The Contingent Commission Crisis
Prof. Bill Long 2/7/06
Spitzer's Suit (and Subsequent Action) ag. Marsh & McLennan
NY Attorney General Eliot Spitzer's October 14, 2004 Complaint filed in the Supreme Court of NY (for the County of NY) was the most dramatic action to hit the insurance industry in years. This essay will begin by bringing the lawsuit "up to date" and then retrace some steps to discuss the nature of some claims filed by Spitzer.
The Action Since October 14, 2004
After Spitzer's office sued Marsh & McLennan (and it sued other companies in other actions) for stautory fraud, securities fraud, antitrust violations and common law fraud and unjust enrichment, as a result of a scheme between 1999-2004 in which he alleged that M & M both accepted large "contingent commissions" from insurers in exchange for steering business to them and that it rigged the bidding process itself, M & M "settled" the case early in 2005. The settlement, as most settlements do, declined to assign any fault, but it resulted in M & M's disgorging $850 million in contingent commissions collected in the years 2003-04. As we have read, the contingent commissions, about $800 million in 2003, represented 1/2 of M & M's profits. The stock of M & M took a 40% hit, its chief executive resigned, and eight Marsh executives pled guilty to various criminal charges which stemmed from the investigation. Then, in mid-September 2005, eight more former executives of M & M were indicted in felony charges relative to the price fixing scandal. Chances are that most (if not all) will not go to trial. In addition, some state attorneys general have considered suing M & M for similar violations.
Note how the current M & M CEO, Michael G. Cherkasky, handled the news of the September 14, 2005 indictments. He said.
"The criminal charges announced today are not against MMC, but against eight former employees who worked in the Excess Casualty division of Marsh's former Global Placement department. They stem from the conduct that the Attorney General outlined in his civil complaint against MMC last October. MMC and Marsh settled all charges against our companies by the New York Attorney General and Superintendent of Insurance relating to these matters last January. This indictment is about the past. MMC today is focused on the future and is committed to excellence and the highest standards of professionalism and service" (from M & M's website).
For those of you interested in pursuing a career in public relations and damage control, note three things that Mr. Cherkasky did in this statement. First he wanted to distance the company from the former executives. They were the bad guys, and they no longer work here. Second, he wanted to emphasize that it was individuals and not the company that was being indicted (he mentioned that the company, which was indicted in the 2004 Complaint, had settled "all claims" already). Third, he wanted to try to focus attention on the future. Then, in a series of "bullet points," Cherkasky emphasized how, in the words of the Apostle Paul, "all things have become new." New management teams are in place. "Sweeping reforms" have been initiated (reforms in the wake of a costly indictment are always denominated 'sweeping') and strict complaince policies and procedures have been put in place. The equity markets, however, have not been convinced. M & M's stock has really not budged significantly in the past 15 months.
Contingent Commissions
The basis for M & M's fall from grace was not simply their practice of pursuing contingent commissions, in which insurers would reward the company for binding additional policies with the insurers but, even more, the notion that Marsh had fixed prices, procured dummy bids for policies and generally done almost everything to serve its own bottom line and that of the insurers, at the expense of the customer. But, you might ask, is the problem in the idea of the contingent commission itself or does the problem lie elsehwere?
Most state insurance commissioners (and perhaps we should either have Joel return or should have had him after we studied this issue) would have said, before the filing of the complaint on Oct. 14, 2004, that contingent commissions were not per se illegal. As long as the client was informed about these commissions and that real choice was provided to the clients, the commisisoners felt that the market would take care of the issue. That is, if one insurer awarded a large contingent commission to the broker and another didn't, it stood to reason that the other insurer would have lower rates. Hence competition could be assured even while contingent commissions were allowed. But what is unique in this case, according to Spitzer's allegations, is that M & M had rigged the entire bidding process so that insurers would deliberately give high bids so as to make another insurer's bid look more attractive. Why would Zurich or Hartford or other insurers collude with M & M, or at least acquiesce in this system? Because they knew that business would get steered to them eventually, too. Thus, it was a win-win situation for all the insurers and definitely for M & M. The only problem seemed to be, as alleged by Spitzer, is that the consumers were the ultimate party "holding the bag."
One Example
Space doesn't permit a full review of the complaint. Let's just point to a few paragraphs in it, where bid rigging was evident in the procuring of insurance for the Greenville (NC) County School Project (paragraphs 67-74). The Complaint alleged that during the bidding process there were two serious bidders competing for the project: Zurich and ACE. But, unbeknownst to Greenville, M & M held out the project as a "carrot" in its effort to entice Zurich to sign a contingent commission agreement. When M & M steered the contract to Zurich, an email from the former to the latter said: "We worked hard to get this to you and as we discussed expect it to be part of the [contingent commission]...
It was not simply the contingent commissions, I believe, that "sunk" M & M. It was the combination of bid rigging and steering business, without informing the consumer, that caught Marsh. And, the story is still unfolding..
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