[Senate Hearing 108-736]
[From the U.S. Government Publishing Office]
S. Hrg. 108-736
OVERSIGHT HEARING ON INSURANCE BROKERAGE PRACTICES, INCLUDING POTENTIAL
CONFLICTS OF INTEREST AND THE ADEQUACY OF THE CURRENT REGULATORY
FRAMEWORK
=======================================================================
HEARING
before the
FINANCIAL MANAGEMENT, THE BUDGET, AND INTERNATIONAL SECURITY
SUBCOMMITTEE
of the
COMMITTEE ON
GOVERNMENTAL AFFAIRS
UNITED STATES SENATE
ONE HUNDRED EIGHTH CONGRESS
SECOND SESSION
__________
NOVEMBER 16, 2004
__________
Printed for the use of the Committee on Governmental Affairs
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97-049 WASHINGTON : 2004
____________________________________________________________________________
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COMMITTEE ON GOVERNMENTAL AFFAIRS
SUSAN M. COLLINS, Maine, Chairman
TED STEVENS, Alaska JOSEPH I. LIEBERMAN, Connecticut
GEORGE V. VOINOVICH, Ohio CARL LEVIN, Michigan
NORM COLEMAN, Minnesota DANIEL K. AKAKA, Hawaii
ARLEN SPECTER, Pennsylvania RICHARD J. DURBIN, Illinois
ROBERT F. BENNETT, Utah THOMAS R. CARPER, Delaware
PETER G. FITZGERALD, Illinois MARK DAYTON, Minnesota
JOHN E. SUNUNU, New Hampshire FRANK LAUTENBERG, New Jersey
RICHARD C. SHELBY, Alabama MARK PRYOR, Arkansas
Michael D. Bopp, Staff Director and Chief Counsel
Joyce A. Rechtschaffen, Minority Staff Director and Counsel
Amy B. Newhouse, Chief Clerk
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FINANCIAL MANAGEMENT, THE BUDGET, AND INTERNATIONAL SECURITY
SUBCOMMITTEE
PETER G. FITZGERALD, Illinois, Chairman
TED STEVENS, Alaska DANIEL K. AKAKA, Hawaii
GEORGE V. VOINOVICH, Ohio CARL LEVIN, Michigan
ARLEN SPECTER, Pennsylvania THOMAS R. CARPER, Delaware
ROBERT F. BENNETT, Utah MARK DAYTON, Minnesota
JOHN E. SUNUNU, New Hampshire FRANK LAUTENBERG, New Jersey
RICHARD C. SHELBY, Alabama MARK PRYOR, Arkansas
Michael J. Russell, Staff Director
Richard J. Kessler, Minority Staff Director
Nanci E. Langley, Minority Deputy Staff Director
Tara E. Baird, Chief Clerk
C O N T E N T S
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Opening statements:
Page
Senator Fitzgerald........................................... 1
Senator Akaka................................................ 24
Senator Carper............................................... 25
WITNESSES
Tuesday, November 16, 2004
Hon. Eliot L. Spitzer, Attorney General, State of New York....... 5
Hon. Richard Blumenthal, Attorney General, State of Connecticut.. 8
Hon. Gregory V. Serio, Superintendent of Insurance, State of New
York, on behalf of the National Association of Insurance
Commissioners.................................................. 9
Hon. John Garamendi, Insurance Commissioner, State of California. 12
Albert R. Counselman, President and Chief Executive Officer,
Riggs, Counselman, Michaels and Downes, Inc., on behalf of the
Council of Insurance Agents and Brokers........................ 30
Alex Soto, President, InSource, Inc., on behalf of the
Independent Insurance Agents and Brokers of America............ 32
Ernst N. Csiszar, President and Chief Executive Officer, Property
Casualty Insurers Association of America....................... 34
Janice Ochenkowski, Senior Vice President, Risk Management, Jones
Lang LaSalle, and Vice President for External Affairs, Risk and
Insurance Management Society................................... 36
J. Robert Hunter, Director of Insurance, Consumer Federation of
America........................................................ 38
Alphabetical List of Witnesses
Blumenthal, Hon. Richard:
Testimony.................................................... 8
Prepared statement........................................... 72
Counselman, Albert R.:
Testimony.................................................... 30
Prepared statement........................................... 96
Csiszar, Ernst N.:
Testimony.................................................... 34
Prepared statement........................................... 115
Garamendi, Hon. John:
Testimony.................................................... 12
Prepared statement........................................... 92
Hunter, J. Robert:
Testimony.................................................... 38
Prepared statement........................................... 130
Ochenkowski, Janice:
Testimony.................................................... 36
Prepared statement........................................... 123
Serio, Hon. Gregory V.:
Testimony.................................................... 9
Prepared statement........................................... 77
Soto, Alex:
Testimony.................................................... 32
Prepared statement........................................... 107
Spitzer, Hon. Eliot L.:
Testimony.................................................... 5
Prepared statement........................................... 55
APPENDIX
American Insurance Association, prepared statement............... 148
The Insurance Marketplace Standards Association (IMSA), prepared
statement...................................................... 150
The National Associaiton of Professional Insurance Agents,
prepared statement............................................. 153
OVERSIGHT HEARING ON INSURANCE
BROKERAGE PRACTICES, INCLUDING
POTENTIAL CONFLICTS OF INTEREST
AND THE ADEQUACY OF THE CURRENT
REGULATORY FRAMEWORK
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TUESDAY, NOVEMBER 16, 2004
U.S. Senate,
Subcommittee on Financial Management,
the Budget, and International Security,
of the Committee on Governmental Affairs,
Washington, DC.
The Subcommittee met, pursuant to notice, at 10:32 a.m., in
room SD-342, Dirksen Senate Office Building, Hon. Peter G.
Fitzgerald, Chairman of the Subcommittee, presiding.
Present: Senators Fitzgerald, Akaka, and Carper.
OPENING STATEMENT OF SENATOR FITZGERALD
Senator Fitzgerald. This meeting will come to order. I
would like to advise the panelists and the audience that the
Democratic Senate Caucus has just called a meeting at 10:30 and
so Senator Akaka will be somewhat delayed, but he intends to
come here later.
Today, I conduct my final oversight hearing as a U.S.
Senator and the hearing is on the growing controversy
surrounding insurance brokerage practices and the impact of
these practices on the consumer. I would like to welcome the
distinguished witnesses we have with us today and thank them
for taking the time out of their busy schedules to share their
perspectives.
Today, we consider allegations that some insurance brokers
hired and paid by their clients to represent them in procuring
insurance suited to their needs have instead steered their
clients to the insurers who are paying so-called contingent
commissions, that is, commissions above and beyond their direct
commissions that are based on volume or profitability of
insurance business. In some cases, according to Attorney
General Eliot Spitzer's lawsuit and the guilty pleas of certain
broker executives, some broker employees have apparently even
engaged in criminal bid rigging and price fixing. Everyone
inside and outside the insurance industry condemns the criminal
conduct and calls for its vigorous prosecution and punishment.
This oversight hearing breaks no new or interesting ground
with respect to criminal bid rigging or price fixing. We do,
however, critically examine the compensation structure of
insurance brokerage and we ask whether that structure poses
unacceptable conflicts of interest and whether our current
regulatory system is equipped to tackle that question with due
regard for both free and fair markets.
