The Insurance Brokerage Industry Post-October 2004

Article excerpt

This article features a panel discussion organized by David Cummins and Neil Doherty for the 2005 World Risk and Insurance Economics Congress (WRIEC) on recent changes in the insurance brokerage industry resulting from the investigation by New York Attorney General Eliot Spitzer. The moderator is Neil Doherty, Ronald A. Rosenfeld Professor of Insurance and Risk Management, and Insurance Department Chair at the Wharton School of the University of Pennsylvania. The first panelist is J. David Cummins, Harry J. Loman Professor of Insurance and Risk Management at the Wharton School of the University of Pennsylvania. David Cummins has published extensive research on the insurance industry, receiving the most citations in a recent survey in this field. The next panelist is Gerald L. Ray, President for Corporate Operations at the Van Gilder Insurance Corporation, a large independent agency that is headquartered in Denver. Gerald Ray has been with Van Gilder for twenty-five of his thirty-seven years in the industry and has experience on the insurer and broker sides of the industry. He is on the board of the Council of Insurance Agents and Brokers (CIAB), and in 2004 was elected as the Insurance Person of the Year by the Colorado State Insurance Association. The final panelist is Terri Vaughan, Ph.D. She was the Insurance Commissioner for Iowa, serving through both Democratic and Republican state administrations. She is currently a Professor at Drake University, and a graduate of the Huebner Program at the Wharton School.

Neil Doherty: The Spitzer investigation began as an investigation of broker compensation. It then proceeded to issues involving how brokers placed business with insurance companies, finding cases of apparent bid rigging. The investigation expanded to other areas too. There were issues of possible conflicts of interest involving reinsurance placements, and then issues involving insurance companies arose. Finite reinsurance and its possible use as an earnings management tool received some of the spotlight as well.

This panel discussion focuses on brokers and all of the issues raised by the Spitzer investigation. The consequences of Spitzer's investigations are quite profound already even without consideration of any new court determinations. For example, all four of the major brokers have abandoned contingent commissions as part of a settlement or in anticipation of class action suits. Also, two members of the Greenberg family have fallen victim to these investigations-the president and the CEO of Marsh and the CEO of AIG. Shareholder values have been significantly affected by changes in the compensation arrangements for brokers. This will possibly lead to a restructuring of the industry in the future in ways that we may not even be able to imagine today.

We have a great panel to look at these issues. First, David Cummins will provide a statistical overview of the brokerage industry and discuss the current state it is in. Gerald Ray will talk next about some of the issues facing brokers and how brokers are addressing those issues. Terri Vaughan then will discuss regulatory aspects related to the brokerage industry and the Spitzer investigation.

Just to start things off, Spitzer came on to the scene and effectively declared that brokers are the agents of their clients. But, if they are paid by contingent commissions, then their interests may not be the same as those of their clients. Therefore, Spitzer purports that such commission structures are wrong. Let me challenge you, as a group of insurance economists, to think a little more deeply about this. The Rothschild-Stiglitz model indicates that when there is adverse selection, there may be an equilibrium in which the insurance company offers a menu of contracts. In a separating equilibrium, good risks signal their status by accepting lower levels of insurance coverage at the cost of lower utility. Some argue that the insurance broker is an information intermediary that presents significant features of the risk to the insurance company. …