Marsh & McLennan Accused of Price Fixing, Collusion
October 15, 2004
By Thor Valdmanis, Adam Shell and Elliot Blair Smith

The nation's biggest insurers are mired in a brewing scandal that many executives fear could shake the industry to its core.

After months of complaints from industry watchdogs, New York Attorney General Eliot Spitzer launched the first salvo against alleged conflicts of interest Thursday, charging the insurance brokerage arm of Marsh & McLennan (MMC) with price fixing and collusion.

A damning civil suit accuses Marsh of steering clients to favored insurers and working with major insurers to rig the bidding process for property-casualty insurance coverage. The lawsuit says the victims ranged from large companies to school districts to individuals.

In addition to the civil complaint, Spitzer announced two guilty pleas on criminal charges against two executives at American International Group (AIG). They are cooperating with the investigation, which could ensnare other insurance giants and executives.

"This investigation is catching like wildfire. These charges radiate out to other insurance companies and brokerages," Spitzer said in an interview. "The entire business model of this industry seems to be predicated on the type of egregious behavior outlined in our complaint."

Some of the nation's largest insurance companies are accused in Spitzer's suit of steering contracts and bid rigging, including AIG, ACE, The Hartford and Munich American Risk Partners. Other insurance companies are being investigated in a scheme that Spitzer said raises everyone's insurance premiums.

Wall Street reacted harshly Thursday, wiping out more than $26 billion in market value of the four companies traded in the USA. Munich is a subsidiary of Germany's Munich Re. Marsh and others named in the complaint said they are cooperating with Spitzer.

Some industry analysts were quick to point out a family connection to Spitzer's probe. Business legend Maurice "Hank" Greenberg runs AIG, while his sons Jeff and Evan are CEOs at Marsh & McLennan and ACE, respectively. Spitzer said he has no evidence of any family ties to the scandal.

Most industry watchers expect Spitzer's investigation to trigger sweeping reform as well as massive lawsuits.

Plaintiffs lawyer John Stoia, who brought civil lawsuits against Marsh & McLennan, Aon and the Willis Group in California and New York - alleging many of the same unfair practices prior to the New York attorney general's complaint - said in a statement that the companies had falsely "represented themselves as honest brokers offering their customers the best coverage from many insurers at the lowest cost, (but) they steered them instead to a few companies that gave them kickbacks and other payoffs."

Spitzer said his six-month investigation was sparked by an anonymous letter and the Washington Legal Foundation, a conservative public policy think tank that in February urged regulators in New York and California to probe so-called contingent commissions.

The industry trade group, the Council of Insurance Agents & Brokers, responded by saying it believed the arrangements, which are at the heart of the Spitzer allegations of kickbacks and conflicts of interest, were being adequately disclosed.

Last month, Marsh disclosed some contingent commission-related data and its code of conduct. At the time, Marsh CFO Sandra Wijnberg said, "What we found is that the bigger clients already were pretty knowledgeable, and they haven't been particularly agitated about this."

That did little to satisfy Spitzer, who noted that Marsh collected $800 million in contingent commissions in 2003 alone, more than half of its $1.5 billion net income. Spitzer said that when he first contacted Marsh executives, they said, "Don't waste your time."

Suit warranted or over-reaching?

Some critics say the ambitious New York attorney general, who is eyeing the state governor's mansion, may be over-reaching.

Steve Smith, a partner at law firm Bryan Cave, has represented Marsh & McLennan in professional liability cases. "Many of the allegations in the complaint are not very specific," Smith says. "The AG will have to come forward with evidence to support his case."

But other industry veterans say the lawsuit is warranted. "Spitzer's right on this one," says former AIG executive Marc Vivori. "They were not acting in the best interests of their clients. At a minimum, they had an obligation to disclose any contingent commission arrangement with their clients."

In May, Advisen, an insurance industry research company, found that 69% of the 330 risk managers it canvassed in an anonymous survey considered contingent commission arrangements a conflict of interest. And 82% said broker disclosure of contingent commissions "was less than fully adequate."

Advisen Executive Vice President Dave Bradford, who conducted the survey, said, "Whatever the outcome of the New York case, the enormous pressure this is going to exude on the industry is going to force it to abandon the contingent commission business or restructure it in a significant way."

