From Summary: This report briefly summarizes the events that occurred and the issues, they raised in regards to violations of state laws, against Marsh & McClennan Companies and Marsh, Inc, which the Attorney General of the Sate of New York filling a civil law suit

Webel, Baird

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1 Marsh, Inc. is a wholly-owned subsidiary of Marsh & McClennan Companies, Inc.  In thisreport, “Marsh” will refer to the insurance broker Marsh, Inc., while the parent company will bereferred to as “Marsh & McClennan.”  Other subsidiaries include Putnam Investments andMercer Consulting, both of whom have been the subject of earlier investigations by Mr. Spitzer.Congressional Research Service ˜ The Library of CongressCRS Report for CongressReceived through the CRS WebOrder Code RS21966November 5, 2004 The 2004 Insurance Broker Investigations: An OverviewBaird WebelAnalyst in EconomicsGovernment and Finance DivisionSummaryOn October 14, 2004, the Attorney General of the State of New York, Eliot Spitzer,filed civil suit for violations of various state laws against Marsh & McClennanCompanies and Marsh, Inc.,1 the largest insurance broker in the United States.  Theprincipal allegations revolve around compensation arrangements between Marsh andseveral insurance companies, and bidding manipulation by Marsh to increase its profitsfrom these compensation arrangements.  Attorney General Spitzer also brought criminalcharges against individuals involved and several guilty pleas have been announced.Since the initial suit, several other states have indicated interest in examining theconduct of insurers and brokers in their states and numerous individual and class actionlawsuits have been filed.  Market reaction to this was swift with Marsh & McClennan’sshare price falling nearly 50% in a few days and other insurance companies and brokersalso seeing significant declines.While the initial complaint has been brought under New York law, the situationmay raise issues for Congress as well.  One concern is the applicability of federalantitrust law.  Among the laws used in the New York complaint was the state antitrustlaw (The Donnelly Act).  Insurers, however, have enjoyed at least limited federalexemptions going back to a Supreme Court decision in 1868 and the McCarran-Ferguson Act of 1945.  Another issue might be whether this situation sheds light on theoverall efficacy of state regulation of insurance, which continues largely becauseCongress has specifically allowed it under McCarran-Ferguson.  This report brieflysummarizes the events that occurred and the issues they raised.  It will not be updated.For current information on insurance issues, see CRS Report RL32789:  ModernizingInsurance Regulation, by Baird Webel.CRS-22 For global revenue, see [http://www.iii.org/international/rankings] original source BusinessInsurance.  Contingent commission revenue attributed to Jay Gelb of Prudential Equity Groupin “Aon Becomes Third Major Broker to Cease Contingent Commissions,” BestWire, Oct. 25,2004.3 See [http://www.oag.state.ny.us/press/2004/oct/oct14a_04_attach1.pdf] for the text of thecomplaint. The Role of Insurance BrokersRecent charges by the New York State Attorney General have highlighted possiblewrongdoing by both insurance brokers and insurance companies, but the complaints focuslargely on insurance brokers and their actions.  Insurance brokers are similar to theinsurance agents who are likely familiar to most people from purchase of individualinsurance, but brokers generally service commercial clients rather than individuals.  Whileinsurance agents can be either “exclusive” or “captive” agents who represent oneparticular company or “independent” agents who may place a person’s policies with anyof several different companies, brokers are almost always independent.  They are typicallyexpected to search the marketplace on behalf of a client for whatever insurance companyoffers the best policy and to act as a knowledgeable advisor to that client.  They can beparticularly important for insurance needs that may be complicated or somewhat non-standard.   Brokers have typically been compensated through some form of commissionon the insurance policies that they arrange.  Listed below are the top five global insurancebrokers listed by total revenue from insurance brokerage, consulting, and related services:Table 1.  Global Insurance Brokers, by Revenue($ in millions)Rank Company GlobalRevenueRevenue fromContingent Commissions1 Marsh & McLennan Cos. Inc. (U.S.) $9,376 $8452 Aon Corp. (U.S.) 6,734 2003 Willis Group Holdings Ltd. (U.K.) 2,004 804 Arthur J. Gallagher & Co. (U.S.) 1,202 45-505 Wells Fargo & Co. (U.S.) 801 UnknownSource: Insurance Information Institute/BestWire.2People of the State of New York vs. Marsh &McClennan Companies, Inc.3This civil suit was filed on October 14, 2004, by Attorney General Eliot Spitzer.  