My study of this insurance brokerage controversy convinces
me that there is a Federal role, the time-honored Federal role
that guarantees competition and fights the mischief of undue
market concentration.
Contingent commission arrangements have been common and
legal for decades. I believe it is no coincidence that the
controversy of these compensation arrangements tracks the
increasing consolidation of the brokerage market, especially
the market for large corporate buyers. I believe it is no
coincidence that Attorney General Spitzer first sued the
largest market player in insurance brokerage, and I believe it
is no coincidence that when Attorney General Spitzer first
investigated contingent commissions pursuant to his powers
under New York's Donnelly and Martin Acts, he appears to have
discovered anti-competitive and even criminal abuses
orchestrated not just by any random insurance broker, but by an
insurance broker that controlled 40 percent of its target
market.
By itself, an ordinary contingent commission seems unlikely
to harm consumers or competition. Indeed, a broker who favored
an inferior insurer merely because that insurer paid contingent
commissions would quickly find itself swamped by competitors
eager to provide a superior service to the broker's ill-served
clients.
But that, of course, presupposes competition. What if
insurance buyers with global insurance needs had little choice
in selecting a broker? And what if insurers seeking global
expansion of their business had little choice in accommodating
a broker? In short, what if one or two global insurance brokers
constituted a market bottleneck?
On the face of it, contingent commissions raise the specter
of a conflict of interest. In any given instance of advising a
client to purchase insurance from a particular insurer, has the
broker provided that advice because it is in the best interest
of its client or because the broker will be better compensated
by this particular insurer under a contingent commission
arrangement?
I believe it is mistaken, however, to look at contingent
commission agreements in the abstract and draw sweeping
conclusions from what first appears to be a misdirected
incentive. Sales forces in many healthy, competitive industries
enjoy incentive compensation or some form of profit sharing.
The operative question should not be, could an unscrupulous
broker theoretically steer business to an insurer despite the
interest of its client and based on self-interest alone? The
operative question should be, could a broker or a dominant
group of brokers consistently get away with steering business
to an insurer despite the interest of its client and based on
self-interest alone?
If we answer the former question yes, then we have a breach
of contract or perhaps a tort claim. If we answer the latter
question yes, then we have a failure of competition. For
failures of competition, our soundest antidote is antitrust
law.
For nearly 60 years, since enactment of the McCarran-
Ferguson Act of 1945, regulation of the business of insurance
has been delegated entirely to the States. The system of State
regulation has worked well for many purposes, but State
regulation purporting to govern global conduct may not always
perfectly detect the abuses of daunting market power.
I believe it is time for Congress to revisit the antitrust
exemption of the McCarran-Ferguson Act with respect to
insurance brokerage and to make clear that vigorous Federal
antitrust enforcement can and will reach the kind of anti-
competitive conduct on the part of insurance brokers alleged in
Attorney General Spitzer's lawsuit.
Furthermore, I see no continuing reason to shackle the
Federal Trade Commission with an antiquated prohibition on even
the mere study of the insurance industry. Until 1980, the
Federal Trade Commission was empowered to study the industry
and make policy recommendations. That year, Congress took away
even that modest authority. The FTC enforces antitrust laws,
among other charges. Declaring the FTC categorically unsuited
even to peer at the insurance industry ignores the reality of
national, indeed global, insurance markets, increasing
consolidation in some market segments, and surges of
centralized coercion that may not readily appear on the
regulatory radar of any single State.
If we profess to favor free markets and robust competition,
then we must equally favor their civilizing predicates,
antitrust law and transparency. Healthy markets thrive on
sunshine, and it has certainly been said of these contingent
commission arrangements in insurance brokerage that disclosure
is woefully inadequate.
We hear numerous calls for better disclosure of these
compensation arrangements. But I will be especially interested
in hearing from the witnesses exactly what form they propose
for this better disclosure, and more fundamentally, whether
disclosure alone is adequate to counter market concentration.
Put another way, for those witnesses who promote greater
disclosure as an adequate fix for this brokerage controversy,
would you likewise support vigorous enforcement of Federal
antitrust law to counter the leveraging of market domination?
I believe that transparency is an important and salutary
measure. Depending on its form and content, it may be more than
we need in markets that are competitive. But in markets that
are not competitive, mere disclosure of a practice that a
dominant company can demand may not be enough.
This oversight hearing occurs at an interesting time, not
only because certain insurance brokerage practices have come
under fire, but because Congress is increasingly focused on
insurance reform. I will be interested in hearing the views of
the witnesses as to whether they believe that this brokerage
controversy lends more or less support to the optional Federal
charter proposal, which would put insurance companies on a
footing similar to banks in the ability to choose either State
or Federal regulation.
And I will be interested in hearing the views of the
witnesses as to whether this brokerage controversy lends more
or less support to the proposal developed by the leadership of
the House Financial Services Committee, the State Modernization
and Regulatory Transparency Act, or SMART Act, a draft of which
has been circulated by Chairman Oxley and Capital Markets
Subcommittee Chairman Baker. The House Financial Services
Committee has conducted 16 hearings on insurance reform since
the Committee's organization in January 2001 and I applaud the
hard work of Chairman Oxley and Congressman Baker in this area.
At this point, I will save my introduction of Senator Akaka
for later when he arrives and I would like to proceed directly
to our first panel of witnesses.
Our first witness is the Hon. Eliot L. Spitzer, the 63rd
Attorney General for the State of New York. Mr. Spitzer
testified previously before this Subcommittee on mutual fund
reform and we welcome you back here today. By the way, after
you testified here, some of the larger mutual fund complexes,
as you may have noticed, lowered their fees, at least on
indexed funds, sometimes by four to five times, so
congratulations. I think you had a significant effect that went
well beyond your complaints.
On October 14, 2004, Attorney General Spitzer filed a civil
suit against Marsh and McLennan Companies for alleged violation
of State law regarding the companies' compensation
arrangements. That same day, he also filed criminal actions
against specific individuals in the insurance brokerage
industry. Last Friday, November 12, Attorney General Spitzer
filed a second civil suit against a California broker,
Universal Life Resources, alleging that Universal accepted so-
called override fees from insurers to steer business to them.
Our second witness is the Hon. Richard Blumenthal, Attorney
General for the State of Connecticut. Attorney General
Blumenthal has launched an investigation into insurance broker
commissions and is seeking new State laws in this area. He was
first elected to serve as Connecticut's 23rd Attorney General
in 1990 and is currently serving an unprecedented fourth term.
Prior to being elected Attorney General, Mr. Blumenthal served
in both the Connecticut State Senate and the House of
Representatives. Mr. Blumenthal also served as U.S. Attorney
for Connecticut from 1977 to 1981.
Our third witness is the Hon. Gregory Serio, Superintendent
of Insurance for the State of New York. He is here today to
represent the National Association of Insurance Commissioners,
known as NAIC. As New York Superintendent of Insurance, Mr.
Serio is responsible for the monitoring and regulation of more
than 1,000 insurance companies, with total assets exceeding $2
trillion. Mr. Serio previously served as First Deputy
Superintendent and General Counsel of the New York Insurance
Department and is Chief Counsel to the New York Senate Standing
Committee on Insurance.