Bradford adds, "My feeling is this is the first domino. The other state attorneys general and insurance commissioners are pretty likely to follow suit." Unlike the securities industry, the insurance industry is not federally regulated.

Whether the arrangements constitute a conflict of interest is a question that may have to be litigated. But insurers may be legally vulnerable if they have not disclosed the arrangements. In 1998, the New York State Insurance Department issued a policy letter requiring that all compensation between brokers and insurers be disclosed to buyers "prior to the purchase so as to enable (them) to understand the costs of the coverage and the motivation of their broker in placing the business."

In that same letter, the department said undisclosed compensation "is sufficient to create the perception that brokers are conflicted in their loyalties."

In the Advisen survey, 56% responded that their broker didn't disclose the agreements.

Potentially disastrous allegations

Thursday's dramatic action is Spitzer's latest crackdown on unethical and criminal behavior in the power corridors of Corporate America, after tackling tainted Wall Street research and fraud in the mutual fund industry.

"It makes you wonder what the other attorney generals and industry regulators are doing to earn their paychecks," says Columbia University law professor John Coffee. "Spitzer has had an extraordinary rate of success in uncovering smoking guns."

Spitzer said the victims in this latest scandal were mostly large corporations, but also included small and midsize businesses, municipal governments, school districts and individuals who were deceived into buying property and casualty coverage that may have cost more than it should have.

For Marsh, the allegations are potentially disastrous. All three of its major businesses are now tainted by scandal. The company's Putnam mutual fund arm was charged last year in Spitzer's mutual fund crackdown. Its Mercer consulting unit was criticized for executive compensation work that helped to justify the $140 million salary of former New York Stock Exchange chairman Richard Grasso.

"We believe that the continuing stream of negative news continues to serve as an overhang for (Marsh & McLennan)," J.P. Morgan insurance industry analyst David Sheusi wrote in a recent report. "Each of its business segments is under significant accounting, regulatory and legal scrutiny."

Thursday's news sent Marsh shares tumbling 24%, which wiped out $5.9 billion in market value.

Although AIG shares fell only 10%, that erased $18.2 billion in market value because of its many shares outstanding. AIG is in a tricky position. Karen Radke, 42, a senior vice president of an AIG division, and co-worker Jean-Baptist Tateossian pleaded guilty Thursday to felony charges of scheming to defraud in state Supreme Court in Manhattan. They face up to four years in prison, but their sentence will depend on how much more they cooperate, Spitzer said.

Spitzer relied on internal e-mail and memos, in which, he said, insurance executives openly discussed actions that were aimed at maximizing Marsh's revenue and insurance companies' revenue, without regard to clients, who ranged from distilled-spirits maker Fortune Brands to a public school district in Greenville County, S.C.

Marsh stressed to insurance companies that it would more aggressively sell the policies of those companies who paid the biggest contingent commissions, the complaint states. Marsh employees who "moved" clients to insurers who paid big commissions were also "rewarded" with pay increases, Spitzer says.

In February 2002, one managing director at Marsh informed nine co-workers that "some (contingent commission agreements) are better than others." He added, "I will give you clear direction on who (we) are steering business to and ... who we are steering business from."

Bid manipulation also appears to be widespread.

Winning back business

In his complaint, Spitzer outlined this scheme involving AIG: When a policy with incumbent carrier AIG was up for renewal, Marsh took the following steps to assure that AIG would win back the business. First, Marsh provided AIG with a "target premium and the policy terms" for the quote. If AIG agreed to the quote, it got to keep the business, regardless of whether it could have quoted a lower premium. But for the deceit to succeed, Marsh had to let other carriers know what the winning quote was and ask them to submit a so-called backup quote, or "B Quote," that was higher, thus putting them out of contention for the business. Spitzer said the cooperation was nothing more than an "entrance fee" for future business.

In December 2002, the lawsuit says, ACE quoted $990,000 for the excess casualty business of Fortune Brands. But the insurer later revised its bid higher to $1.1 million. An e-mail from an ACE assistant vice president to ACE's vice president of underwriting explained the revision this way: "Original quote $990,000. ... We were more competitive than AIG in price and terms. MMGB (Marsh McLennan Global Broking) requested we increase the premium to $1.1M to be less competitive, so AIG does not lose the business," the complaint alleges.

Clients who were allegedly abused are not amused.

"We're already investigating the matter," said Fortune Brands Vice President C. Clarkson Hine.

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