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The Spitzer Inquiries

 

By Curtis Larsen, Montana State Fund and Cora Butler, Missouri Employers Mutual

Introduction
In October 2004, the insurance industry was roiled by New York Attorney General Eliot Spitzerís charges against Marsh and McLennan, a major United States insurance broker. Mr. Spitzer accused Marsh and McLennan of bid-rigging and conflicts of interest relating to Marshís agreements with insurance carriers. Mr. Spitzerís investigations and charges against Marsh and other brokers called into question the efficacy of long-accepted insurance industry practices. Several other regulators and attorneys general instituted similar investigations against prominent brokers and even several carriers.

This article will examine the nature of the charges filed by Mr. Spitzer and other attorneys general, and the outcomes of those filings. The insurance industryís and regulatorsí response will be outlined. By now, more than a year after Spitzerís initial filing against Marsh, the industry and regulators appear to have settled into a much-needed new way of conducting business that should make for more transparent and acceptable business practices.

Agent-Broker Distinction
Attorney General Spitzerís charges were filed against large insurance brokers, and not insurance agents. Some confusion has existed in the press and among regulators about the nature of the business relationships scrutinized by Spitzer and others. There are fundamental differences in the functions played by brokers and agents in the insurance industry. Since brokers and agents may be involved in insurance transactions between state funds and their customers, a brief description of the differences between brokers and agents is highlighted here.

Many state funds and other insurance carriers utilize the services of independent agents. These agents typically, though not always, act for a carrier under a written appointment by the carrier. The agent may represent several carriers at the same time that have competing lines of business. The agent is considered first and foremost the agent of the carrier, and not of the policyholder customer. Most importantly for this discussion, the agent is paid a commission exclusively by the carrier. These commissions are usually a percentage of premium paid, under a schedule established by each carrier.

Some carriers, including state funds, have established incentive plans for their agents that will pay additional compensation to the agent for meeting certain business targets over a given period of time. These targets may be based on business growth, retention, profitability and other factors.

Insurance brokers, on the other hand, are retained and paid by the policyholder. In most cases, the broker will be considered an agent of, and working for, the policyholder. The brokerís function is to find the best insurance package to fit the needs of the customer. This may not always mean placing coverage with carriers that offer the lowest price. Among other things, brokers tout their established business relationships with insurance industry players, and the enhanced customer service and claims handling that may thereby be obtained.

As the Spitzer investigation brought to light, many major brokers receive compensation not only from their customers, but also from carriers with whom they placed business. These additional sources of compensation may not have been disclosed to the customer in many cases. Since brokers represent the insurance consumer, a separate undisclosed agreement between the broker and carrier has the potential to create a conflict of interest.

These agreements between brokers and carriers carry many names, including placement service agreements, market service agreements, and contingent commission agreements. Brokers claim that these agreements compensated brokers for services provided to the carrier. Spitzer and other investigators were dubious of these claims.

While the agreements between brokers and carriers may take several forms, they have some common elements. The agreements typically compensate the broker for a combination of financial factors attributable to the brokerís book of business with the carrier. These factors typically include some combination of growth, retention and profitability.

The Spitzer Allegations and Outcomes
The Spitzer complaints against brokers alleged that these separate undisclosed fee arrangements between brokers and carriers created conflicts of interest, and caused some brokers to steer customers to carriers that paid the best fees. The large brokers who commanded these arrangements with carriers allegedly had a financial incentive to place their customersí insurance business with the carrier that offered the best contingent commission return, rather than the carrier that presented the best deal for the customer.

As part of a concerted effort to enhance their return from these contingent commission arrangements, some brokers apparently engaged in suspect quote- or bid-rigging practices with some carriersí underwriters. These bid-rigging practices included using strong-arm tactics to extract phony and artificially high quotes from these inside underwriters in order to create an illusion for the customer that the broker was soliciting competitive quotes from several carriers.

Mr. Spitzer and other statesí attorneys general charged several major brokers; the most prominent of which was Marsh and McLennan. Marsh agreed to refunds to customers of $850 million of contingent commissions received, to give up completely contingent commissions, and to make certain management changes.

Spitzer reached other significant settlement agreements with Aon and Willis. The Illinois and Connecticut Attorneys General entered into similar settlement agreements with Gallagher and Hilb, Rogal and Hobbs, respectively. Several private lawsuits have been filed, none of which have gone to trial.

In addition to these actions, several statesí insurance departments opened investigations and filed litigation. In addition, insurance departments around the country sent letters of inquiry to carriers and brokers. Many AASCIF members received these letters of inquiry. They asked carriers and brokers to disclose ďinappropriate solicitation activities.Ē To date, no significant administrative action appears to have resulted from these inquiries.

