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By George M. Mangion – Partner, PKFMALTA
The insurance industry in the United States consists of more than 5,000 companies with over $1.8 trillion in assets. It is broken down into two segments of equal importance: property/casualty and life/health. The insurance industry is one of the largest and most interdependent of the United States industries. Regrettably insurance fraud has become one of the most prevalent and costly white collar crimes. Public concern about the price of insurance and the solvency of the insurance industry has prompted the insurance industry to conduct both internal and external reviews of the various insurance cost elements.
To give some background to the problem we can state that most insurance companies have used any surplus to write more policies, even if the only way to sell more insurance was to capture customers from competitors by cutting the price of insurance. Now, critics lament that there is no valid reason why insurance companies have to write more insurance policies if the premiums they can charge won’t make the policy profitable. In a recent case that rocked America we find that Marsh & McLennan, the world's largest broker, and American International Group,( AIG ) the world's largest insurer, are both implicated in an investigation by Eliot Spitzer the formidable New York Attorney General . He is suing Marsh & McLennan, claiming it took kickbacks from insurers in return for business. At the heart of the scandal is the suggestion supposedly independent brokers are in the pocket of the insurers . Specifically, the lawsuit alleges that Marsh illegally steered clients to insurers that paid it the highest commissions and solicited rigged bids for insurance contracts. Mr Spitzer alleges the insurance broker took $800m in improper commissions last year alone - more than half of its profits. The scandal has already wiped out half of Marsh & McLennan's stock market value. Also suffering from the backlash are Aon Corp and Willis Group Holdings who have also been subpoenaed. The abuse centers about the issue of contingency fees. These long-standing industry practices in general involve policies sold to businesses, not to individuals. Contingent commission arrangements are not unusual in the history of the insurance industry. Properly constructed contingent commissions - based on business volume or profitability – have been an established and legal industry practice not just in the US, but worldwide . The existence of such arrangements is well known among corporate buyers of insurance and risk managers.
A major part of the investigation over contingent commission plans centres on certain anti-competitive practices that may have existed. There is also the issue as to whether contingency agreements are adequately disclosed to insurance buyers and whether they present a conflict of interest for brokers that represent and are often compensated by insurance buyers. Insurance brokers are intermediaries that help buyers of insurance secure coverage.
These are paid compensation in the form of both commissions and fees. Typically brokers are paid standard commissions by the insurers and reinsurers, with whom they place business for services provided. Historically, such standard commissions are determined as a percentage of the premium associated with the business placed, though flat-fee arrangements are not uncommon. Brokers also have arrangements with certain insurers under which they are paid contingent commissions based upon the underwriting profitability of the business. The Securities and Exchange Commission said last month it was considering bringing civil charges against AIG for allegedly helping PNC Financial Services hide under performing loans. Before that, AIG was entangled in a separate investigation by the SEC into whether it helped Brightpoint, a distributor of mobile-phone data, hide $12m in losses through an unusual insurance contract. The SEC fined AIG $10m, though the company did not admit any guilt. AIG is a huge insurer that, according to Spitzer’s investigation so far, both paid commissions to Marsh to get business and submitted false bids to keep the scheme going. In 2002, AIG went to the New York State Insurance Department for guidance about the payment of this kind of commission.
Wrong doings at Marsh
Thus we note that historically the insurance industry’s fate has fluctuated amid boom and bust cycles.
The global market has witnessed the years of 2002 and 2003 characterised as a time of extremely competitive premium prices amid excess underwriting capacity. So what is new about the latest controversy that has hit the US insurance industry? This allegedly involves two types of inappropriate behaviour. The scheme uncovered by Spitzer’s investigators was very simple. Spitzer has alleged businesses have been paying more for their insurance than necessary because of the contingent commissions, which are upfront payments from insurance companies in exchange for having business steered their way.
It came as no surprise that Aon, has been served with a subpoena as part of Spitzer's probe. Aon said it expects to have all of its contingent commission agreements terminated by the end of the year. Aon joins Marsh & McLennan, the Willis Group Holdings Ltd. brokerage and several large insurance companies that have announced they will no longer use contingent commissions. One of the areas targeted by the investigators is "contingent commissions" These are widespread in the insurance industry and is seen by many as perfectly legitimate as long as the commissions are disclosed to customers. The commissions are paid by insurers to brokers on the basis of the volume of business directed their way, and also on how profitable that business is likely to be. Put in that context, the alleged bid-rigging schemes by Marsh, Aon and other insurance brokers follow a certain business logic that is sustained by greed.
Conclusion
Pundits are describing this episode as the start of the downfall of the Greenberg dynasty. Mr Hank Greenberg, whose position in America's corporate society ranks him alongside Warren Buffett and General Electric's former chairman Jack Welch, all form part of the clique of powerful business supporters of President George Bush. If one of the Greenberg dynasty is tainted by the outcome of the Spitzer case, it is likely to hurt the others, at a time when the influential family has already lost much of the business world's reverence. Jeffrey Greenberg, chairman of embattled insurance broker Marsh & McLennan Cos., is facing intense pressure to quit amid the deepening scandal over allegations of fixing prices and rigging bids. At stated earlier on Marsh & McLennan, is fighting an $800m lawsuit brought by New York's attorney general, Eliot Spitzer against Jeffrey Greenberg. Mr Spitzer alleges that Marsh took illegal payments for steering clients to particular firms. Shares in Marsh, the world's largest insurance broker, have collapsed since the Spitzer investigation was unveiled, and the firm is now renegotiating $2.8bn in bank financing. The latter alleges Marsh & McLennan masterminded a scam with certain insurance companies to cream off millions of dollars from customers in inappropriate fees.
Looking back in hindsight one can comment that Spitzer’s investigation did not come a moment too soon. He has gone to the root of the scandal and exposed the arrangements that ostensibly compromise a broker’s duty to act in the client’s best interests by encouraging them to refer business only to those companies that pay them handsome contingency fees. Everybody augurs that the insurance industry will come out of this investigation stronger and that Spitzer nibs in the bud certain abuses that have beleaguered the market.
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