Our fourth witness is the Hon. John Garamendi, Insurance
Commissioner for the State of California. Mr. Garamendi was
first elected as Insurance Commissioner in 1991. He
successfully implemented Proposition 103, which put into place
a major reform of the auto and homeowners' insurance industry
in California. In 1995, President Clinton appointed Mr.
Garamendi as Deputy Secretary at the U.S. Department of the
Interior. He was elected to a second term--I guess you came
back and were elected to a second term as California's
Insurance Commissioner in 2003, and last month, he proposed
regulations that would require disclosure of certain financial
incentives received by insurance agents and brokers.
Again, I would like to thank you for being here to testify.
Mr. Garamendi traveled for 5 hours to get here, all the way
from the Golden State, and we know it takes a lot of time to
come to Washington to testify. We appreciate it.
In the interest of time, we will include your full
statements in the record and we would appreciate it if you
could limit your opening remarks to 5 minutes. We will have a
light that is at your table that will kind of keep track of the
time.
Attorney General Spitzer, welcome again to the
Subcommittee. We really appreciate your help and I compliment
you on the outstanding job you have been doing. You have been
breaking new ground in many different areas and I admire your
courage and tenacity. So thank you for coming before us.
TESTIMONY OF HON. ELIOT L. SPITZER,\1\ ATTORNEY GENERAL, STATE
OF NEW YORK
Mr. Spitzer. Mr. Chairman, thank you very much for your
kind words, and in particular, thank you for your leadership on
these issues. They have not always been easy issues, but you
have played a unique role in leading Senate inquiries into
critically important areas in the financial services sector and
I am tempted just to adopt your statement as my statement and
then leave it at that. It was right on point, in particular
your statements about McCarran-Ferguson, the FTC, and the need
for Congressional inquiry. I will get there in a moment.
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\1\ The prepared statement of Mr. Spitzer appears in the Appendix
on page 55.
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To quote but amend Yogi Berra, this is deja vu all over
again one more time. This is the third time we have seen the
same story. We saw it with analysts at the investment banks. We
saw it with mutual funds. Now we see it with the insurance
industry. There are common elements to each of these three
stories and I will very quickly run through them.
In each instance, we have seen the financial services
sector incapable of resisting a conflict of interest. In every
instance, it has capitalized on that to the detriment of those
to whom it owed a duty of care. Indeed, at one point, we all
know the famous comment from one Wall Street analyst who said
what used to be viewed as a conflict of interest is now viewed
as a synergy and they simply do not understand the difference.
Second, in each instance, each of these three story lines,
there has been an abject failure of self-regulation. Nobody
came forward to say there is a problem, there is an issue with
respect to steering, bid rigging, conflict of interest that run
deep in the industry, just as nobody came forward with analysts
or mutual fund scandals.
Third, there has been a failure of the regulatory entities
that are supposed to oversee the sector. They failed to ask
even obvious questions that would have revealed deep-seated
problems.
Fourth, we have had continuing claims of purity and
excessive regulation, and indeed claims of intense competition
from industry leaders up until the point that the allegations
were leveled.
And finally, we had dramatic mea culpas only once they were
caught.
This is a story line which would be tiresome and grow
wearisome over time. Indeed, we have seen it in other sectors,
as well, most notably the pharmaceutical sector, but since we
are here to discuss financial services, I will not verge into
that.
Let me describe very quickly the sequence of our--the
progression of our inquiry, and it began with simply a letter
which notified us that there were PSAs, MSAs, contingent fees
which are, as you said, Mr. Chairman, not in and of themselves
improper. But given the magnitude of these fees, we simply made
an open-ended inquiry to Marsh and McLennan and asked them, how
do you ensure that these fees do not taint the decisionmaking
that you endeavor to make on behalf of your clients?
We were told two things. First, there is adequate
disclosure. And second, there is no information flow within the
company such that the front-line brokers who were making the
decisions about what products to recommend don't even know what
the contingent fees are, and therefore, we were told, they
cannot be influenced.
We learned very quickly that the claim of adequate
disclosure was simply false. The disclosures that are made are
not only grossly inadequate, they are often misleading, and
indeed the companies, and I say that plural, intentionally make
it difficult for their clients to find out what MSAs, PSAs, or
overrides are paid because they do not want that information to
be made available.
We went back to the company and said, give us more
information. They said, well, nonetheless, even if the
disclosure is not adequate, there is no information flow, and,
of course, we found out very quickly not only was it impossible
to cabin information relating to an $800 million revenue flow
within the company, but there were specific instructions to the
brokers to steer business based upon the magnitude and the
relative value of the override payments and contingencies.
We dug even further and we were told by the company in
response, well, maybe there is steering, but there is no
steering to detriment, a comment that seems blatantly
contradictory on its face. If you are steering, it is
necessarily steering to detriment. We then said to them, how
can that be, and they said, well, only if there are identical
proposals for an individual client would we choose based upon
the MSA, and we said that is somewhat ridiculous, and indeed it
is.
We then dug further, asking the last logical question,
because, of course, if I have a fiduciary duty to a client, I
don't want that client to see different bids in the file and to
have the client see that I am not picking the best bid. So
necessarily, then, you begin to act in a way to ensure that
only the bids you want end up in the file. And so we inquired
of the carriers, do you have any information for us that would
indicate bid rigging in the system? Forty-eight hours after we
served that interrogatory on the carriers, lo and behold, our
phone started ringing and we were the recipients of remarkable
information about the bid rigging scandal that we have seen as
a consequence.
There is liability that extends to brokers. There is
liability that extends to carriers, civil and criminal. As you
said, there have been criminal pleas entered. There will be
more criminal pleas entered very shortly, perhaps as early as
today, from another carrier. That is ongoing as we speak. And
we are finding undisclosed relationships that clients simply
would be appalled to understand if they had ever been told.
The impact on our markets is enormous. The insurance sector
is vast. The numbers are laid out in my testimony. And it has
indeed become part of our political discourse over the past few
years that the impact of rising premiums has been a tremendous
drain and disincentive for the creativity of our capital
markets and businesses in general.
Unfortunately, we have not heard that one of the reasons
the premiums have been rising has been the collusive behavior,
illegal behavior, of brokers and carriers, behavior that they
understood that they simply refused to detail to the public.
Let me say, Mr. Chairman, I think there are four discrete
areas where Congressional inquiry would be terribly useful,
inquiry that is necessary for Congress to undertake, because
frankly, I think only Congress has the capacity to reach the
subpoena power to really delve fully into the breadth and scope
of the issues before us. With all due respect to my fellow
regulators at the State level who have done, in many ways, a
very good job, these are issues that Congress must begin to
inquire into.
The first area relates to the massive insurance capital
flow to offshore vendors. Why is it that suddenly Bermuda is
the home to so many insurance carriers, reinsurance carriers,
brokers? Why have we seen such massive capital outflow from the
United States, where there is regulatory authority for the
States to exercise, to venues where the insurance carriers, the
reinsurance carriers, and the brokers intentionally secrete
themselves in ways and in areas that we cannot inquire into?
There is, I would suspect, a Pandora's box that should be
opened so we can understand what is going on in these offshore
venues. It will not be a pretty picture.
