Are carriers to cozy with brokers?

Insurance brokers have long played an important role in the local, regional, national, and international insurance marketplace. As intermediaries between customers and insurers, insurance brokers locate and secure appropriate insurance coverage for their clients, pursuant to agreements with those

clients. Brokers use their professional experience and expertise to act in the best interest of their clients by identifying the available insurance coverage to fit the needs of those clients, which often are complex and sophisticated businesses in need of customized coverage. Brokers also work with their clients to evaluate the cost and terms of insurance coverage available to best match the clients' goals. To accomplish this responsibility, brokers typically maintain relationships with numerous insurers, enabling the brokers to access the broadest range of coverage options.

Insurance brokers can be compensated for their services in a variety of ways, including through the payment by insurers of fees under placement service agreements. A placement service agreement compensates a broker for placing a specified volume of named types of coverage with an insurer and varies from carrier to carrier and by type of business involved. These agreements are negotiated individually, and involve business a broker has identified as desirable to an insurer, translating into advantages to the broker's Clients, such as coverage stability, favorable pricing, and enhanced coverage. Placement service agreements are permissible under the insurance laws of every state. It is a common, although not universal, industry practice for brokers to disclose to their clients the possibility of such compensation. Such disclosures promote transparency, contribute to the trust between the broker and client, and ensure that clients are knowledgeable about their broker's compensation agreements.

In November 2004, Jeffrey Perlman wrote an OpEd piece in the Trenton Times alerting us to the need for the insurance industry to clean up its act. In discussing the scandals and misbehaviors at Marsh & McLennan, American International Group Inc., and ACE Limited, and their investigations by New York State Attorney General Elliot Spitzer, he concluded by saying, "The insurance industry needs to honestly explain its own compensation model in order to regain public trust or Spitzer will help rewrite the model."

Mr. Perlman is a principal at Borden Perlman Insurance in Lawrenceville, currently a member of the Board of Trustees and Executive Committees of the College of New Jersey; Greenwood House, Home for Jewish Aged; and the Mercer Regional Chamber of Commerce. He has also served for a number of years on ARC/Mercer's Mansion in May Committee. We decided to catch up with Perlman and ask him how things have gotten better, worse, or stayed the same in the ensuing nine months.

Over a year ago, April 26, 2004 the Council of Insurance Agents & Brokers commented that Placement Service Agreements (PSAs) between commercial insurance brokers and the insurance carriers with which they do business are not an issue of concern in the industry. Is this true today?

"It's obviously a problem today; it's definitely a problem," according to Perlman, who goes on to say, "The way most brokers get paid is contingent commission income [a set of standard measures of profitability]. Placement service agreements can put smaller firms at a distinct disadvantage."

Marsh has discontinued contingent commissions. Short of doing that, what are the step that brokers, large and small, can do to assure transparency and disclosure in this area? Perlman offers, "They [Marsh & McLennan] jumped off the wagon before it crashed. As long as we're doing a good job for our clients and a responsible, prudent job for the insurers, we [at Borden Perlman] will do well in this business offering competitively priced products." Perlman added, "I sent a copy of the OpEd piece from the Trenton Times to over one hundred clients without a single comment coming back to me. That tells me that clients don't really concern themselves with how brokers get paid as long as they are getting great service from their broker."

The IIABA (Independent Insurance Agents & Brokers of America, Inc.) has a fully descriptive position piece on standards governing PSAs - a policy statement adopted and issued in October 2004. Is this effective? Is it enough? Since Borden Perlman doesn't involve itself with any business arrangements that include PSAs, they have no opinion on the document or the standards enunciated there.

In June, the IIABA issued a statement saying a proposal to establish an optional federal charter (OFC) for insurance regulation is not the best or right solution for regulatory reform in the industry. They, rather, restated their support for the SMART Act. Do you have an opinion on this? "Only this:" said Perlman, "There can be some benefits to Federal licensing for the independent broker. We are licensed in forty-eight states and maintaining the paperwork and licensing requirements can be very time consuming."

What has happened since November 2004? Marsh & McLennan Companies in January agreed to pay $850 million to settle a suit filed by New York Attorney General Eliot Spitzer that accused it of rigging bids, fixing prices and steering business to insurers paying the highest placement fees. Marsh also said it would no longer collect these placement fees, also called contingent commissions. As a result, ongoing quarterly revenue fell 9 percent. Total reported revenue rose 2 percent to $3.10 billion, boosted largely by Marsh's July 2004 acquisition of corporate security company Kroll Inc.