Mr. Spitzer believed that secret contingent commission arrangements were widespread in the insurance industry, saying, ďThese hidden payments drive the insurance business as a whole.Ē This assertion paints with a broad brush, of course. It fails to recognize the distinction between the roles of independent insurance agents, which many carriers use as their primary means of distribution, and brokers. Agents are hired and paid only by carriers. Many state funds use the services of insurance agents for this purpose. While carriers accept placements from brokers, these brokers also play an important role in the insurance industry.

The industry and regulators have concluded that the problems revealed by Spitzer and others can be alleviated through some straightforward changes in business practices and procedures.

Industry Response
All segments of the industry were quick to respond to the furor created by Spitzerís sweeping allegations of improper compensation practices in the insurance industry. The recurrent theme across the industry trade organizations, which included among others The Council of Insurance Agents & Brokers (CIAB), Independent Insurance Agents & Brokers of America (IIABA), and the American Insurance Association (AIA), was that there should be: (1) transparency and prior disclosure with regard to total payment arrangements; (2) uniformity in inquiries made by state regulators; (3) regulatory clarity and standardization across jurisdictions; and (4) recognition that compensation practices that legitimately reimburse additional services provided by the producer to the carrier benefit all parties to the transaction.

The IIABA, which represents many of the independent agents placing business with various AASCIF members, recommended the following disclosures be made by insurers where the policy is placed by an independent insurance agent:

  • Insurance policy was placed by an independent agent not an employee of the company.
  • The insurer believes the use of independent agents and brokers is an efficient and effective way to distribute its policies.
  • The agent or broker placing the policy may receive commission for that placement.
  • Where profitable volume or other such measures are a part of the compensation scheme, that the agent or broker placing the policy may receive additional compensation on the basis of such measures.
  • Questions about the nature of the compensation should be directed to the agent or broker placing the business.

Regulatory Response
Legislation modeled after either the Compensation Disclosure Amendment to the Producer Licensing Model Act adopted in December 2004 by the National Association of Insurance Commissioners (NAIC) or The Producer Compensation Disclosure Model adopted in March of 2005 by the National Conference of Insurance Legislators (NCOIL) made its way through several state houses during 2005. Included among the states considering or adopting new producer compensation regulation were several AASCIF member states such as California, New York, Texas and Rhode Island.

Here again, both models had continuing themes, which primarily focused on controlling self-dealing and conflict of interest. The approach generally used by the regulators was to require that an insurance producer or affiliate who receives compensation from the customer, as well as the insurer, for the placement of insurance be required, prior to the placement, to obtain the customerís documented acknowledgment that the producer or affiliate will receive compensation from the insurer. That disclosure is either to include the amount of such compensation, or if the amount is unknown, the specific method of calculation to be used is to be revealed and, if possible, a reasonable estimate of the amount.

Hilb Rogal and Hobbs (HRH) adopted as a part of their business reforms following settlement with the Connecticut Attorney General over compensation practices a Customer Bill of Rights to be followed when they are acting as an insurance agency. The HRH Agency Customer Bill of Rights given to agency customers seems to embody the principles in the NAIC and NCOIL models, and includes the following:

  • The insurance agency represents insurance companies and is paid by them for selling insurance to customers.
  • The customer has the right to know all fees and commissions that will be earned on the sale of the insurance policy.
  • The insurance company may pay agency additional amounts, based on factors such as the number of policies placed or renewed, the amount of premium paid, or the loss histories of customers.
  • Commissions are built into the cost of insurance.
  • The insurance agency may receive other compensation for the placement of business from other intermediaries, such as wholesalers or premium finance companies.
  • The agency may earn interest on premiums before paying premium to the insurer.
  • If the client requests, the names of insurers who competed for the business and the prices they offered or if they declined to quote is to be provided.

Summary
In the 15 months following the tempest created by New York Attorney General Eliot Spitzerís sweeping allegations, a survey conducted among more than 500 corporations and government entities found that almost half of the buyers who participated in the survey had become more wary in their insurance transactions. According to the survey conducted by Advisen, Ltd., many buyers reported implementation of heightened standards related to their insurance bids.

Many insurance purchasers have implemented the practice of splitting the larger program between several brokers, according to the report. Others are, according to the report, requiring proof that their insurance was competitively bid or reviewing quotes with the insurers themselves. In general, the buyers of insurance queried in this survey were looking for more effective communication with regard to their insurance transactions.

With the transparency of business practices created by full disclosure, insurance purchasers and their brokers should be able to avoid the conflicts that Mr. Spitzer found so troubling. The insurance industry and state regulators have met the challenges brought forth by Mr. Spitzer and others.

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