Second, we need to scrutinize the wide-ranging interlocking
relationships that have been revealed just from our superficial
inquiry among brokers, insurance carriers, reinsurance
carriers, reinsurance brokers. There is a multi-layered stream
of income that flows to these companies, often with common
ownership, that is simply not understood, that is not revealed,
that has every indication of being corrupt and anti-
competitive. It is an ugly picture.
Third, how are premiums being set? We hear much that is
said about their huge losses. We see premiums spike. But I
don't think we really understand the true finances of these
companies. Part of the reason is they have secreted assets
overseas. They have hidden them offshore. It is about time that
we get accountability. The only way is to delve into, in a much
more serious way than has ever been done, the way they set
their fees.
Finally and fourth, I would suggest that there should be a
fundamental inquiry into the ethics of an industry that needs
to be fundamentally scrutinized. Just as has been the case with
every other scandal that has come before us, the failure of
this industry at any point to put up its hand and say, we have
a problem, their willing, rapid descent to the lowest common
denominator of behavior that is criminal, violates common
decency, is appalling. This is an industry that has for years
claimed purity. Once again, we are seeing that the more
profound their claims of purity, the more profound the heinous
behavior we find. Thank you very much.
Senator Fitzgerald. Thank you, Mr. Spitzer. Mr. Blumenthal.
TESTIMONY OF HON. RICHARD BLUMENTHAL,\1\ ATTORNEY GENERAL,
STATE OF CONNECTICUT
Mr. Blumenthal. Thank you, Mr. Chairman. I would like to
join General Spitzer in thanking you for your leadership, your
courage, and your tenacity as a leader of this Subcommittee and
I am chagrined to hear that we are at your last hearing, but I
hope it is a meaningful one and I know that your leadership
will be much appreciated in this body.
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\1\ The prepared statement of Mr. Blumenthal appears in the
Appendix on page 72.
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I would like to thank my fellow panelists, most
particularly General Spitzer for his leadership in this area.
Each of them has played a role and I am honored to be with them
on this panel.
In Connecticut, we have an investigation that is separate
and distinct, has involved some 43 subpoenas beginning in
October. Even earlier, we issued letters of inquiry. The scale
and magnitude of corrupt practices and unethical conduct
continue to mount. Increasing evidence of those practices
certainly means that fundamental reform is necessary, more than
simply disclosure, as you quite rightly suggest.
The evidence of illegal and harmful conduct, harmful not
just to individual consumers but to our entire economy,
mandates that we act decisively and dramatically to restore the
credibility and trust in this industry and in the regulators
who have a responsibility to oversee and scrutinize it. What we
have seen in our investigation is evidence of bid rigging,
fraudulent concealed commissions, secret payoffs, and conflicts
of interest, all stifling competition and inflating the cost to
consumers as well as businesses.
There will be a barrage of well-aimed, powerful State
enforcement actions. They will involve more than one State. We
are now seeing a multi-State response to this crisis, and even
as we speak, there is communication and growing cooperation
among those States to address this problem.
Our aim is to pursue these actions promptly and
aggressively, not to be diverted by any voluntary changes on
the part of the industry, but uncover all the wrongdoing and
recover ill-gotten gains for consumers. Restitution is a vital
objective.
But reform is also an important goal and I want to be very
straightforward with this Subcommittee. I welcome the idea of
changing Federal antitrust laws so as to enable and encourage
Federal enforcers to play a greater role and I welcome the
inquiry that the Congress may make in regard to the areas that
have been concealed. But I would strongly resist, indeed, the
States will fiercely fight, any effort to preempt them or
supplant them or prevent them from protecting their consumers.
Antitrust has been traditionally a strong and vital role for
the States. Consumer protection in the insurance industry has
been traditionally and historically a State responsibility. And
so while we may fervently hope for cooperation, we would
fiercely fight any preemption.
On the other hand, while federalizing the problem is not a
solution, States must reform their own houses and stronger
State laws are necessary. I want to commend Insurance
Commissioner Garamendi for his leadership in this area, and my
testimony sets forth some very specific proposals that go
beyond disclosure, although they focus also on disclosure, full
and complete disclosure, when a broker, for example, is
compensated by both the insured and the insurer.
I believe there must be consumer choice to have a broker
represent him exclusively. There must be a code of ethics that
is binding. There must be other reforms that mandate better
practices, forbid conflicts of interest and provide the
policing and resource authority that is necessary.
So I think that State insurance laws must be reinvigorated
and reinvented so that they are real agents of reform and
insurance commissioners cease to be captives of the industry as
they have been all too often in the history of insurance
regulation.
Federalizing the problem may not be a solution, but the
States must do a better job in protecting consumers. I welcome
this opportunity and hope that it is the beginning of a
constructive dialogue between the States and the Congress on
this subject. Thank you very much.
Senator Fitzgerald. Thank you, Mr. Blumenthal. Mr. Serio.
TESTIMONY OF HON. GREGORY V. SERIO,\1\ SUPERINTENDENT OF
INSURANCE, STATE OF NEW YORK, ON BEHALF OF THE NATIONAL
ASSOCIATION OF INSURANCE COMMISSIONERS
Mr. Serio. Mr. Chairman, thank you. The events of the past
month have shone a bright and rather unflattering light upon
the insurance industry. Compensation arrangements that smack of
bid rigging, of steering, of favoritism are wrong and they have
always been wrong. The industry has tried to split legal hairs
to say that alternative compensation arrangements are lawful,
but they seem to miss the point when they do that. There are
serious endemic problems inside the industry that have only now
been uncovered.
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\1\ The prepared statement of Mr. Serio appears in the Appendix on
page 77.
---------------------------------------------------------------------------
The use of PSAs, MSAs, and other contingency arrangements
and how they have been used in insurance brokering for overtly
or implicitly influencing basic insurance transactions for the
benefits of the broker and/or the insurer and to the detriment
of the insured is wrong and has always been wrong. Failing to
disclose these arrangements to commercial buyers only makes
that matter that much worse.
For brokers and carriers, the test was and always is a
straightforward one. Have they acted in the best interest of
the consumer, or could their acts be seen to constitute a
conflict of interest? Frankly, putting it more bluntly, we
would ask, would the consumer of the insurance product object
to the fees and the additional costs if they knew about them,
and would they object if they knew that the compensation
arrangement figured prominently into the recommendation to make
a certain placement?
This test, applicable to virtually every broker-driven
insurance transaction, is particularly crucial to the integrity
of the insurance transactions that take place at supposedly
sophisticated levels where by law there has been minimal
regulatory authority or legal standards defining the four
corners of the transaction. Yet time and again, brokers and
carriers both ignored the test, thereby ignoring the best
interests of the insurance buyer.
The insidious nature of the transgressions, together with
an apparent ``go along to get along'' attitude on the part of
the carriers and even some buyers has turned the legal actions
taken so far into a rocket fuel for changing the course of
public policy. Brokers and insurers are even racing to disavow
PSAs. At this point in time, though, we are not satisfied with
simply undoing the inappropriate behavior. We want to take the
opportunity to effectuate real and meaningful change and
improve the integrity of the market and better protect all
consumers at all levels of sophistication.
