Since Spitzer turned his focus squarely on the insurance industry last year there have been high-profile job losses, guilty pleas and sizable settlements But Liberty Mutual is not taking it lying down, explains Mairi Mallon.

Liberty Mutual Group has come out guns blazing against the US attorneys general who have been hounding the insurance industry for the past two years. As a company that is not listed, it does not have to worry about plummeting share prices, antsy shareholders or even analysts having a pop. Instead of paying out huge sums in compensation, it has decided to fight its corner and prove once and for all that contingent commissions, called "kickbacks" by the attorneys, are not illegal and that it should not be penalised for using them. Brokers, agents and insurance companies are all waiting in the sidelines to see what will happen in the coming months, as this David takes on the Goliath of the US justice system.

At the beginning of May, lawsuits were filed by New York attorney general Eliot Spitzer and Connecticut attorney general Richard Blumenthal as part of an ongoing investigation into the insurance industry. Boston-based Liberty Mutual, which in 2005 had $21.2bn in consolidated revenue and $78.8bn in consolidated assets and is the sixth largest US property/casualty insurer, is accused in the documents of using kickbacks and bid-rigging to boost sales. "It is simply appalling that a major financial institution would rig bids and induce brokers and agents to abuse their position of trust with the insurance-buying public," Spitzer said in a statement when the lawsuit was filed last month.

Fighting its corner

Unlike larger organisations that have settled with Spitzer, such as Marsh & McLennan and American International Group, Liberty Mutual said it will vigorously defend itself rather than accept a proposed settlement. It called the proposals and their terms "excessive and unreasonable: both in terms of magnitude and in their demands that we change legitimate business practices in states outside their legal jurisdiction."

Few details are known about the settlement talks between Liberty Mutual, Blumenthal, and Spitzer, but it is understood they were based on a blueprint established by previous deals such as a $1.6bn payment by AIG announced earlier this year or last year's $850m payout by Marsh & McLennan to settle charges. In March, Zurich American Insurance agreed to pay $153m. And in a separate deal with nine states in the same month Zurich agreed to pay nearly $172m to settle allegations of bid-rigging and price-fixing in the commercial insurance market.

A month later in April, as part of the bid-rigging investigation against it, stemming from the Marsh case, Ace settled with New York, Illinois and Connecticut for $80m in restitution and penalties. And while Spitzer did not demand changes at the top, executives such as AIG chairman Maurice "Hank" Greenberg and Marsh & McLennan's Jeffrey Greenberg lost their jobs. In addition, 17 executives in five companies - including eight former Marsh employees - pleaded guilty to criminal charges in the overall insurance investigation.

Liberty Mutual will not roll over and hand over cash. It vigorously denies kickback allegations, and blames the bid-rigging charges on two former low-level employees that it said "seriously violated our trust and our standards". The company claims that this was an isolated incident and that one of the employees involved left the business in 2001 while the other resigned during the investigation into allegations in 2005. In a statement, the company said it was disappointed the suits were filed. It said, "Liberty Mutual has a culture not just of compliance, but of 'doing the right thing'."

Debating contingent commissions

Spitzer has been fighting a crusade against what he sees as price fixing measures used by the insurance industry, which keep prices artificially high. He is particularly against the illegal practice of bid-rigging. As part of the same investigation, he has also been gunning for contingent commissions, which he believes also artificially inflate the price of commercial insurance.

Despite the fact that contingent commissions appear to be legal, Spitzer has linked them to kickbacks and has been using his not insignificant influence to get insurance brokers to stop the practice. And brokers have been keen to comply, wanting to be seen as above board and squeaky clean in a post-Enron US.

But there are those who question whether rolling over and playing dead is the right thing to do. David Cummins, a professor of insurance and risk management at Wharton, a Philadelphia insurance university, believes it is appropriate for Spitzer to investigate bid rigging, but he draws the line at eliminating contingent commissions. "Contingent commissions can help keep property/casualty and other markets efficient," said Cummins. "The practice may actually level the playing field by giving buyers and sellers equal access to vital market information."

Cummins said contingent commissions are not the real problem with pricing in the insurance industry. Instead, there may simply be too few insurance brokers operating at the top of the industry. When a small group of dominant brokers act as gatekeepers and are allocating a limited supply of insurance among companies seeking coverage there is a greater potential for pricing abuse, he explained. "Under an ideal insurance brokerage distribution model, insurance brokers will get requests from companies and will consider the buyer's coverage, loss history and other issues," he said. "The broker will then solicit bids from a variety of insurance providers." But the low bidder does not necessarily always win, he said, adding that can actually be a good thing.

According to Cummins the price of the commercial insurance policy is only one of several criteria that corporate buyers consider. Other issues include the breadth of coverage, the risk management services provided, and the insurer's reputation for claims settlement and financial strength.

But according to Spitzer's complaint, pay-to-play schemes distorted the market's pricing mechanism. The attorney general contends, for example, that insurers were "in" on the commission schemes because of certain "favoured" business they were to receive from Marsh, Aon and others in exchange for extra payoffs. The insurers would recoup their payoffs by passing them on to commercial customers in the form of higher prices.

Another of the few voices against Spitzer's contingent commissions campaign is Robert Hartwig, chief economist at the Insurance Information Institute.

He believes that if Liberty wins its epic battle against the attorneys, brokers, agents, insurers and customers will all benefit. He said that now the "hysteria" surrounding insurance fraud in the US has died down there is a better understanding of how the insurance industry works and that commissions are no different from other bonuses paid in other fields. In fact, he believes that Liberty Mutual has a good chance of winning this battle - and looks forward to the day. "It is a win, win, win situation," he said. "It will be good for the broker, good for the agents and good for the insurance company."

