The National Consumers League is alleging that brokers are acting in an anticompetitive manner by the practice of leveraging, though the industry has countered that greater transparency now exists in the market. Ronald Gift Mullins reports.

The world's largest re/insurance brokers have chosen not to respond to allegations from a US consumer group that they are practising 'leveraging' in an unethical manner to increase their revenues which could mean inflated prices for primary insurance and reinsurance.

The National Consumers League (NCL), a consumer activist group in Washington, DC, in March 2003 urged authorities in New York, California, Connecticut and Florida to investigate "a potentially dangerous practice" in the insurance industry known as leveraging. "We have been told by credible insurance industry whistleblowers, who prefer to remain anonymous, that insurance companies are often discouraged from retaining brokers who could find them the best reinsurance coverage," said Linda Golodner, president of the NCL. "One of our informants referred to leveraging as the 'dirty underbelly of the insurance business'."

The practice, also called 'tying', involves pressure tactics used by re/insurance brokers, according to the NCL, and often inhibits insurance companies from being able to bid their reinsurance business competitively. "As a result," she said, "insurance companies are compelled to send their reinsurance business to the broker which has sent so much primary business their way even when paying more - sometimes millions more - for reinsurance. This could be unnecessarily costing insurance companies - and consumers - millions of dollars each year."

Ms Golodner said leveraging begins when an insurance company wants to purchase reinsurance and retains a broker to perform this service. "The broker is supposed to solicit bids from a variety of reinsurance providers," she said, "and seek out the best coverage at the best price. Some of these reinsurance brokers also broker for primary insurance. They match companies that are not in the insurance business (for example, an automobile manufacturer or shipping company) with insurance providers.

"Some of these reinsurance brokers then threaten to withhold primary insurance referrals unless the insurance company gives them a sole-source opportunity to broker that company's reinsurance needs. The insurance companies, fearful of losing lucrative primary insurance referrals, allow themselves to be held hostage by the broker."

The consumer group says this is unethical because brokers are supposed to find the best price for reinsurance. And the NCL suggests that leveraging may contribute to a primary insurance company's overall underperformance, "which could translate into lower stock prices or over-priced insurance premiums." Finally, in a letter to the attorney generals of the four states, the NCL posed this question: "In order to survive, could an insurance company be forced to go with a reinsurance company that does not offer adequate coverage?"

Global brokers take a pass
A former CEO of a large US reinsurance company, who requested anonymity, said that tying or leveraging would most likely happen in Aon and Marsh because they have the larger, the jumbo accounts that can be used to tie various accounts together. "In other words," he said, "the big brokers can apply muscle. I expect it has been going on since brokers began broking and will probably continue. It's part of doing business, and certainly the practice is not limited just to the re/insurance industry."

William A Graham IV, CEO of the Graham Company, a large broker in Philadelphia, Penn, commented, "Frankly, I have never heard of this practice. We compete in the marketplace all of the time, and premiums are sometimes a second or third consideration for a buyer, with coverage, claims service and safety services being more important than just premium costs. It sounds like the National Consumers League does not really understand how business relationships are developed, or how business deals are negotiated."

He explained: "If a broker puts pressure on a primary insurer to buy reinsurance through it alone, and the reinsurance costs and provisions are not real competitive, this would make the primary insurer less competitive. So, if the broker then places business insurance with a primary insurance company that is not competitive, and does not provide good service, the broker would ultimately lose what is called the 'retail customer' or the ultimate insurance buyer."

Representatives from the Council of Insurance Agents and Brokers (CIAB) said they were unfamiliar with leveraging or tying. Said Barry Meiners, director of communications, CIAB, "I think the NCL owes the industry an explanation of what they are talking about. We don't understand the terms, and we know of no other colleagues who know what the NCL is talking about."

Coletta I Kemper, vice president, Industry Affairs, CIAB, said: "The broker's job is to get the best deal for the customer. Even the biggest broker is nowhere near the size of even a mid-sized insurance company and if the company says no they will not be involved in such a deal, well that's that."

But regarding contingency fees, if the customer wants information, brokers should disclose it, according to Ms Kemper. "Contingency fees are legitimate," she said, "and the Risk Insurance Management Society has agreed to them as long as they are not linked directly to placement of an insurance policy. The relationship between the insurer and broker require that fees be negotiated, and if they are not happy with the result, change brokers." She, nonetheless, agreed: "It is a complicated issue."

'Override' in the UK
Though slightly different from leveraging or tying, in the UK, override had been worrisome to risk managers. Christopher Henley a solicitor with London law firm Ashurst Morris Crisp who has written extensively on the subject of override, explained that an overrider, volume or profit commission, or other payment from a third party received by a broker which relates to the risk which he has placed and which he fails to disclose to his client, the insured, "is likely to be a secret profit, to which the insured is entitled in any event, and the presence of which entitles the insured to affirm or void the contract from its inception."

