Competitive Storm Brewing: What Spitzer’s Lawsuit May Mean to Us All

Perhaps like you, I have been fascinated by the press coverage our industry has received lately–probably more individual stories in prominent newspapers than at any other point in the last 25 years, all thanks to the lawsuit New York Attorney General Eliot Spitzer filed against Marsh & McClennan Oct.14.

I wondered what was really behind it and, perhaps more important, what it might mean to other brokers, agencies, carriers and, especially, our customers. Here is what I know: There are very good, well-meaning people in this business who have integrity, who are honest, and who work hard for the good of insured customers every day. Unfortunately, theirs are not the stories being told these days. Instead, we are being painted with a broad brush of fraud and collusion. Investors have banged the industry incredibly hard recently, wringing perhaps 10 percent of the collective market values out of our industry. The impact is obvious–the harder questions are: Why has this happened? What are the long-term implications?

The complaint itself
Having practiced insurance regulatory law for a large part of my career, it was a natural instinct for me to set aside the press coverage and get to the source. So, I obtained and have studied Spitzer’s actual Summons and Complaint (the actual allegations and suggested evidence that set up the lawsuit). The document is 31 pages, and contains 60 factual allegations. The instances described by Spitzer, if proven, illustrate violations of several New York laws–notably Fraudulent Business Practices–Executive Law section 63(12), Antitrust violations, General Business Law section 40 et seq, Securities Fraud, General Business Law section 352-c, and Unjust Enrichment, a general Common Law fraud.

The factual allegations are stunning. Summing them together, it would appear that Spitzer has proof that Marsh (1) held itself out as a trusted advisor to its fee-paying corporate customers while at the same time insisting that some of those customers’ policies be placed with favored carriers that provided Marsh with revenue-enhancing “Services Agreements” and (2) systematically cajoled carriers into rigging high bids that created an artifice of actual competition where there was none.

Most Summons and Complaints that initiate lawsuits are somewhat vague, setting up the discovery process and allowing each side to gather facts in discovery that prove or defend against the allegations. Not this one. It cites internal and external e-mails, notes from executive meetings and minutes from carrier meetings that appear to leave no doubt that these things actually did happen.

As an attorney, I can always find a way to fashion a defense. Try as I might, I cannot fashion any kind of legitimate defense construct for what Marsh appears to have done, and what the carriers did to support this process.

The murky status quo
I recall in the mid-1980s drafting a new agency agreement form for a property and casualty insurer with whom I worked. Even then, the relationship was between the agent and the customer versus the agent and the company. The duty of care that followed was murky at best. In the vein of independent agencies and brokerages, it is often unclear whether the agent/broker is representing the interests of the insured exclusively, the carrier exclusively, or both, depending on the issue. This is an area of confusion that has allowed the kind of exploitation that Marsh seems to have undertaken. The Spitzer suit does not help. In it, brokerage fees and agent commissions are lumped together and classified as payments made by insureds to purchase independent advisory services. As a result, the Spitzer suit has broad implications for the industry as a whole.

Moving toward transparency
It would be easy–and it is too easy–to distinguish ourselves from the Marsh practices, especially the bid rigging conspiracy, and leave it at that. The investor community has not left it at that, nor have insurance regulators in other states such as California and Connecticut who are proposing regulations based on full disclosure of commissions and fees to customers. In a word, the impetus is toward transparency.

We almost certainly will see specific regulations that require agencies and brokers alike to fully disclose the source and nature of payments they receive from insurance transactions. The only question will be the scope and timing of these regulations: Will they apply to personal as well as commercial lines in property/casualty transactions? Will they also apply to the life, and accident and health side of the business? As an industry, we likely face a sea of change in this regard. It will happen, just as the Securities and Exchange Commission has begun forcing full disclosure of administration fees and expenses in the mutual funds industry.

What you can do
Investors have dragged down the stocks of a number of other brokerages. Why? Because they believe that, in an era of transparency, competition will heat up dramatically. They see that we are not well positioned to compete effectively when it comes down to disclosing commissions or fees and the services (or, in many cases, the lack thereof) that justify these payments. On the property/casualty side of our business, it is already intensely competitive. For practical purposes, it really is a zero-sum economic scenario at present. How will we handle another competitive situation? Investors clearly believe we aren’t prepared to handle this, and my own experiences suggest to me that they are probably right in a number of cases.

As a principal or shareholder of an agency or brokerage, what should you be thinking right now? How do you position your firm to protect your current position as well as to turn these events into opportunities? Here are some specific questions you might ask:

Protecting profitability: Will my carriers suspend their commission arrangements? If so, how do I replace the 2 to 4 percent of premium revenue that in some cases constitutes a large share of my operations’ net income?

Recruiting: Is there an opportunity to recruit new producers who have excellent experience and contacts? If so, how do I distinguish who are the best? The worst? Who will best fit my operation’s culture?

Full disclosure of commissions and fees: What proactive services do I provide my customers that can help justify that we have earned those payments? How do I articulate and document these services? How can I get my entire team pulling together to help support our operation and our customers in this regard?

Meeting competition head on: If my competitors are willing to cut their fees or commissions to retain or grab new business (not much of a stretch in our industry), how will we respond? What happens when a downward spiral of commission cutting results in lousy service to insureds? How do we handle that?

Planning: What does the coming storm mean for my growth plans? How do I retain revenue? How do I effectively compete and still grow organically? What kind of contingency planning should I be doing? How will my plans be altered, and what impact will that have on my operation, our people and our customers? How do I position our services? Since we can’t be all things to all clients, do we have some type of segmentation model that will enable us to provide value added services that allow profitability across our book of customers?

Ethics: What checks and balances do I have in place in my operation that would prohibit the types of self-dealing that seem to be pervasive and likely in the brokering model?

These are scary questions, aren’t they? Especially if you are thinking about them for the first time.

In my career, and especially more recently, I have had the privilege of meeting agency and brokerage principals and carrier executives who are well positioned not only to meet, but to profit from, these new challenges. They are thoughtful, honest people whose primary interest is, and has always been, excellent service to their insured customers. I have had the good fortune of being able to help these folks fine-tune their operations to meet all these challenges. They are asking the right questions and instituting the right mechanisms. Can you honestly say you are, too?

Kevin DeVaan is a consultant with The Wedge Group, an insurance
industry consulting firm headquartered near Dallas. Previously, he practiced insurance regulatory law for a variety of insurance company clients. For more information, visit www.thewedge.net