Eliot Spitzer, Neelie Kroes and now Connecticut AG Richard Blumenthal have made life less than easy for brokers. Nick Thorpe examines what their investigations mean for the industry and asks how brokers will be paid in the future.

14 October 2004. It was on this date that the insurance broking community was shaken to its very foundations and made to answer some very uncomfortable fundamental questions about the way the industry worked. It was on this day that Eliot Spitzer, then attorney general of New York State, announced his intention to sue Marsh & McLennan Companies following an investigation into fraud and anticompetitive practices in the insurance sector.

Two years on and several multi-million dollar settlements later, the larger global brokers have diversified their business plans and contingent commissions has become a very dirty word.

Just when it seemed safe for brokers to breathe easily again, European Commissioner for Competition Neelie Kroes announced the findings from the largest-ever investigation into business insurance in Europe. The results were troubling: European businesses could be paying too much for insurance due to anti-competitive practices. To cap it all off, some brokers have controversially announced the reintroduction of commission payments. So what do these developments mean for the industry and will brokers ever find an acceptable way of getting paid?

The day the world changed

“The insurance market fundamentally changed on 14 October 2004,” says Guy Bessis, managing principal of international insurance and reinsurance at broker Integro. “That investigation turned the industry on its head and it hasn’t really been the same since.”

Eliot Spitzer took issue with a particular form of commission payments – contingent commissions – that are structured in such a way that the insurers compete for business from the broker based on the commission fee, rather than by offering the best price for the broker’s client. This, Spitzer argued, could influence brokers to pass business on to those insurers who pay the highest commission fees, rather than those who are offering the most competitive coverage.

Having levelled bid-rigging and price fixing charges against Marsh and named and shamed numerous other broking behemoths, the settlements started rolling in. Marsh eventually settled for $850m, Aon for $190m and Willis for $51m. None admitted liability, most issued apologies but all abolished contingent commissions. Marsh went as far as to promise to adopt greater transparency initiatives so as to limit the conflicts of interest between its brokers and its clients. The lawsuits hit brokers hard – Marsh cut 3,000 jobs across the company, share prices at all three broking houses nosedived and bottom lines suffered heavily.

It took two years and major internal reorganisations at the “Big Three” brokers (Marsh, Willis & Aon) to recover from these setbacks. In the process, both Aon and Marsh attempted to reinvent themselves as risk consultancies. This was a move that provided a huge opportunity, according to Aon Global Risk Consulting’s CEO Stephen Cross (speaking to GR earlier this year). “Intellectually it could be at least as challenging as the broking side because risk is a constant, it will always be there. Broking, meanwhile, tends to be more cyclical – an event happens, the market dries up, a new entrant comes in and so on. Companies will always have a fluid risk profile to attend to and I can see a considerable market opportunity.”

At the time of going to press, Standard & Poor’s had shed doubt on the success of Marsh’s efforts by downgrading its parent company MMC to “BBB-” from “BBB”, reflecting the “many challenges” it faces in coming years.

Brussels on a mission

“Two years on and several multi-million dollar settlements later, the larger global brokers have diversified their business plans and contingent commissions has become a very dirty word

27 September 2007. The broking world is faced with yet another significant challenge as Neelie Kroes publishes the findings from her department’s investigation into business insurance in Europe. Among its other findings, which include questions surrounding lack of competition in the subscription market, the sector inquiry reopened the debate surrounding broker transparency and disclosure.

The Commission concludes that the lack of transparency surrounding broker remuneration meant customers were unable to make fully informed choices. It says that even where attempts were made to disclose information; it did not appear to be “clear, complete or understandable”. The extent to which brokers spontaneously disclose information was also found to vary enormously between countries and brokers themselves (see figure 1).

The inquiry, which polled various players in the European insurance industry in 2005-2006, states that: “The majority of respondents in the public consultation considered that transparency was essential in managing conflicts of interest, and that insurance intermediaries had to provide clients with sufficient information to make informed choices.”

At the heart of the matter is not whether brokers are accepting illegal fees or contingent commissions, but rather if they are being transparent about their fees. Respondents to the investigation seemed to agree that the current market environment did not go far enough in protecting the brokers’ clients and in creating a fair and level playing field for insurers. According to the report, lack of transparency inhibits “true competition”.

“Disclosure is what people seem to want,” says one broking source who wished to remain anonymous. “But meaningful disclosure has to happen if the playing field is to be level for everyone. There is definitely a momentum building towards greater transparency but the problem is you simply cannot accept contingent commissions and be transparent.” The contingent commission question has surfaced again as the EC inquiry report pointed out that commission rates were “very high” (sometimes up to 40% of the premium) in some classes of business and that small brokers across Europe were still widely accepting the disputed payments.