Itenumerates six different causes of action, but the complaint can be seen as having twoprimary facets.  One is relatively narrow, namely that an insurance broker, Marsh Inc.,CRS-34 See, for example, Alan Reynolds, “Not Spitzer’s Job,” Wall Street Journal, Oct. 22, 2004,p. A16.  Online at [http://www.cato.org/research/articles/reynolds-041022.html], for a viewopposing that in Mr. Spitzer’s complaint.along with a number of insurance companies, AIG, ACE, Hartford, and Munich-AmericanRisk Partners, rigged the bidding on a number of insurance placements for clients beingrepresented by Marsh.  The complaint alleges that Marsh would predetermine theinsurance company that should be chosen by a client and asked other companies toprovide higher bids than that preferred company, with this extending to “fake”presentations by these other companies to give the appearance of competition.  In oneinstance, it is even alleged that Marsh went so far as to completely falsify a bid when aninsurance company, CNA, refused to offer a bid.  Such bid-rigging is clearly a violationof law and three insurance executives have already entered guilty pleas in response tocriminal complaints that were filed along with this civil complaint.The other primary aspect of Mr. Spitzer’s complaint is a much broader indictmentof the relationship and payment structures between insurance brokers and insurancecompanies.  In addition to the buyer’s commission, usually a percentage of the insurancepremiums paid, insurance brokers have also received commissions directly from theinsurance companies.  These commissions have allegedly been based on more than justa percentage of the premium, with brokers receiving higher commissions if certainvolume or dollar targets are met.  Known generically as “contingent commissions,” theyapparently were also known as “placement services agreements” (PSAs) or “marketservices agreement” (MSAs) at Marsh.  The complaint indicates that Marsh wasaggressive in soliciting such agreements from insurance companies.  Such contingentcommissions could provide a major motivation for the bid-rigging that was describedabove since, unlike with a straight percentage commission, an insurance broker couldpossibly gain a higher commission if a particular insurance company were chosen by theirclient.  These commissions, however, were reportedly widespread in the industry, andtheir propriety has been a topic of much more debate than the clear wrongdoing seen inbid-rigging.4  Whatever the ultimate legality of these commissions, as shown in Table 1,they appear to have been a large revenue generator at Marsh, but not as large at the otherinsurance brokers.Market and Regulatory ResponseParticularly in light of the fallout from previous investigations by Mr. Spitzer intofinancial companies, the market reaction to the latest lawsuit was very swift.  Marsh &McLennan shares fell nearly 50% in the aftermath of the allegations, while otherinsurance brokers’ shares fell as well with Aon, Inc. and Arthur J. Gallagher down asmuch as 30%.  The fall in broker shares is likely due both to the large uncertainty createdin such a scandal as well as the market recognition that the contingent commissions areboth a large part of broker earnings and are likely to be curtailed or eliminated in thefuture.  Marsh and Aon have reportedly already indicated that they will no longer chargecontingent commissions and several insurance companies have also announced that theywill no longer pay them.  Although the ending of contingent commissions may mean thatthey have to pay less fees, the share prices of insurers also reacted generally negativelyCRS-45 See the California Department of Insurance website, at [http://www.insurance.ca.gov/docs/FS-PRS084-04.htm], for specific information.6 15 U.S.C. §§ 1011-1015. 7 Donnelly Act (N.Y. General Business Law, §§ 340 et seq.). 8 15 U.S.C. § 1012(b).9 15 U.S.C. § 1013(b).to the uncertainty following the lawsuit.  AIG and ACE shares saw drops in the 20%range and mutual funds based on insurance stocks saw lesser declines.Following the initial complaint, the legal investigations into possible insurancebroker and company wrongdoing have expanded in both geographic area and scope.Attorneys General and insurance regulators in other states, including Connecticut, NewJersey, Massachusetts, Illinois, Florida, and Minnesota are reportedly looking intoquestions similar to those raised by Mr. Spitzer.  California’s Insurance Commissionerannounced on October 20, 2004, a new set of regulations designed to ensure that brokeror agent income from other sources be fully disclosed and to clarify the duty of agents andbrokers to serve their clients’ best interests.5  The National Association of InsuranceCommissioners (NAIC) has set up a 13-state task force to coordinate investigations anddraft a model law address the issues.  