Spitzer Probe May Exacerbate Softening Market

"Insurers paid hundreds of millions of dollars in contingency fees to brokers to direct business to them. Now that such deals have been scrapped for the most part, they'll need to compete in another way," said Mark Puccia, managing director of the Financial Services Ratings Group at S&P. "Brokers are feeling the heat to provide a more competitive market to clients. Inevitably, price is going to be a big part of that mix, exacerbating the softening of the market."

"We know certain companies paid more of these [contingency] fees than others," said Mr. Puccia, while declining to name any specific carriers. "What will they do to maintain their competitive position now that these fees are no longer an incentive available to most of their big brokers, lower prices? That's pure speculation for now, but it would be a safe bet."

Fitch Ratings put together a "stress test" to try to judge the impact of the end of contingency fees and any bid-rigging on an insurers combined ratio. For example, if a carrier generated 5 percent of its net premiums written through incentive compensation and/or outright price-fixing, and such manipulation raised premiums by 5 percent over what would normally be produced in a market free of these influences, the end of such activities would leave its combined ratio at 102.1.

However, if a carrier generated 10 percent of its premium volume via such activities, and the pricing benefit was 25 percent, removing such advantages would leave the combined ratio at 104.

Given this analysis, even though Fitch believes the industry is "somewhat under siege" with all the probes going on, "it would take a pretty extreme amount of this type of activity to seriously skew the bottom line," according to Keith Buckley, managing director of insurance at Fitch Ratings in Chicago.

"Thats why we decided to keep the outlook for property-casualty commercial lines stable," he added, outlining his analysis at the Society of Insurance Research annual conference in Atlanta. While citing damage to the industrys reputation and threats to its "financial flexibility" because of the scandal, "we dont believe this is going to have a material impact long term."

However, in the short term, he said, "the brokers wont be able to recoup this lost [contingency fee] revenue. It would be a PR nightmare to put on another commission charge to replace it. But at the end of the day, brokers should be able to earn additional income according to how they add value for the client and the insurer. Its just a matter of how to charge for that."

At a time when major brokers and insurers are being accused of fixing prices for their own benefit at the expense of their clients, how will a buyer know they are not getting a raw deal going forward? Maurice Greenberg, chairman and chief executive officer of American International Group in New York, provided an answer during his address to the PWC/S&P conference.

"We will not pay brokers any contingency fees," he said. "Every quote we make will contain whatever commission we're paying. I would hope the buyer would insist that such disclosure is made in every quote from every insurer so that the broker's compensation is completely transparent and buyers can judge the broker's value for themselves."

Mr. Greenbergs firm has been named by New York Attorney General Eliot Spitzer as one of the insurers that participated in a Marsh Inc. brokerage scheme to rig bids in return for contingency fees. Two suspended employees at AIG have pled guilty to misdemeanor charges relating to the probe.

Mr. Greenberg, while suggesting that ethical and legal breaches in the industry are most likely "restricted to a small group of individuals," nevertheless said "there needs to be a thorough review of the industry's practices." He said industry leaders "need to work with government officials to fix what's broken. I hope to get this behind us very quickly."

Reproduced from National Underwriter Edition, November 23, 2004. Copyright 2004 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.