This industry has earned a sweeping reform, whether through
legal and regulatory action taken so far or future legislative
action. And frankly, the professional insurance buyers have
also earned some of the reforms that will be coming down the
road.
The NAIC, which has spearheaded a multi-year effort to
uniformize rules for the licensing and regulating of brokers,
proposed a new rule for the disclosure of all compensation the
producer receives from an insurer in the placing of business.
Furthermore, to make certain that insurance buyers are indeed
active participants in the insurance transaction, the NAIC
proposed that buyers provide written consent for the producer
to receive any contingent compensation. The NAIC is also
coordinating a nationwide information network for people to
provide online tips to the insurance commissioners around the
country to register complaints regarding broker activities.
The NAIC's member insurance departments discipline brokers
and agents every day for violating the respective duties they
owe to their clients. The regulatory actions are taken after
investigations, are usually started with a complaint, are
usually from insured or from information gained from tips or
from information gained during other regulatory activities.
The specific actions taken in New York over the past month
by the Insurance Department relating specifically to broker
compensation, the citing of 15 separate Marsh entities and the
flagging of all licenses associated with Marsh, the citing of
ULR and its principal, and the expected increase in regulatory
activity over the coming weeks arose out of the collaborative
efforts between the New York Insurance Department and the New
York Attorney General. This matter originated with a single and
specified complaint to the Department by a carrier and
accelerated into the investigation it is today through the
filing of very specific complaints by others with the Attorney
General.
In fact, I have to agree with the Attorney General that the
industry has not been forthcoming on providing specific
information about these problems. Indeed, we had to take what
would be called the slow road to our examination, our early
examination into the use of PSAs because the very complainant
who brought an initial complaint to us, a competitor in the
marketplace, failed to provide the Department with the kind of
information that would have led us down this path.
It has been because of the Attorney General's powers as the
chief law enforcement officer of the State as the appropriate
lead agency on this matter, given his broader legal powers, his
greater investigative resources, and frankly, his tireless
pursuit of cases of this nature, and the Department has been in
every respect a full collaborator on this and on many other
matters that we have undertaken jointly over the past several
years.
The State regulatory system, insurance regulators and law
enforcement together, have worked to reveal these problems in
the marketplace. Though people will still be tempted to declare
this a crisis of regulation or to declare an acute need for
wholesale Federal intervention in the regulation of insurance,
these should be avoided as the only responses for these
reasons.
The insurance industry, as the preceding speakers have
said, more than regulation itself, needs modernization. An
industry that does not provide a written contract at the time
risks are bound needs to be modernized. An industry whose
executives are afraid to sign certifications stating that their
regulatory filings comply with the law needs to be modernized.
An industry that has sought Federal legislation as much to
escape regulation as to improve its own efficiency and efficacy
needs to be modernized. And certainly an industry that finds
itself facing questions of fundamental fairness in its
treatment of customers needs to be modernized, no matter how
small or compartmentalized the problem may seem to be. I agree
with Attorney General Spitzer that it is not a small or
compartmentalized problem at all.
The modernization will come from the legal and regulatory
actions now being taken. It will come from the NAIC. It will
come from Commissioner Garamendi and our colleagues at the
NAIC. And the Congress' own deliberations on SMART, which has
been moving, to provide uniformity of rules across State lines
will also be an important component of this.
The Congress' recent work in the area of military sales of
life insurance could well provide a workable model of joint
Federal-State regulation. Federal declarations of the authority
of State insurance departments to regulate insurance sales,
together with oversight, is a good way to go about this.
Much of the modernization, though, will still have to come
from the industry itself. I noted to the Senate Banking
Committee back in September that Federal regulation has not
been the missing link in the efforts to modernize insurance.
Rather, the absence of an industry-wide self-regulating
mechanism promoting the highest and best standards on corporate
governance, market conduct, and financial safety and soundness
represents a significant hole in the insurance regulatory
construct.
Creation of an industry compliance model is a priority.
Taking the steps within property casualty that were taken by
the life industry after the illustration scandals of the early
1990's is an imperative. Joining in a property casualty
industry-wide organization is overdue. Acceptance of a 21st
Century regulatory structure allowing State regulators to peer
beyond the four corners of regulated entities into the 21st
Century corporate structures that own or control these
regulated entities will be the first measure of good faith that
the industry can exercise to let us know that they are serious
about putting the current matter behind them and taking some
personal responsibility for how they operate as corporate
citizens in the months and years ahead.
I look forward to your questions.
Senator Fitzgerald. Thank you very much. Mr. Garamendi.
TESTIMONY OF HON. JOHN GARAMENDI,\1\ INSURANCE COMMISSIONER,
STATE OF CALIFORNIA
Mr. Garamendi. Thank you very much, Mr. Chairman, for the
invitation to appear. This hearing is extremely important. You
have my written testimony. I will summarize it and add a few
additional comments.
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\1\ The prepared statement of Mr. Garamendi appears in the Appendix
on page 92.
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There has been much discussion in recent weeks,
particularly since the election, about values, about morality.
It is rather narrowly defined. Unfortunately, we are faced with
a situation here of values. We are faced with a situation of
ethics. And above all else, just flat out greed. It has to be
addressed.
This issue is not new, as Attorney General Spitzer pointed
out in his opening remarks. It is found pervasively throughout
corporate America. This country, this economy will not prosper
and will not move forward if there is no trust in the basic
systems that we must have. So we must go further.
I don't know where this is going to end up. We are in the
opening pages of a very long and sordid chapter in America's
corporate life and we have to change it. We absolutely must.
Otherwise, we are going to have a series of problems. We simply
cannot have economic growth without a sound, viable, readily
available, competitive and fair insurance system. It is one of
the fundamental building blocks of economic systems and
particularly the American system.
We will, in California, continue our investigations, both
with the Department of Insurance effort of investigating. We
will be bringing lawsuits against numerous brokers as well as
insurance companies. Those are underway. Those will be
coordinated with other States. We are already coordinating with
the New York Department as well as Attorney General Spitzer and
we will see much more coordination among many departments of
insurance across the Nation as well as Attorney Generals.
You will have over 100 investigative agencies on this
issue. All the various departments of insurance, 50 of them,
plus a couple of districts--one district and some territories
will be engaged, and Attorney Generals. That is a very
formidable enforcement action that will take place, and I
suppose that eventually the Federal agencies will wake up and
get at it, also.
In California, beyond the investigation, we have the
lawsuits that we will be pursuing. We are also pursuing a very
vigorous effort to rewrite our regulations. This is not going
to require new law. The laws have been in place for a long
time. They basically say that a broker owes its allegiance to
the consumer, to the customer, whether that be mom and pop on
the corner or in the home or a major corporation. It is that
breach of fiduciary responsibility that is at the heart of this
problem.
To better illuminate and to provide a bright line, in
California, we are writing new regulations to do just that, to
illuminate and to clarify, and I will very briefly go through
that for your use here at the Federal level. This particular
regulation is becoming the starting point for the National
Association of Insurance Commissioners to develop a draft model
law or regulation as may be required by the various States, and
that process is moving along very swiftly and I would expect it
to be completed at the December meeting of the NAIC.
So here is what we propose to do in the regulatory process.