Numerous private lawsuits have been filed acrossthe country.  Other types of insurance, such as group life, disability, and health policiesthat are often purchased as employee benefits are apparently being scrutinized, as is otherbroker activity, such as the possibility of “tying” of primary insurance business togetherwith reinsurance business from the same firm.Issues for CongressThe primary federal statute addressing insurance regulation is the McCarran-Ferguson Act of 1945.6  This act affirmed the primacy of the states as regulators ofinsurance, including a limited exemption from the federal antitrust laws.  Since itspassage, almost all congressional or other federal action on insurance begins withquestions revolving around McCarran-Ferguson.  Any federal action on the latestinsurance scandals would be no exception.McCarran-Ferguson’s Antitrust ExemptionOne of the state laws cited by Mr. Spitzer in the complaint was New York’s antitrustlaw.7  If there were to be any federal legal action, federal antitrust law would almostcertainly be invoked as well.  Federal antitrust actions against the insurance industry,however, are complicated to some degree by the language of McCarran-Ferguson, whichprovides that the Sherman Act, the Clayton Act, and the Federal Trade Commission Actwill be applicable to “the business of insurance to the extent that such business is notregulated by State Law.”8  The law also states, however, that the previous preemption ofthe Sherman Act does not apply to “any agreement to boycott, coerce, or intimidate, oract of boycott, coercion, or intimidation.”9  Thus, rather than simply establishing aviolation of the federal antitrust laws, a federal claim against someone in the insuranceCRS-510 See CRS Report RL31982, Insurance Regulation: History, Background, and RecentCongressional Oversight, by Carolyn Cobb, for a discussion of the history of McCarran-Fergusonand the following court decisions.11 While it was originally assumed that McCarran’s use of the term, “business of insurance,” wasvirtually interchangeable with the term, “insurance companies,” the Supreme Court made clearfirst in 1969 and again in 1979, that this assumption was erroneous.  In Securities and ExchangeCommission v. National Securities, Inc. (393 U.S. 453 (1969)), the Court held that a state statutedirected at protecting the stockholders of insurance companies was not a statute regulating thebusiness of insurance, and that the merger of an insurance company and another company wasnot entitled to McCarran’s “business of insurance” protection: “[Only s]tatutes aimed atprotecting or regulating [the relationship between the insurer and the insured], directly orindirectly, are laws regulating the ‘business of insurance.’” 393 U.S. at 460, emphasis added.  InGroup Life & Health Insurance Co. v. Royal Drug Co. (440 U.S. 205, 211 (1979)), the Courtstated emphatically that the McCarran exemption “is for the ‘business of insurance,’ not the‘business of insurers.’”  Relying on those cases, the Supreme Court and the lower federal courtshave, in a variety of circumstances, steadily narrowed the McCarran antitrust exemption; it nowgenerally excludes activities carried on by insurance companies that may be deemed “ancillary”to the underwriting or risk-spreading function of writing insurance policies, whether or not thoseactivities ultimately redound to the benefit of policyholders.  In Union Labor Life Ins. Co. v.Pireno (458 U.S. 119 (1982)), for example, the Court summarized its holding in Royal Drug: “Insum, Royal Drug identified three criteria relevant in determining whether a particular practiceis part of the “business of insurance” exempted from the antitrust laws ...:  first, whether thepractice has the effect of transferring or spreading a policyholder’s risk; second, whether thepractice is an integral part of the policy relationship between the insurer and the insured; andthird, whether the practice is limited to entities within the insurance industry” (458 U.S. at 129,emphasis in original).  See also, e.g., U.S. Dept. of Treasury v. Fabe, 508 U.S. 491 (11993);Hartford Fire Ins. Co. v. California, 509 U.S. 764 (1993); Podiatrist Ass’n, Inc. v. La Cruz AsulDe Puerto Rico, Inc., 302 F.3d 6 (1st Cir. 2003); McKnight v. Chicago Title Ins. Co., Inc., 358F.3d 854 (11th Cir. 2004); AmSouth Bank v. Dale, 2004 WL 2092997 (6th Cir. 2004); and similarcases that discuss the factors to be considered in determining whether a practice constitutes the“business of insurance.”industry must also establish that the acts in question were either not the business ofinsurance or that they constitute boycott, coercion, or intimidation.Until a specific case is filed and brought to conclusion; it would be impossible topredict a conclusion with certainty, however, it does not appear that the courts would bebreaking with precedent in allowing a federal antitrust case along similar lines to thatbrought by the State of New York.  