He said that Liberty Mutual had dealt with the bid rigging issue. "Two low-level employees violated the rules. Then there is the contingent commission issue. They have been, are and will continue to be legal. It is a form of incentive-based compensation."

Hartwig believes that enough "light has been shed on the issue" and that pubic opinion against the insurance industry is not so strong, and fighting for contingent commissions is not a no-hoper. In his opinion the allegations made by Spitzer about widespread bid-rigging have proved to be untrue, and have only been found in a limited number of cases. "Spitzer portrayed every transaction as inherently corrupt, but in fact there were a limited number of rigging of bids. He did not find that dealings with brokers and customers were tainted with bid riggings." Hartwig believes that now, for the first time, contingent commissions will be validated as proper conduct. "Liberty Mutual has a very strong case and should be able to prevail," he said.

- Mairi Mallon is a freelance journalist.

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Spitzer v Liberty Mutual

The suits state that since the mid-1990s Liberty Mutual and other insurers have paid hundreds of millions of dollars in contingent commissions to the biggest producers, including Marsh & McLennan, Aon, Willis, and Arthur J Gallagher. The contingent commissions are based on factors such as renewal rates or profitability. These often went undisclosed to customers, but meant that producers' recommendations to their clients "were biased in favour of insurers who paid contingent commissions," according to Spitzer's suit, which he says means they are in violation of their fiduciary duties to clients.

Spitzer's suit states that Liberty Mutual sometimes "took this corruption a step further" by colluding with Marsh & McLennan and others to rig bids and submit false price quotes to clients nationwide. The actions took place in excess casualty insurance, which covers losses above the limits of standard insurance policies.

To make sure a favoured insurer such as Liberty Mutual would win a certain client's business, the regulators claim that Marsh & McLennan would tell other insurers to provide "intentionally losing bids" that were described as "fake", "backup", or "protective quotes".

Both suits cite the 8 August 2005 guilty plea to criminal charges by Liberty Mutual assistant vice president Kevin Bott, who said Marsh & McLennan brokers instructed him to submit protective quotes to help another carrier win the bid, providing millions of dollars in commissions and fees to Marsh & McLennan. Liberty Mutual would win other business in return, Bott said, and his supervisor knew of the arrangement.

Eliot Spitzer - Timeline

- May 2006 - Spitzer files a lawsuit against Liberty Mutual alleging that the firm participated in a pervasive bid-rigging scheme.

- April 2006 - Spitzer and State Insurance Superintendent Howard Mills reach an $80m agreement with ACE to resolve allegations of bid-rigging and improper finite reinsurance transactions.

- March 2006 - American International Group reportedly hands over an internal report which it is claimed revealed accounting fraud within the insurance giant and led to the departure of Maurice (Hank) Greenberg.

- September 2005 - Over 30 state insurance regulators working through the National Association of Insurance Commissioners announce a multi-state regulatory settlement with Marsh & McLennan (MMC). Spitzer and State Insurance Superintendent Howard Mills indict eight former Marsh executives concerning "a massive bid rigging scheme that defrauded clients of millions of dollars".

- April 2005 - Martin Sullivan, president and CEO of AIG, sends a letter to shareholders assuring them that the company's global franchise is sound and its financial position solid.

- March 2005 - AIG states that its accounting for a non-traditional transaction with General Re, the reinsurance subsidiary of Berkshire Hathaway, was improper. AIG CEO Maurice (Hank) Greenberg steps down. Martin Sullivan is named president and CEO. Later Greenberg retires his position as chairman of the board. Aon agrees to pay a settlement of $190m to compensate its US policyholder clients.

- February 2005 - The Securities and Exchange Commission (SEC) and Spitzer subpoena RenaissanceRe for information relating to non-traditional insurance. An insurance executive at MMC and two executives at AIG plead guilty to criminal charges in connection with the investigation. Spitzer and the SEC subpoena AIG for information relating to non-traditional insurance.

- January 2005 - MMC agrees to pay $850m to compensate its US policyholder clients in settlement of charges against the company by Spitzer and the New York State Insurance Department. ACE announces the resignation of Susan Rivera, CEO of its US insurance operations, ACE USA.

- December 2004 - General Re receives a request from the SEC to provide information relating to non-traditional or loss mitigation insurance products.

- November 2004 - Spitzer subpoenas Swiss Re, MBIA, ACE, Zurich Financial and St Paul Travelers for information related to non-traditional insurance products, such as finite risk insurance and reinsurance. Two insurance executives from Zurich American Insurance plead guilty to criminal charges in connection with the MMC investigation.

- October 2004 - Aon and Willis announce they will terminate contingent commission arrangements. MMC chairman and CEO Jeffrey Greenberg resigns. Michael Cherkasky is named president and CEO. AIG and ACE discontinue making contingent commission payments to brokers. Spitzer files a civil suit in State Supreme Court in Manhattan, bringing charges of fraud and antitrust violations against MMC.

- August 2004 - San Francisco-based insurance consumer rights group United Policyholders sued MMC, Aon and Willis Group, alleging that they defrauded California customers by not adequately disclosing contingent commissions they receive.

- July 2004 - Illinois Circuit Court judge certifies a national class action lawsuit against Aon, alleging that the broker accepted contingent commissions from insurers without disclosing them to customers.

- May 2004 - Spitzer issues a dozen subpoenas to several major brokers and insurers requesting information on contingent commission agreements.

- February 2004 - The Washington Legal Foundation writes to Spitzer and the insurance commissioners of New York and California, urging them to investigate insurance broker commission agreements.