion. And MMC also owns Putnam Investments and Mercer Consulting.
To be fair, Spitzer's charges haven't been proved in court. Further, MMC responded to the charges by putting a stop to Marsh's pocketing of contingency fees, installing a new CEO, and instituting a slew of governance changes. Aon and Willis also said they would stop taking fees.
Still, the damage to the big brokers' reputations might be irreparable. Skepticism about whether the firms are acting in their clients' best interest should soon start running high among CFOs. In turn, finance chiefs will turn to the risk managers who report to them and ask the million-dollar question: Is there a way to cut out the middleman?
To do that, corporate insurance buyers would need a whole lot more comparative information about insurance prices, products, and services — facts previously in sole possession of brokers and insurance companies. It's that need that could give a new boost to the kinds of online solutions aimed at bringing buyers and sellers directly together that were so much a part of the Internet bubble.
Web-based transparency alone won't do the trick, however. "Corporate America needs to become more engaged...in the procurement process," says Brent Bannerman, the founder of IE-Engine, an online marketplace that runs auctions of mostly health and welfare benefits coverage along with some sales of workers' compensation and property/casualty insurance. While the portal's corporate subscribers can submit requests for proposals and view any number of bids from participating insurers, they still must choose among those bids.
Indeed, the software, which includes consultants like Watson Wyatt among its users, doesn't delete the middleman. Even if CFOs and risk managers have competing bids in hand, they still must rely on the strategic know-how of a "trusted adviser," Bannerman argues. Most often — since companies don't want to hire someone to do that job — the adviser ends up being the broker or consultant.
In the health and welfare benefits field, however, some buying can be automated. That's especially true when it comes to the service of culling financial and product data, acknowledges Ted Chien, a benefits director at Watson Wyatt, which has linked 100 of its corporate clients to IE-Engine. But the clients still need the consulting firm's analysis of the cost and services being provided, he contends.
For corporations with large property/casualty risks, eliminating the intermediary would be an even stickier wicket. Spitzer acknowledged that in his complaint against Marsh when he stated that the broker "specializes in complex insurance arrangements where all things are rarely equal, and where subjective judgment calls have to be made among competitors with varying coverages, financial security and price."
Up until now, commercial insurance buyers have relied heavily upon brokers in making those subjective judgment calls. Following the erosion of trust sure to stem from the contingency fee scandal, however, buyers will have to find ways to depend more on their own resources.
David Katz's column "Risks and Benefits" appears every other Thursday. Contact him at DavidKatz@cfo.com.