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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.
"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.
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.
In time, such incidents may prove to have been more commonplace than most insurance buyers might have thought possible. Kramer, for example, observed in late October that a number of Anderson Kill's clients had been coming to the firm with questionable details about their insurance programs in the wake of Spitzer's lawsuit. "I can't believe they're isolated, and I don't think it's nothing," she says. Marks notes that in another audit assignment he's just undertaken, the client's broker had divided the company's $50 million in directors' and officers' liability insurance among five different carriers. "Now if you know the D&O market, you know the major carriers, the better carriers, can put out paper for at least $25 million of coverage," he says. "So the question I have to ask of the broker is, why do we have five carriers? One answer, which I'll not get from them, is that they are just trying to feed their five carriers rather than put the business with one carrier or the other for the best possible deal."
Second opinions don't come cheap but might be justified, given the potential savings. Marks says his firm might charge about 10 percent of the primary broker's income, which in turn might represent about 1 percent of the insurance premium. Companies that are not prepared to hire a risk-management consultant or a second broker, though, can still take measures to better their chance of getting insurance coverage that's been properly placed and priced: they can insist on meeting with their broker for assurances they weren't overcharged, for example, and to see evidence that controls have been put in place to assure pricing transparency going forward.
Meanwhile, if contingent commissions truly created a conflict of interest for brokers between their clients and their insurance carriers, companies might wonder whether it made sense for their brokers to be negotiating their claims settlements with insurers in years past. In the view of claims-management consultant Rick Sabetta, managing principal at Risk Navigation Group LLC in Mendham, New Jersey, there's little chance that doing so resulted in companies winning smaller settlements. In fact, he says, odds are the reverse was true. "Most account executives so covet their client base that they will do whatever it takes to retain their clients — especially their big clients," says Sabetta. That includes leveraging the broker's relationship with its insurance carriers to try to negotiate a better settlement on their clients' behalf.
Ironically, the increased levels of skepticism resulting from Spitzer's investigation ultimately could lead risk managers to put even more faith in their brokers, says Richard Betterley, president of Betterley Risk Consultants. Because they are likely to be less trustful of the industry in general, he says, insurance buyers may become even more loyal to brokers that can earn their trust. "In some ways," says Betterley, "it may become even more of a personal relationship business."
Randy Myers is a contributing editor of CFO.
Following the Money
Apart from individual instances of bid-rigging, it may never be possible to know just how much the insurance shenanigans alleged by New York State Attorney General Eliot Spitzer might have cost corporate policyholders. In part, that's because the value of an insurance policy is determined not just by its price but also by a range of ancillary factors, including the strength of the insurer, its claims-handling ability, and the breadth of its coverage. "On any given day, for many lines of insurance at any given company, you can probably find a lower bid than that which is on the table, because there are so many carriers willing to bid," observes Peter Rousmaniere, an independent risk and insurance consultant in Woodstock, Vermont.
Too, the use of the contingent commissions denounced by Spitzer had become so widespread that it's difficult to gauge the degree to which they might have stifled competition. Property-and-casualty insurers in the United States paid out $3.7 billion that way last year, according to securities analysts at Morgan Stanley, an amount equal to 1 percent of industry premiums. "Even when this industry ran more like a cartel, before there were antitrust laws and before it was considered interstate trade, people competed," says David Schiff, editor of the iconoclastic Schiff's Insurance Observer and a frequent industry critic. "It's too big a marketplace to really, really rig."
Although Marsh & McLennan Cos. and the nation's other big insurance brokers pledged to stop taking contingent commissions in the weeks after Spitzer filed his lawsuit, insurance experts say corporate buyers shouldn't expect a dollar-for-dollar reduction in their costs as a consequence. More likely, they say, brokers will offset their lost income by charging higher fees or by negotiating higher regular commissions from insurance companies on the policies they sell. What corporate buyers can expect, industry observers agree, is greater pricing transparency, already promised by Marsh and other big brokers. Frank Borelli, who retired as CFO of Marsh at the end of 1999, says buyers must insist that they be told exactly which insurance companies their brokers have solicited; how the resulting proposals differed; and why, after analyzing them, their brokers recommended a particular insurer. —R.M.