David Gamble, executive director of the Association of Insurance and Risk Managers (AIRMIC), said: "Under the law of agency in the UK, brokers have to give best advice and that should not in any way be tainted by conflict of interest. The issue that we had was how was it possible for a customer to have best advice when the broker is using only a limited number of insurers because he is getting an override for placing the business from that limited group. The broker is not acting totally on behalf of his insured, and is using his position to play one off the other."

The Code of Conduct to the Insurance Directorate of HM Treasury adopted in May 1998 was initially aimed at Lloyd's brokers. The code recommended that these brokers should not accept volume overrides, growth incentives or profit commissions, or prompt payment discounts, long term agreements and renewal incentive bonuses without the policyholder's informed consent.

"Some of our biggest members still want to see as much transparency as possible," continued Mr Gamble. "Some insurers are saying no to overrides, and at the moment they are able to do quite well. I know a number of brokers have made efforts to be more transparent in their transactions and fee structure. Aon and others signed on to a code of conduct a while ago."

In April 1999, after consultation with AIRMIC, whose members were worried by increasing evidence of incentives paid by insurers to brokers, Aon introduced a Code of Business Conduct. The broker promised to disclose the amount of brokerage fees and commission for each placement for each client, including discounts and incentives, and to take reasonable steps to ensure that it does not receive any inducement likely to conflict with any duties owed to the client.

Aon's policy statement can be found on its website: "No transaction shall be effected and no payment shall be made by or on behalf of the company with the intention or understanding that the transaction or payment is other than as described in the documentation evidencing the transaction or supporting the payment."

Mr Gamble said he didn't know of any agreement Marsh had become involved in to date. "I think it is not an easy procedure to implement," he added.

Marsh has this on its web page: "...Marsh and its affiliated companies may have agreements with insurers providing coverage to Marsh clients through which Marsh may derive compensation contingent upon such factors as the size, growth and/or overall profitability of an entire book of business placed by Marsh with the insurers. This contingent compensation would be in addition to any other compensation Marsh may receive such as retail, excess and surplus lines and wholesale brokerage fees or commissions, administrative fees, etc. Marsh will provide additional information upon the request of a client."

"The Code of Business Conduct does not preclude additional fees," Mr Gamble said, "because in all fairness, often risk managers and insurers require brokers to do all kinds of additional work that the insurers won't pay for. But we want to have it understood that the fees are more open to discussion now... But," he added with a sigh, "I am sure override is still going on."

Who's in charge?
Ms Golodner said that the whistleblower who had contacted her about leveraging had worked for one of the larger P/C companies but had quit because she could not take not being able to place reinsurance in a competitive environment. "She felt she had been coerced to allow a specific broker to place the reinsurance coverage to his advantage," Ms Golodner recounted, "which seemed to her often to be too expensive. She felt that eventually down the line it would raise the price of P/C insurance. I felt it was serious enough to notify the attorney generals of the four states and suggest they investigate this practice further.

"I haven't heard from the insurance commissioners yet," she said, "though I heard from Attorney General Richard Blumenthal in Connecticut. I don't know if that office is going to do anything about it. I gave them as much information as I have."

Yet, a spokeswoman for the Connecticut Attorney General's office said they knew nothing about a letter from the NCL or any conversation with Ms Golodner, and suggested the state's insurance commissioner be asked.

A representative from the Connecticut Insurance Department said an anonymous letter concerning leveraging had been received, but she had no knowledge of any letter from the NCL. The anonymous letter was sent to the department's lawyers to determine what action should be taken if any, and thus the commissioner could not comment further.

Joanna Rose of the New York State Insurance Department when asked about receiving a letter from the NCL concerning leveraging, replied by email: "This is something we are looking into and we have responded to Ms Golodner's letter." On a follow-up phone call to determine the contents of the letter, Ms Rose said succinctly, "We are investigating the allegations," adding that was all that would be said right now.

NCL naïve?
"I am amazed that the National Consumers League (incidentally, I have never heard of them) could be so concerned about this," Mr Graham of the Graham Company, said. "Don't they have anything to do all day? It seems so naïve to me to think that a successful business would just blindly buy insurance indefinitely from a particular broker, if they were not doing an outstanding job. They might buy for a year or two, but eventually a poor job would be uncovered, and a change would be made."

"While greater transparency is clearly to be applauded," said Ashurst Morris Crisp's Mr Henley, "it would be difficult to rationalise any fee or compensation from an insurer to an agent/broker as not providing an incentive to place business with that insurer."

By Ronald Gift Mullins
Ronald Gift Mullins is an insurance journalist based in New York City.