Whereas Spitzer was of the opinion that disclosure would be sufficient, the EC investigation seems to insinuate it would not. Calling the existing disclosure rules “insufficient” and “too vague”, the report calls for full disclosure, including “all relevant information, including full broker earnings related to the business placed, but also for instance, details of facultative reinsurance”. Clear standards for disclosure are necessary to achieve transparency, it says, as brokers otherwise might provide information in such a way that clients would not be able to draw meaningful conclusions on the potential for conflicts of interest.

This was further clarified at a teleconference in November organised by legal firm Steptoe & Johnson. When asked if it was just pricing that the inquiry was interested in, Christoph Emsbach, from the Directorate General for Competition at the EC, indicated they were also concerned with “cosiness” between insurers and brokers.

The concern arises from the tendency for brokers to act as advisers to clients as well as a distribution channel for insurance companies. There could, the inquiry argued, be a conflict of interest arising from this dual role. “The brokers’ objectivity could be affected by its own commercial incentives and this could weaken competition in the insurance market place” comments a report by DLA Piper.

Not over yet

In the midst of the EC enquiry, more allegations have surfaced in the US about supposed violations of antitrust laws. This time it is Connecticut’s attorney general Richard Blumenthal who is suing Guy Carpenter, claiming the reinsurance broker conspired with reinsurers to fix prices and eliminate competition, both of which would violate Connecticut’s antitrust and unfair trade practices acts.

“The concern arises from the tendency for brokers to act as advisers to clients as well as a distribution channel for insurance companies

“We are drawing back a cloak of secrecy that has existed for years on industry practices that damage consumers by raising the amounts they paid to insurance companies, since those insurance companies have to pay higher amounts to the reinsurers,” Blumenthal said in a statement, adding that: “Guy Carpenter orchestrated separate conspiracies over decades to overcharge those insurance companies to the benefit of the reinsurance companies that cooperated and to itself.”

Guy Carpenter was quick to defend itself, alleging the lawsuit demonstrated a “fundamental misunderstanding of reinsurance facilities that have been in operation for the benefit of small and midsized clients for as long as 50 years.”

The attorney general has indicated he expects his investigation to lead to new federal and/or state laws. Whether Blumenthal will prove to be another Spitzer is questionable. Research quickly reveals he has a chequered history. In a report by thinktank Counsel for Special Projects at the Competitive Enterprise Institute, Hans Bader wrote, “The nation’s worst state attorney general is Richard Blumenthal, a tireless crusader for growing the power of his own office and spreading largesse to his cronies.”

New challenges

At the time of writing, there was one more twist to the story emerging. Gallagher London, the London branch of Arthur J Gallagher & Co, revealed in November that it has approached clients over plans to introduce an additional 1.5% commission fee for placing business in the London market. According to various reports, a spokesperson for the company said the commission was “fair” and a legitimate attempt to restore the “balance of earnings”.

The move comes after similar plans from Marsh and Willis, both of which are now seeking a 2.5% levy from insurers. Joe Plumeri, chairman and CEO of Willis, commented on the matter: “The UK market has been paying a 2.5% brokerage on fee accounts. It creates an unlevel playing field if some take it and others don’t. It allows our competitors to offer reduced fees to clients. If the brokerage commission was available to our clients, it didn’t make sense to us to leave it in insurers’ hands. We had to reconcile those issues against the backdrop of our principles. In our case, this is beyond transparency.”

Plumeri went on to say that the charge had been introduced in the UK and not the US because in the UK brokers are responsible for the wordings in contracts and the claims processing, both of which mean added costs. Clearly aware of the likely controversy surrounding such a decision, Plumeri was also at pains to distance the fees from contingent commissions. “This has nothing to do with supplemental or contingent pay or anything else,” he said. “It’s Willis’ 2.5% based upon our principles and that’s the reason why we’re doing it.”

A statement from Marsh confirmed the same thing, emphasising that “Marsh’s decision to charge a uniform 2.5% brokerage is fully transparent and disclosed to clients as part of their total cost of risk.”

It is fair to say that brokers are facing unprecedented levels of change as we enter a new year. The entire broking model is being re-evaluated and realigned in response to a tougher stance on anti-competitive practices. All eyes are now on the European Commission. Its enquiry could have far deeper and wide-ranging affects than Spitzer’s as the body delves into inner workings of brokers and examines if the European business insurance market is inherently anti-competitive. Most seem to accept that transparency and disclosure is now inevitable. Whether brokers will take it upon themselves to act now or wait for disclosure to be forced on them by the regulators will soon become apparent.