The intent of it, and the language follows along, is to require
disclosure of all compensation a broker receives from any
party, including an insurer, in connection with the placement
of insurance on behalf of a client. Pretty simple, should have
been done, hasn't been done.
Second, to prohibit a broker from putting his own financial
interests ahead of a client's by, for example, failing to
obtain quotes for insurance from a reasonable number of
insurers able to meet the client's needs because the broker has
an agreement to receive compensation from other insurance or
from a specific insurer.
Third, failing to present an offer for an insurer to be
able to meet the client's needs because the broker has an
agreement, MSA or a contingency commission. And fourth,
recommending that a client accept an offer from an insurer
because a broker has an agreement to receive compensation from
that insurer when another insurer has made a superior offer.
It would seem to be that these would be uncontroversial and
should not be imposed by anybody. It is simply a matter of
fairness, competition, and open markets. As I have said, I
believe that there has been a need to clarify. Yet, you are
going to hear from the industry objections and I want to
respond to those objections right here and tell them they are
going to have a big fight.
First, the objections are these. With respect to the
disclosure of the amount of commissions, brokers and agents
will ask, well, why should we have to disclose the amount of
the commissions? Most salespeople in other industries, they
don't say what their commissions are, and they don't say where
they are getting their money. The answer is this. Buying
insurance isn't like buying groceries. It is not like buying a
car. Security brokers and real estate brokers are required to
disclose the sources and insurance salespersons and brokers
should, also.
Second, you are going to hear, why do these only apply to
brokers? Why not to agents? The answer is fairly simple. Agents
have a specific--they work for the insurance company. They
don't work for the customer.
Third, you are going to hear that how could we disclose the
amount when we really don't know what it is going to be,
because, after all, these are contingencies. Well, make a good
guess to fully disclose everything you know. Even though it may
not be totally accurate, at least the customer will know where
you are getting your money.
And finally, and this is probably going to be the biggest
fight that we are going to have, brokers and agents will
complain, oh my, you are imposing an impossible obligation on
us. You are asking us to tell the customer what is suitable or
what is the best available option and there are too many
factors for us to do that. These are supposed to be
professionals. These are supposed to be people that know the
market. And to simply be able to apply their judgment, their
best judgment, is not an impossible task and they are not going
to face any more lawsuits in this area than they would in
some--and that they already might, and certainly by not
disclosing and by steering, they are facing some very serious
lawsuits.
We are not holding the broker to an obligation to find the
very best policy, but rather it is the broker's duty to take
all reasonable steps to determine the client's needs, to use
its expertise in the best manner possible, and to make a
recommendation based upon their experience and knowledge, and
to keep their finger off the scale. That is what this is all
about. It is about ethics and it is about fiduciary
responsibilities.
Thank you, Mr. Chairman.
Senator Fitzgerald. Well, thank you all very much. I want
to begin by following up with Mr. Garamendi's discussion of
fiduciary responsibilities. Isn't one of the problems here that
under the laws in most States, insurance brokers aren't
actually treated as fiduciaries? In fact, my understanding of
New York law is that they are not fiduciaries typically and
that the courts, New York courts, have held that insurance
brokers are actually--they are not even professionals, they are
mere order takers and it is only when they engage in certain
types of conduct where they can rise to the level of
fiduciaries and owe their clients fiduciary duties.
I think Mr. Spitzer's complaint in the Marsh vs. McLennan
case is careful to cite all the advertising that Marsh and
McLennan had done in which they are advertising how they are
going to serve the client and they are going to try and get the
best deal for the client, and you find the duty arising out of
some of their statements. I believe they probably did develop a
fiduciary duty with those statements that they make.
But shouldn't consumers around the country be on guard that
their insurance agent is not like their lawyer, who owes them a
fiduciary duty? It is not like the trustee or the trust
department at the local bank, which has a duty to avoid
conflicts and has a duty to avoid self-dealing and to treat
their clients' money as they would their own, or with a higher
degree of care than their own, even. Insurance agents typically
aren't fiduciaries and you have to be very careful dealing with
them.
Mr. Garamendi. Mr. Chairman, if I might, in California, we
do have a dual law that allows a person to be both a broker and
an agent, but there is a very clear distinction. In our
proposed regulations, we make it clear what that distinction
is. It is not a new distinction. It is based in our law as well
as in the various court decisions that have come down over the
decades, and that is that a broker--a salesperson becomes a
broker when they offer their services on behalf of the client.
That is, they work for the client, the customer, the
individual----
Senator Fitzgerald. And you are proposing making them
fiduciaries in that instance, is that correct?
Mr. Garamendi. They already are fiduciaries----
Senator Fitzgerald. They already are.
Mr. Garamendi [continuing]. In that instance, both under
California law and under the various numerous court cases in
California. We are not changing it, we are simply clarifying,
making it clear that that is the situation. So when they offer
their services to the customer on behalf of the customer, on
the other hand, an agent is working for the insurance company.
There is a clear distinction, at least in the California
situation.
Mr. Blumenthal. You are correct, though, Senator, that in
most States, including Connecticut, there really is no
unequivocal explicit fiduciary duty and that is one of the
problems in the State laws and the lack of definition as well
as the blurring of lines between agents and brokers in many
States' laws. Under the model act that the insurance
commissioners themselves devised in past years, the Model
Insurance Act, the Insurance Producers Act, in effect
contributed to the blurring of lines between agents and brokers
and to the evaporation or the lack of----
Senator Fitzgerald. So that model act is a problem because
it blurs the line. How many States have adopted the model act?
Mr. Blumenthal. Exactly, and the kinds of reforms that are
being suggested by Commissioner Garamendi will help, I think,
lead us out of that morass.
Senator Fitzgerald. But they need to be adopted not just in
California and Connecticut. We need to see it changed around
the country. Mr. Serio, do you care to comment?
Mr. Serio. I think that it does need to be changed around
the country, but I think that defining the fiduciary duty and
making it binding has to be one central objective.
Senator Fitzgerald. But making these brokers fiduciaries
imposes a lot of new duties and there are a lot of brokers--
real estate agents, they are probably not fiduciary duties. I
would imagine the average person out there, if you are going to
get a real estate lease and say you are a small company and you
go to some real estate brokerage firm, they could well be
steering you to a building where the building owner is giving
them a kickback for steering you into that building. You don't
know who they represent.
Mr. Serio. Let us back up a little bit. We don't want to
get caught up in the idea of whether the threshold is to be a
fiduciary duty or not. They are licensed entities, these
brokers, and in New York, we do have a bifurcation between
agents and brokers and they do hold separate licenses, so it is
a little bit clearer in our jurisdiction as to what banner they
are flying under. It doesn't dissolve the overall question of
compensation, but it does at least make it a little bit
clearer.
But here is the thing. We take regulatory action against
brokers every day. We suspend licenses, we revoke licenses, we
fine them, not because they have violated any fiduciary duty
but because they have violated the standard of
trustworthiness----
Senator Fitzgerald. What is the standard of trustworthiness
for a broker?
Mr. Serio. That they did not act in the best interest of
their customer, that they have not operated in the body of law
that we have and the fact patterns that are presented to us----
Senator Fitzgerald. So if they are steering their customers
to carriers who offer them, the brokers, a bigger commission,
they are violating their duty to their----
Mr. Serio. That would be accurate.