Over the past few decades, courts have generally beenseen as narrowing the scope of preemption provided by McCarran-Ferguson.10  Ofparticular importance in such a federal antitrust case would be the definition of “businessof insurance” which the courts have addressed a number of times.11  Depending on howthe courts might interpret the language of McCarran-Ferguson in such an antitrust case,Congress might wish to clarify this antitrust exemption.Quality of State RegulationFor the past 60 years or more, the insurance regulatory world has existed in a stateof varying tension between those who favor the existing state-based system and those whoargue for federal involvement, or even a federal insurance charter.  Whenever Congressexamines insurance regulation, and thus raises the possibility of increased federalCRS-6involvement, one of the primary arguments of the supporters of the state regulatorysystem is that the individual states are essentially better regulators than an envisionedfederal system would be.  This argument, however, raises the stakes for any problems inthe insurance marketplace as some might use them as counterexamples against theclaimed superiority of the state-based system.  In the late 1980s, there were a number of large insurer insolvencies, which werefollowed by congressional reports and hearings led by Representative Dingell that werehighly critical of the regulatory system and discussed federal solutions to the problems.These insolvencies were an embarrassment to the state regulatory system and regulatorswere galvanized to show progress combating the problems.  To some degree they weresuccessful, and suggestions for federal intervention abated through the middle and latterpart of the 1990s.   Following this lull Congress is now again examining the insuranceregulatory system, due primarily to the changes made to the financial regulatory systemby the Gramm-Leach-Bliley Act of 1999 which freed banks and security firms from manyDepression-era restrictions but left insurance regulation largely unchanged.  The focus inthe past few years has focused on uniformity of insurance regulation, and to some degreeon deregulation, particularly of insurance rates.The question for Congress is how to interpret this new insurance scandal.  Is it anexample of the state system working since it was a state Attorney General who hasuncovered and prosecuted the wrongdoing?  Or is it a failure of the system since theproblems were allowed to manifest themselves for as long as they did?  It has been arguedthat contingent commissions were widely used in the industry over the past decade.  Ifthese commissions are indeed a source of conflict of interest, why did the regulators notimpose rules sooner?  Commercial insurance is one of the more lightly regulated parts ofinsurance on the presumption that large enterprises are able to fend for themselves ininsurance market.  What does this scandal say about this presumption?  Does it shed anylight on the suggestion that other insurance regulation, such as rate regulation, might bereduced?  Or is the question of tightening market conduct regulation essentially separatefrom the question of loosening rate regulation?OutlookWhile the investigations are continuing, it seems likely at this point that the ultimatescope of the scandals may center on two issues.  First, is an answer to the question of thepropriety of contingent commissions.  If it is judged that these commissions are notimproper, then the initial complaint essentially reduces to specific illegal rigging of bids,which is certainly serious, but is much narrower than an indictment of a widespreadindustry practice.  Second, is whether further damaging evidence is found, particularly onthe question of “tying” with reinsurance activity, which reportedly is a focus of ongoinginvestigation.The Senate Governmental Affairs Subcommittee on Financial Management, theBudget, and International Security has announced a hearing planned for November 16,2004, that would focus on insurance broker issues.  It is unclear whether and when theother committees that have held insurance regulatory hearings during this Congress,namely the House Committee on Financial Services, the Senate Committees onCommerce and on Banking, may take action on this issue.  To this date, no legislationspecifically addressing this issue has been introduced or announced.

The 2004 Insurance Broker Investigations: An Overview

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The 2004 Insurance Broker Investigations: An Overview

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