Last October, Michael Cherkasky replaced Jeff Greenberg as Marsh & McLennan Companies' Chief Executive. The summer months have not been good to Cherkasky or to Marsh. In May of this year, Cherkasky was elected to the board of directors by Marsh shareholders. Speaking at the company's annual investor meeting in New York City, Cherkasky, who was addressing his first annual meeting with shareholders, said he was optimistic that the company will be successful despite its challenges, and will continue to be a market leader. "I'm not going to apologize anymore... we've apologized enough," he said. He added that while actions at its Marsh unit raised trust issues among clients, the company was committed to making sure that people won't fail in their responsibilities.

Also in May, the insurance industry, already under scrutiny by state and federal authorities for various practices, began facing another questioner. The FBI launched a probe of the insurance industry that targets some of the accounting mistakes found at American International Group to see how widespread the problems might be. The FBI review is not confined to insurer accounting but is also looking into agents and brokers who may be diverting premiums for their own use and into the operations of workers' compensation plans sold by professional employer organizations (PEO). The FBI said its agents are talking to industry executives and regulators as well as looking for patterns in existing complaints and civil records. "We do not want to be caught napping on this," Chris Swecker, an assistant director at the FBI who oversees the financial crimes unit, told The New York Times. "We are taking a very, very hard look at this to see if it represents a pervasive problem." The FBI said it would conduct traditional investigations as well as "utilize sophisticated techniques, to include covert undercover investigations, to apprehend the fraudsters..."

Charkasky acknowledged Marsh is paying the price for bad publicity it received as a result of Spitzer's investigation according to a Reuter's story of August 2, 2005 filed by Joseph A. Giannone.

"We've done a good job restoring the retention rate for old customers," Cherkasky said in an interview. "Where we're having problems is new business, which was expected but still disappointing. Those who don't know who and us only read about us in the newspapers are not going to use us. We're not getting our fair share of new business."

Then, the company's quarterly profits plunged 57%, also reported on August 2. "The results reflect the discontinuance of contingent commissions and the continued evolution of the marketplace in the post-Spitzer era," said Williams Capital Group analyst Peter Streit. Risk and insurance services revenue fell 11% to $1.5 billion, reflecting the loss of placement fees. Insurance brokerage, the business at the center of last year's probe, posted an 18 percent decline in revenue to $1 billion. Even ignoring the loss of the controversial fees, broking revenue fell 8 percent.

Meanwhile, at AIG, Seventeen insurers sued American International Group Inc. on August 3, accusing the big insurer of trying to collect too much money on reinsurance coverage it bought from them, according to the Wall Street Journal. The lawsuit, filed in state court in Boston, was brought by members of three reinsurance pools - the American Reinsurance Co., units of Hartford Financial Services Group Inc., Canada's Manulife Financial Corp. AIG Spokesman Chris Winans told the journal the company denies all allegations of wrongdoing and said the dispute should be resolved in arbitration. The insurers accused AIG and Trenwick America Reinsurance Corp. of fraud and conspiracy. The plaintiffs alleged that the two companies "colluded" to try to collect too much money, in part by submitting "suspicious" and "manufactured" claims. insurers use reinsurance to spread the risk of loss from policies they sell. This lawsuit is unrelated to recent regulatory probes into AIG's accounting and reinsurance transactions, according to the journal.

As both work to put scandal behind them, AIG's main business seems to be emerging relatively unscathed, while Marsh's methods of making money have probably changed forever, leaving it a less-profitable company, analysts said. The Marsh investigations resulted in significant changes in the brokerage business," Dreyfus Neenan, an equity analyst at Morningstar, said on August 2.

"Marsh's business got significantly worse because of what it had to stop doing. AIG wasn't overcharging customers like Marsh it was moving items around on its financial statements. From an accounting standpoint, that's naughty, but the impact on its business and future profitability is much less," according to Alistair Blair at MarketWatch.

Seventeen insurers sued American International Group Inc. on August 3, 2005, accusing the big insurer of trying to collect too much money on reinsurance.