Senator Fitzgerald. In all cases?
Mr. Serio. And this is the concern that we have had with
this entire situation, is that no customer complaints ever came
in on this issue. The carriers did not come forward to tell us
about this. And frankly, inside, I am told certain people went
to the Attorney General's office. We did not even get an inside
view from anybody as to how these were operating. But in your
normal mom and pop operation, when somebody is not happy with
the way that their broker treated them, they make a complaint
to the Insurance Department----
Senator Fitzgerald. Now, you said that on November 5, you
made a statement that for some reason, the customers of
insurance brokers were mute on this. Why do you think they are
mute?
Mr. Serio. Not only have they been mute, but they are still
mute on this issue.
Senator Fitzgerald. Are they terrified of Marsh and
McLennan and AON?
Mr. Serio. We have been given some off-the-record
conversations with individuals who said some of the buyers are
embarrassed that they didn't see this happening, that they
didn't say something about it when they did see it happening.
There are buyers who were told about contingency fees or were
told they were not going to be provided information on
contingency fees and they did not----
Senator Fitzgerald. So they were embarrassed they were
snookered.
Mr. Serio. And that they didn't do anything about it.
Senator Fitzgerald. OK. Mr. Spitzer.
Mr. Spitzer. Mr. Chairman, you are correct. Additional
clarity about the precise contours of fiduciary duty and when
it is triggered would certainly be helpful. Obviously, as you
pointed out, in our complaint we allege that a fiduciary duty
existed based upon representations that were made by Marsh
individuals to their clients, and therefore the client could
suppose and legitimately rely upon the Marsh individuals to act
in a fiduciary capacity.
I would add this other point, however, and I think this is
to a certain extent what Greg was hinting at. The nature of the
violations that we are alleging and that have been plead to and
have been confessed to by individuals in court do not depend
upon there being a fiduciary relationship. In other words, this
is common law fraud. This is a violation of more common law,
traditional responsibilities that are incurred even if they do
not rise to the level of fiduciary. That is why the issue of
steering and bid rigging and the undisclosed payments are so
surprising and appalling to all of us. Even in the absence of
the fiduciary duty, those would constitute violations.
One last point with respect to the mutinous of those who
were allegedly the victims. I do think that we are now seeing
behavior in the marketplace, and this, I think, proves the
point that we all agree upon. Where this behavior is disclosed,
where there is adequate opportunity and information flow for
the purchasers of insurance to make informed judgments, they
will do so. I have heard and have reliable information that
there is now a very significant push back against the brokers
by the major purchasers in various lines of insurance to ensure
that they not only get full information, but that they
eliminate the type of behavior that is injurious to the
consumer.
And so while we may not have seen and did not see--and Greg
certainly is right about this--consumers running to regulators
complaining, we are now seeing them act in their economic self-
interest, which is exactly what we want to permit them to do by
mandating disclosure and prohibiting certain types of
relationships.
Senator Fitzgerald. Now, following up on the nature of the
allegations in your complaint, some commentators have made
light of your complaint and said, well, the only thing you
found that was illegal is bid rigging and everybody agrees it
is illegal. So what? But when I read your complaint, I found
that you have six counts, I believe, and you found a whole lot
more than bid rigging. Maybe you would want to elaborate on
that.
Mr. Spitzer. Absolutely. Bid rigging is perhaps the most
egregious and the most immediately violative area where we
found behavior because it is so clearly corrosive to the
marketplace. Steering is in and of itself a violation of law,
because when the companies steer, they are making a judgment
that is not in the interest of their client and they are making
it for the improper purpose that they are receiving undisclosed
additional compensation.
I have not heard, and maybe you will hear it today from
witnesses for the industry, I have not heard a single industry
voice say steering is OK. Steering is wrong. Steering should
not be permitted. We have senior executives under oath. When
they see the E-mails--E-mails relating only to steering, where
they say they are appalled, it should not happen, it should not
be permitted. Strip out the bid rigging component of that. That
was really the third layer of the onion. Steering is the second
layer of the onion, and it is sufficient to say these companies
have violated their duty. This behavior cannot be permitted to
continue.
Senator Fitzgerald. Very analogous to the revenue sharing
we saw with the mutual fund industry.
Mr. Spitzer. Absolutely correct.
Senator Fitzgerald. And you found instances in which Marsh
and McLennan actually took existing clients who were already
placed with a given insurer and you had Marsh and McLennan
pressuring their clients to move their existing policies to
some other company that was going to pay them a higher
contingent commission, is that correct?
Mr. Spitzer. Yes, sir. And, in fact, the most--that is
correct. We saw oversteering predicated solely upon the
overrides that were being paid, and we also saw Marsh
indicating to certain carriers that they should increase their
bids so as to eliminate the possibility that the coverage would
go to a carrier which was not going to pay them as much. I
mean, the E-mails where they say, please increase your bid
because we want the business to stay here or move, there is
appalling stuff, and yet that is what we were finding.
Senator Fitzgerald. And you also state a count for
securities law violations.
Mr. Spitzer. Absolutely.
Senator Fitzgerald. Do you want to go into that and explain
how you arrived at that?
Mr. Spitzer. Sure, because there are disclosure violations.
There is a duty to disclose to investors what the basis of the
revenue stream is. Here you had a company that was deriving
$854--I think that is the right number--$854 million in revenue
from contingent fees, the basis of which was not disclosed and
the inherent illegality which was not disclosed.
Senator Fitzgerald. And in fact, when they were asked about
it by analysts on conference calls when explaining their
quarterly earnings, they refused to go into it, isn't that
correct?
Mr. Spitzer. They not only refused to break out the revenue
that they derived, but they claimed that it was too murky and
impossible to break out the distinct revenues that flowed from
the contingencies when, in fact, internal to the company they
had a very careful accounting that defined precisely where the
contingencies came from, how to maximize them, and were acting
as one would expect, in a way to increase the revenue that was
generated.
Senator Fitzgerald. And this was very relevant information
for investors and the analyst community because I think just a
few months before, a J.P. Morgan--I believe it was a J.P.
Morgan analyst--had written a whole thing about the dependency
of the insurance brokerage market on contingent commissions and
this analyst questioned whether contingent commissions would
still be allowed after we were just uncovering similar
conflicts in the mutual fund industry. And still, Marsh and
McLennan was refusing to answer questions about----
Mr. Spitzer. That is correct, and just to show that I can
say favorable things about that analyst, that indeed was a very
prescient report where the analyst not only focused on this
issue, raised the regulatory risk that Marsh was facing, but
also quite accurately predicted where the stock would move in
the event that there was any regulatory effort to disallow the
revenue streams that he was talking about.
Senator Fitzgerald. Now, do you think that these sorts of
abuses could have occurred if Marsh and McLennan only had, say,
8 percent of the market as opposed to 40 percent of the market?
You have an extremely concentrated insurance brokerage industry
in America. There were a lot of acquisitions during the 1980's
and 1990's whereby the bigger players got bigger and bigger,
Marsh and McLennan and AON being the two largest. They bought
up a lot of smaller brokerage firms. Today, those two have
about 70 percent, I am told, an estimated 70 percent of the
commercial insurance brokerage market for large companies. I
guess that would be Fortune 1,000 companies they are referring
to.
