Insurance Investigations Under Way Over Fees
By JOSEPH B. TREASTER
The New York Times
April 24, 2004
Two new investigations have been opened into the insurance industry, industry executives and officials said yesterday. Both focus on incentives and other fees paid by insurance companies to commercial insurance brokers.
In New York, the office of Eliot Spitzer, the state attorney general, has issued subpoenas to the country's three biggest insurance brokers: Marsh Inc., the world's largest broker and a unit of the Marsh & McLennan Companies, which is based in New York; Willis Group Holdings, also in New York; and Aon, a Chicago company that ranks immediately behind Marsh in size. The three companies, which account for most of the commercial insurance brokerage business, all confirmed receiving the subpoenas.
In California, John Garamendi, the insurance commissioner, said last night that he was looking into potential conflicts of interest in several insurance brokerage companies across the country but declined to identify the targets.
At issue in the investigations are payments made by insurance companies to brokers for exceeding targets on the sale of policies and for providing consulting services. Although the payments have been a routine practice for many years in the industry, it is not clear whether the payments are in fact legal. Regulators and industry analysts say the costs of the bonuses are passed on to customers; there is concern, too, that customers may be getting inappropriate insurance.
Some experts say the payments are only illegal when they are not disclosed to customers, but the Washington Legal Foundation, a nonprofit research organization that brought the situation to the attention of investigators, says that, in any case, they raise questions about whether a broker's recommendations are honest and unbiased.
In a letter, the foundation noted a statement by the New York State Department of Insurance to brokers and insurance companies in 1998 saying that a failure of a broker to disclose the payments from insurance companies may be a violation of New York state insurance law "as a dishonest or untrustworthy practice." Through a spokesman, Gregory V. Serio, the superintendent of insurance in New York, declined to comment on the investigations.
Over the years, the risk managers who buy insurance for major corporations have expressed concerns about the insurance company payments. But neither regulators nor investigators have taken action until now.
In raising questions about the practice, Mr. Garamendi said that "the broker is presumed to work on behalf of the customer and the bonuses or commissions for volume sales, especially, can be a conflict in that they may cause the broker to divert business to an insurance company that may not provide the best deal for the insurance customer."
Marsh, Aon and Willis Group Holding said the subpoenas demanded information on "compensation agreements" between them and the insurance companies that sell policies to American corporations.
In its statement, Aon, noted that the payments that Mr. Spitzer was investigating were "a long-standing practice within the insurance industry," adding that "many major carriers have these agreements with brokers."
Vinay Saqi, an analyst at Morgan Stanley, said in a note to investors earlier this year that the payments from insurance companies accounted for 2 to 6 percent of brokers' revenue. Most of the rest of the brokers' money comes from fees paid by corporate customers.
Brokers acting as their customer's representatives operate in contrast to insurance agents who work for insurance companies and are legally obligated to the insurance companies. In another contrast, brokers deal in commercial insurance and agents sell policies to individuals for things like cars and homes. Agents also sell life insurance and other personal coverage. David Brown, the chief of the Spitzer unit that has been at the forefront of the financial investigations, refused to comment on the investigations into the big insurance brokerage companies or even to confirm that subpoenas had been issued. "We're not commenting at all," Mr. Brown said.
Earlier this year, Mr. Spitizer's office began investigating life insurance companies and securities brokerage firms for abusive trading of stocks in variable annuities, a type of investment that combines insurance and mutual funds and is intended for retirement savings. He turned to the insurance industry after several months of uncovering activities by investment banks, mutual funds and brokerage houses that were harmful to investors and sometimes illegal. Those investigations have resulted so far in settlement payments of $1.4 billion from Citigroup, Merrill Lynch and others. The investigation of 44 mutual funds has resulted in 80 mutual fund executives losing their jobs and settlement payments by the funds of $1.8 billion.
Many aspects of the investigations have made front page news. As a result, other investigators and some of the targets of the investigations have complained that Mr. Spitzer was trying to draw attention to himself for a possible run for governor of New York.
There was speculation in the insurance industry late yesterday that Mr. Spitzer had also issued subpoenas to some big insurance companies. Representatives of the American International Group, one of the world's largest insurers, did not return calls seeking comment. And Mark Greenberg, a spokesman for the Chubb Group, another big insurer, refused to comment.
For his part, Mr. Garamendi said he was not investigating the insurance companies, but was concentrating for the moment on the brokers. "The issue is one of the brokers' obligation to the customer," he said.
In letters to Mr. Spitzer and Mr. Garamendi earlier this year, the Washington Legal Foundation urged investigations into the payments from insurance companies, saying that they "can compromise the broker's fiduciary duty to represent the best interests of their clients." Executives of the foundation did not respond to calls late yesterday.
The brokerage companies, which report billions in revenues annually, would not discuss the investigation.
The three companies disclose on their Web sites that such payments are a part of their overall compensation. Spokesmen for the companies would not discuss the details of the compensation or how it is specifically disclosed with each corporate client. But on its Web site, Marsh said it "provides additional information about its compensation practices at the request of a client."
Al Modugno, a spokesman for Marsh, said, "We provide information to clients on a regular basis so they can make informed decisions."
In a note to investors yesterday, Jay Gelb, an analyst at the Prudential Equity Group, said, "Our understanding is that these agreements are fully disclosed to clients." Some insurance analysts said they were surprised that Mr. Spitzer and Mr. Garamendi felt the payments were worth investigating.
"The question whether it is a conflict of interest for brokers to get paid these bonuses," said one analyst. "By and large I do not think it is. If the buyer is aware that the brokers get these extra commissions and the buyer still buys these policies, what's the problem? If they hide them from the client, that's a problem."
Mr. Gelb added in his note to investors, "We see nothing wrong with these arrangements."