The Spitzer Effect on Business Insurance

Article excerpt

Even though abuses surrounding contingent commissions are being resolved, risk managers are scrutinizing information from their broker about coverage and costs.

THE $850 MILLION SETTLEMENT BETWEEN NEW YORK state attorney general Eliot Spitzer and Marsh & McLennan Cos. Inc. was the first step in resolving the insurance brokerage scandal, but it will not be the last. The investigations continue, and some individuals could face criminal charges. How the fallout from the scandal will affect insurance brokers' relationship with their clients has yet to be determined. Many brokers have already sworn off the contingent commissions that were at the heart of this scandal. But will that be enough? * From Donald G. Barger Jr.'s perspective, the answer is yes. Barger, the senior vice president and CFO of Yellow Roadway Corp., a transportation services company based in Overland Park, Kan., sees the situation as a test case for companies' vendor relationships in the Sarbanes-Oxley era. At Yellow Roadway, "The insurance brokerage issue will have a marginal impact on the way we do business," he says. "The bigger impact involves the need to set the tone at the top in business dealings, including those with customers and vendors. The tone at the top determines how we, as a company, operate and establishes expectations for the ethical behavior of vendors and customers."

Barger expects Yellow Roadway's procurement professionals to communicate the company's legal and ethical concerns and expectations with all its vendors. When it comes to insurance purchasing, those discussions focus on verifying pricing transparency, clarifying contingency relationships and learning how the insurance market works. "Our relationship with our broker is good, so we don't expect negative or defensive responses to these types of questions," says Barger. "The fact that we are not afraid to ask difficult questions will help our broker relationship over the long term."

A Festering Wound

The recent scandal turned the spotlight on an issue that has been bothering finance and risk management executives for some time. The fact is, they have been well aware that insurance companies offered contingent commissions to insurance brokers, and they have been troubled by the lack of transparency in insurance pricing and broker compensation arrangements. "The Spitzer disclosures merely confirmed what CFOs have always been uncomfortable about: Does the broker work for the insurance company?" says David Horn, CFO of professional services firm Tatum Partners in Atlanta. "This is a significant event, because it brings to the forefront something that has gnawed at insurance buyers for a long time."

When the use of contingent commissions began many years ago, a broker generally received that form of commission if the insurance company's profit from the policies the broker sold reached a specified level. Brokers also received compensation for handling certain administrative functions for insurers, such as issuing policies. "Over time, however, the administrative fees and profitability measures have fallen away, and contingent commissions became volume-of-business bonuses," says Cathy L. McKeon, a principal and leader of the insurance risk management solutions practice at PricewaterhouseCoopers LLP in New York City. "What was a surprise was that this led to bid rigging."

Since the scandal broke, many insurance brokerage companies have pledged not to accept contingent commissions in the future. However, because contingent commissions represented a relatively large percentage of broker profits, these organizations likely will have to modify their business models and find alternative sources to replace the lost revenue. Brokerage companies will probably also begin charging companies for services they had previously provided for free. "The cost of those services was absorbed by the broker because the broker was compensated from a different source," says McKeon. …