Looking for Profits at Marsh

November 18, 2007

The Marsh & McLennan Companies, or MMC, has seen its once dominant position atop the brokerage world assailed by changing conditions, Eliot Spitzer, more competition and its own internal restructuring.

Although MMC posted over $2.8 billion in revenues for the third quarter of 2007, a 10 percent increase, that figure was greatly enhanced by the sale of its Putnam Securities division in August. MMC’s non-brokerage divisions, Mercer, Oliver Wyman and Kroll all reported revenue increases. Guy Carpenter, its reinsurance and risk management brokerage division, earned $226 million in the third quarter, up 5 percent (four percent on an underlying basis) from the same period last year.

However, Marsh, the brokerage division and MMC’s original business, has faired poorly. So poorly that President and CEO Michael G. Cherkasky stated in the earnings report: “Despite continued strong performance in our consulting businesses, MMC’s third-quarter results were significantly impacted by unacceptable financial performance in our insurance broking business. We have changed the leadership at Marsh and are taking comprehensive actions to improve profitability.”

The main action, aside from firing Marsh’s former CEO Brian Storms last September, is an initiative aimed at “the middle market,” as Cherkasky described it in the analysts’ and investors’ earnings conference call. He outlined five areas that he — as the now acting CEO of Marsh — seeks to make changes and improvements. These include; 1) new management and leadership; 2) simplifying Marsh’s business structure; 3) narrowing its external focus and improving its use of technology; 4) reducing costs and centralizing operations, and last, but certainly not least, 5) increasing the commissions it receives.

Cherkasky stressed that he has no intention of returning to the acceptance of contingent commissions. He pointed out that Marsh’s major competitors, Aon, Willis and Gallagher, do not use them, but a number of mid-size brokers do. “What we want,” Cherkasky said, “is a level playing field.” He’s proposing a “2.5 percent enhanced commission,” which he said would be fixed, would not be based on contingent placement of business and would be fully disclosed to clients.

“It will be mainly applied to small commercial and mid market business,” he continued, adding that it would not be applicable to risk management services and would exclude Marsh’s Fortune 1,000 clients. The charge would be paid by those carriers who agree to do so — not Marsh’s clients. “It will be fully disclosed and completely transparent,” he stressed. Marsh has been slowly implementing the system in the United Kingdom, and has found a great deal of support for it.

There’s also support from other quarters. Both Marsh and Aon have discussed such an arrangement with U.S. and U.K. carriers, including Chubb and Travelers, who appear to be interested.

Willis had originally opposed the idea, but that may be changing. At the recent Federation of European Risk Management Associations (FERMA) Conference in Geneva, Sarah Turvill, the chairman of Willis International, indicated that “insurers seem to be willing to pay more money for enhanced services.” She advocated a 2.5 percent surcharge, for providing clients with those services.

The reaction to the proposal at FERMA was decidedly mixed. “Rates should be based on value and services,” said XL Insurance CEO Clive Tobin. Essentially higher payments are only justified if the broker has done something to “add value” to the policy.

That may pose a problem for Marsh and the other large brokers. If Marsh excludes “risk management” services under the fixed commission plan, or if MMC charges straight fees to its clients when they use the expertise of Mercer, Oliver Wyman or Kroll, what is the 2.5 percent being paid for? That question will apparently have to be answered out before there is widespread acceptance of a basic change in the standard broker commission business model.