The Pfundstein Report
Last month New York Attorney General Elliot Spitzer reached deep into the insurance brokerage community’s wallet. His office reportedly uncovered substantial bid-rigging and other illegal activity among certain name brand members of the industry. It seems as though initially Spitzer’s office was simply following up on complaints concerning insurers’ payment of contingent commissions to brokers placing business with them. Most brokers also are paid a fee by the customer/prospective insured.
What is a contingent commission? This type of compensation or fee arrangement has been around for several decades. Contingent commissions are paid in addition to the regular or ordinary commissions received for the placement of insurance. An insurer pays a contingent commission in exchange for substantial volumes of business, a year-over-year growth in business placed with the insurer, profitability of the placed business (fewer or less expensive claims), or some combination of the three.
These agreements are sometimes structured as market service agreements or placement agreements. The focus of the most publicized instances of abuse involve brokers, not agents. There is a substantial difference between these two insurance producers.
Insurance brokers owe a duty to the prospective insured to act loyally. The broker does not generally act as an agent of the insurance company. Because the broker is the insured’s agent, payment for placement of the insured’s business based on volume, profitability or some combination of the two raises concerns. The allegation is that a broker will place business with the insurer that has the richest contingent commission arrangement irrespective of the broker’s obligation to the insured to find the best coverage at the best price.
An insurance agent is generally the agent of the insurer. Absent a “special relationship,” the agent does not owe any duty to the insured beyond the duty of reasonable care and diligence.
The New Hampshire Supreme Court most recently described this duty in a case decided in September.
Following Spitzer’s lead, various attorneys general and insurance departments around the country have weighed in. The New Hampshire Department of Insurance has been engaged on the issue.
Several days after New York’s initiation of its lawsuit against the targeted brokerage firm, California Insurance Commissioner Garamendi issued proposed regulations addressing broker compensation. The California proposal merges the distinction between agents and brokers which strikes me as questionable in light of the fact that they generally serve different masters.
The National Association of Insurance Commissioners (NAIC) has established a 13-member state task force to develop a proposed model law for the disclosure of compensation arrangements involving brokers. It also will develop and coordinate an inquiry/examination mechanism for states to use with insurers and brokers. The NAIC has additionally launched an on-line fraud reporting service to allow anonymous “tips” of “unscrupulous business practices for investigation by the states.”
The brokerage community has responded quickly – some demonstrating good crisis management. There have been two guilty pleas, a high-profile “brokered” (no pun intended) resignation and probably more pain to come. Several top-shelf brokerages, including the primary target of Spitzer’s actions, have abandoned use of the contingent commission agreements. It’s not clear whether they’ll be replaced.
When the various attorneys general, insurance regulators and class action lawyers are through with these issues, it seems as though one certain result is increased transparency. Simply put, rules will require adequate disclosure of insurance commission compensation arrangements. In light of recent enhancements in general corporate governance and a renewed focus on accounting transparency, it would seem as though this change is warranted.
I would caution against upsetting compensation systems that have worked well in the agency distribution channel due to allegedly illegal actions on the part of some brokerage firms. The regulatory response to the bid-rigging fiasco should be tempered as it relates to the contingent commission compensation arrangements. This is particularly true for their use by agents.
While disclosure may be entirely appropriate, over-regulation or prohibition may actually decrease consumer choice. If it becomes difficult for agents to comply with forthcoming regulations dealing with compensation arrangements with insurers, one likely result is to do business with fewer insurers. This will actually provide consumers with fewer choices and less “agent-based” competition.
Decreasing choice and limiting competition is not in the interest of the insurance consuming public. Regulatory responses should be measured and focused primarily on the true evils – bid-rigging and other illegal activity.
Donald J. Pfundstein is managing director of the Concord law firm of Gallagher, Callahan & Gartrell. He can be reached at email@example.com.