Academic journal article Journal of Risk and Insurance

Market Reaction to Regulatory Action in the Insurance Industry: The Case of Contingent Commission

Academic journal article Journal of Risk and Insurance

Market Reaction to Regulatory Action in the Insurance Industry: The Case of Contingent Commission

Article excerpt


We examine the market's reaction to New York Attorney General Eliot Spitzer's civil suit against mega-broker Marsh for bid rigging and inappropriate use of contingent commissions within a generalized autoregressive conditionally heteroskedastic (GARCH) framework. Effects on the stock returns of insurance brokers and insurers are tested. The findings are: (1) GARCH effects are significant in modeling broker/insurer returns; (2) the suit generated negative effects on the brokerage industry and individual brokers, suggesting that contagion dominates competitive effects; (3) spillover effects from the brokerage sector to insurance business are significant and mostly negative, demonstrating industry integration; and (4) information-based contagion is supported, as opposed to the pure-panic contagion.


On October 14, 2004, New York Attorney General Eliot Spitzer filed a civil suit in the New York State Supreme Court against Marsh & McLennan Cos. (MMC), the world's largest insurance broker, for bid rigging and inappropriate use of contingent commissions. The suit alleged that MMC had guided clients through fictitious bidding processes with preselected insurance company "winners." The driving force behind this flawed process is considered to be contingent commissions, an arrangement in which an insurance intermediary receives a percentage of the premiums realized by the insurer, if it can meet certain goals in terms of volume, persistency, and profitability in the business it places with the insurer. (1)

The suit against MMC resulted in considerable loss of wealth for the insurance industry. The MMC stock price dropped 44.4 percent in 2 days, MMC Chairman and CEO Jeffrey Greenberg resigned within days, and MMC discontinued its practice of receiving contingent compensation and agreed to pay $850 million in restitution to buyers as part of the settlement. Several other leading brokers, including Aon and Willis (the second and third largest) followed suit, discontinuing the practice of contingent commissions. The investigation then broadened to include property-liability and life-health-accident insurers, resulting in serious repercussions. (2) In the aftermath of the event, both market and regulatory advocates proposed increased emphasis on transparency in firm operating behavior, and the National Association of Insurance Commissioners (NAIC), the organization of state insurance regulators, developed a set of requirements for brokers' disclosure of compensation. (3)

Although the event study technique has been used to examine numerous corporate events, these studies generally limit themselves to the standard market model, in spite of the fact that stock return data often exhibit generalized autoregressive conditionally heteroskedastic (GARCH) properties (Engle, 1982; Lamoureux and Lastrapes, 1990). We contribute to the literature by adopting the GARCH framework to account for these data properties. We examine the effects of the Spitzer suit ("the event") on three aggregate portfolios, insurance brokers, property-liability insurers and life-health-accident insurers, and on the individual firms in these sectors of the industry. The purpose is to determine whether the effect of the event was limited in scope to the target firm (firm specific), whether it was also transmitted to other brokerage firms (intra-sector effects), and/or whether it spilled over to other sectors of the insurance industry as well (inter-sector effects). We also investigate whether the effects on the nontarget firms are of a "contagion" or "competitive" nature and whether inter-sectoral effects are pure contagion or information based. (4)

We find that the information conveyed by the Spitzer suit event contains all three elements (firm, sector, and industry effects), demonstrating evidence of spillover among the insurance brokerage, property-liability, and life-health-accident insurance sectors. …

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