Private Lawsuits Challenge

Private Lawsuits Challenge

Brokerage Contingency Fees

Private lawsuits challenging contingent commissions could have a big impact on the insurance industry. They are poised not only to up the ante regarding producer compensation–particularly for insurers that, to date, have escaped relatively unscathed from regulatory scrutiny–but also to define substantive standards of conduct through judicial rulings.

One complication is that numerous private class actions have been filed in recent months alleging that contingent commission arrangements violate federal and state laws. We'll look at three cases.

o Several have been consolidated as multi-district litigation in New Jersey federal court–In re Insurance Brokerage Antitrust Litigation–wiith a high-profile plaintiff's firm (Milberg, Weiss, Bershad & Schulman) as co-lead counsel.

The amended complaint filed in that proceeding charges collusion among insurers and brokers to rig bids, submit false quotes and adopt contingent commission deals. It alleges further that brokers and insurers sought to maximize the profitability of policies by collusively discouraging policyholders from seeking the most favorable terms or from filing certain claims, thereby allegedly breaching a relationship of trust and confidence with potential policyholders.

The causes of action alleged include violations of the federal Racketeer Influenced and Corrupt Organizations Act, federal and state antitrust laws, and state deceptive practices statutes, as well as breach of fiduciary duty and unjust enrichment.

The defendants have asserted powerful legal defenses. For one, under the McCarran-Ferguson Act, federal antitrust laws do not apply to insurers because "the business of insurance" is regulated by state law. The marketing of insurance and, in particular, rate-setting, has repeatedly been held to constitute "the business of insurance."

In addition, defendants argue that RICO claims fail to meet the "enterprise" requirement, as they merely plead various broad "associations-in-fact"–either of the entire insurance industry or of so-called "Broker-Centered Commercial Insurance Enterprises." Defendants also challenge the RICO claims for failure to plead the "predicate acts" necessary to establish a pattern of racketeering activity.

This proceeding may clarify the intersection between federal law of general applicability for businesses (for example, antitrust and RICO) and state law specifically governing insurance. In addition, it may address whether an insurer owes any duty to a policyholder for activities prior to policy inception.

o Another notable California lawsuit concerning contingent commissions–which pre-dates recent investigations by New York Attorney General Eliot Spitzer into bid-rigging and contingency fee abuse–is In re Insurance Broker Commission Litigation, in San Francisco County Superior Court.

That case–brought by a lawyer as a private attorney general under California's unfair competition statute–alleges that insurers made secret payments to brokers ("kickbacks"), prompting the brokers to steer thousands of purchasers to those insurers and to encourage policyholders to buy unneeded coverage.

The plaintiff here focuses on the insurer's alleged duty, under California law, to disclose all material facts in selling insurance. Nondisclosure of the contingent commissions is unlawful, the plaintiff asserts, because the commissions are material and defendants have reason to know that purchasers are unaware of them.

Furthermore, nondisclosure of contingent commissions constitutes fraud under California law, the plaintiff claims, because insurance purchasers may be deceived as to the benefits of proposed policies.

When Proposition 64 was adopted by California voters in 2004, defendants argued it mandated dismissal of this case, as the initiative requires plaintiffs who prosecute unfair competition claims in the interest of the general public to show personal injury in fact–a showing this plaintiff couldn't make.

The trial court disagreed, but on Nov. 30 the Court of Appeal reversed that decision. Finding that Prop. 64 repealed the statute on which this case was predicated, the appellate court ruled it must be dismissed.

Prop. 64 highlights another difficulty plaintiffs face–demonstrating actual injury caused by contingent commissions. Policyholders should be obligated to prove they actually paid higher premiums or received less coverage due to contingent commission arrangements before recovering damages. Despite sweeping allegations, little proof of actual harm has been adduced.

o Another "pre-Spitzer" contingent commission case–Daniel vs. Aon Corp. in Cook County, Ill. Circuit Court–recently reached a preliminary nationwide class settlement earlier this year. In that case, Aon customers claimed that Aon breached its fiduciary duties by accepting contingent commissions, or "kickbacks," without their consent or knowledge.

Plaintiffs claimed harm from an undisclosed conflict of interest created by Aon's procurement of insurance for them without revealing its receipt of commissions based on the total business referred to the insurer or its loss ratio performance.

Plaintiffs sought disgorgement into a constructive trust of all "kickbacks" Aon received, an injunction preventing future contingent commission arrangements, and punitive damages under the Illinois consumer fraud statutes.

In certifying the case as a nationwide class action (as to breach of fiduciary duty, only), the Daniel court found that all class members sought to litigate a common legal issue: Whether Aon's having received or being eligible for receipt (without the consent of its clients) undisclosed commissions or "kickbacks" in connection with the placement of insurance violates their fiduciary duty or confidential obligations imposed under Illinois law.

It is possible that the certification of a nationwide class could be reevaluated in the wake of the Illinois Supreme Court's recent decision in Avery vs. State Farm Mutual Auto last August. Nonetheless, the plaintiffs have articulated a unique constructive-trust theory of recovery–that damages be measured by the profits retained by Aon, rather than by traditional proof of out-of-pocket losses sustained by individual class members.

On March 9, 2005, the court preliminarily approved a settlement agreement that allows Aon customers to share approximately $228 million. Aon must also implement certain business reforms:

o As compensation for its brokerage and related services, Aon will accept only a specific fee paid by the client, a specific percentage commission on the premium paid by the insurer, or a combination of both.

o Before binding any policy, Aon will disclose all commissions to clients and obtain consent, both in writing.

o Aon will not accept any commission based on placing a particular number of policies or dollar value of premium with an insurer; achieving a particular level of growth in those measures; meeting a particular rate of renewal of policies; placing or keeping sufficient business with the insurer to achieve a particular loss ratio; or any other limiting measure of profitability.

o Aon will not provide preferential treatment in the placement process, including the number of quotes sought from insurers, or obtain anything else of material value for the insurer.

Like the regulatory settlements with Marsh, Aon, Willis and Gallagher stemming from the Spitzer probes, the Daniel preliminary settlement not only imposes a large monetary penalty but also significantly affects how the defendant will do business prospectively.

What are the implications for the insurance industry? These suits make clear that settlement with government agencies may not resolve fully the exposure of insurers or brokers related to contingent commissions.

Indeed, the ultimate impact of the private cases is far from clear, as they will undoubtedly face a number of substantive and procedural hurdles. In a climate where standards of conduct for insurers and brokers have become murky, however, these private lawsuits should be watched carefully.

Thomas W. Brunner chairs the insurance practice and Anne McBride Walker is Of Counsel at Wiley Rein & Fielding in Washington.

Caption for shot of money changing hands:

Private lawsuits challenging contingency fees make clear that settlements with government agencies on this controversy may not fully resolve the exposure of insurers or brokers.