For some reason, Fortune 1,000 companies, why don't they go
to a smaller insurance brokerage agency? Why do they feel
compelled to use the biggest?
Mr. Spitzer. Let me make one observation, Mr. Chairman. I
think you are exactly correct. Certainly, the market power that
Marsh had in certain cities and in the market writ large
contributed to its capacity to extract the overrides. Having
said that, there are much smaller companies that receive a
larger percentage of their revenue when you look at their total
revenue and look at the overrides that they receive, a larger
percentage of their revenue in the overrides.
I do not agree with you, however, that Marsh would have
been in a position to structure the illicit relationships that
it had absent market power. The steering, and then the bid
rigging, were dependent upon its capacity to foreclose clients
from seeking other brokers who might have provided access to
the insurance they needed. So I believe that it is market
strength that was a necessary prerequisite to the structure
that we have seen.
Mr. Serio. And that market strength came, not just from the
brokering of insurance business, but from the related services
and the related organizations that the Marsh entity had
acquired over the years to make it essentially a one-stop
shopping opportunity for a lot of large companies.
Senator Fitzgerald. And those other entities are Putnam
mutual funds----
Mr. Serio. Mercer, risk services, and all these other
entities that don't fall underneath any one regulatory
umbrella. You were speaking a moment ago about the financials
of the large brokerage and whether this would have been
revealed at some point earlier if the financials of Marsh or of
other large brokerages are actually examined on a periodic
basis the way company financials are examined on a regular
basis.
Brokers are not inside that regulatory paradigm, however,
and they largely operate, save for their market conduct
activities and their relationship to their clients, there
really are no other regulatory nexes between the brokers and
the insurance regulators around the country. Perhaps if they
were on a regular schedule of financial examinations, those
glaring deficiencies in explaining where so much of their
revenue source was coming from may at least have been
identified earlier, if not acted upon earlier, if the brokers
were under the same regulatory regimen that the companies are
under.
Mr. Spitzer. Can I add one last thought----
Senator Fitzgerald. Yes.
Mr. Spitzer [continuing]. Because I think this interlocking
set of relationships really is at the essence of it and it is
not only across a horizontal line to Mercer and to perhaps
mutual funds, but really even within the insurance sector you
have brokerage, you have investments that are made by the
companies themselves and underlying carriers. You have
investments in reinsurance brokerage and you have investments
in the reinsurers themselves.
And so you have these four pieces that all fit together
with common ownership that we just don't understand, and I
think it is not only market strength in terms of the 40 percent
you cited in terms of the brokerage business, but also what
market strength do they garner by virtue of the vertical
relationships to insurers, reinsurance brokerage, and then
reinsurers themselves. I think that dynamic is one that needs
to be----
Senator Fitzgerald. Yes. Does anybody care to comment on
the reinsurance business? Apparently, both Marsh and McLennan
and AON set up reinsurers, offshore, I believe, in the case of
AON, in Bermuda, and----
Mr. Blumenthal. I would like to add a thought on this, what
is fundamentally an antitrust issue, before we move on. I think
it ties directly to the point you were raising and the reason
that we are here today. The remedy here has to be stronger
antitrust enforcement. If nothing else emerges, and a great
deal will besides this point, the scrutiny has to be to the
size, dominance, market power of these companies, and it has to
be an ongoing----
Senator Fitzgerald. Of the brokers? Or are you saying of
the insurers, as well?
Mr. Blumenthal. Both. And the interlocking relationships at
various levels. That is why ongoing scrutiny is so important,
and that may be where the Federal Government ought to have a
role.
Senator Fitzgerald. Well, let us talk about that for a
second. The McCarran-Ferguson Act of 1945 exempts the business
of insurance from antitrust regulation with a few distinct
exceptions, such as boycotts and a couple other things. It is
not clear to me whether the McCarran-Ferguson Act exempts
insurance brokers from Federal antitrust regulation. The
language is the business of insurance, and clearly it covers
carriers.
Would it make sense to amend the McCarran-Ferguson Act--it
would be very hard to ever repeal the antitrust exemption with
respect to insurance carriers. If you see all the insurance
industry people in this room, you would understand why, and
there are other good reasons, actually, to allow companies to
share underwriting information with each other, losses, age
groups with buying cars or driving cars. But let us just focus
on insurance brokers.
Is there a reason to have the insurance brokerage industry
exempt from antitrust laws? Shouldn't McCarran-Ferguson be
amended to make it clear that exemption from antitrust laws
only applies to the carriers, not to the brokers?
Mr. Blumenthal. If it is not clear now, it should be made
clear so that there can be more robust and effective Federal
antitrust enforcement in this area. But the States certainly
should pursue strong and effective remedies, and perhaps as a
result of these court actions, there will be.
Senator Fitzgerald. Now, I want to add that in reading
Attorney General Spitzer's complaint, I got the impression that
only a company that had a strongly dominant market position
could get away with the kind of rogue behavior that is outlined
in that complaint. I have to believe that Marsh's humongous
market share is what enables them, in part, to engage in that
kind of rogue behavior.
Mr. Spitzer. I agree with the following caveat. There is
also, to use Mr. Grogan's word, a synergy that benefits both of
the carriers and the broker when they pay the overrides. One
can very well view the override payments as an access fee,
access to the cartel. In other words, if, in fact, Marsh is
playing the role of organizing a bid rigging scheme that drives
premiums up for everybody and allocates business among the
carriers, the fee that is being paid by the carriers to Marsh
for entry into that system is the overriding set of payments.
Therefore, even without enormous market power, this is
really a negotiation between the two sides of the transaction,
a divvying up of the gains that result from the cartel
behavior, and I think that is a theory that we will be pursuing
in terms of damages that arise, because obviously the bid
rigging drove the entire supply curve to a point where premiums
were going up and we were all paying that in the form of
premiums and the division of that gain was reflected by the
override payments. So even theoretically, without the enormous
market power that Marsh had, that relationship could have
emerged.
Mr. Garamendi. I don't want to leave the impression that
this is only a result of market concentration. It may very well
be that the market concentration created the atmosphere where
this kind of steering and these kinds of compensations became
the norm within the industry. But it is clear from our
investigations that you don't have to be real large to be
engaged in practices that are every bit as illegal as what Mr.
Spitzer has found with Marsh. We believe this goes way down
into the smaller reaches of this industry.
Now, with regard to changing the McCarran law, what we
have, it seems to me, with Marsh is a synergy in which the
company was able to use its various pieces, whether it was the
reinsurance business or the access to capital and the movement
of capital from one place to the other or the brokerage, to
create opportunities for itself, to tie, if you will, one part
of its business to another part of its business. Tying happens
to be illegal in most States, and it may very well be as these
investigations, as we move to the various pages ahead of us in
our investigations, that we are going to find tying and other
State antitrust activities, or State laws, antitrust laws,
being breached. I would be surprised not to find that.
Clearly, however, you are onto something very important,
and that is concentration within the economic systems of this
Nation, not only with insurance, but in many other economic
sectors of the Nation. The concentration is an anathema to a
competitive market.
Senator Fitzgerald. Now, what do you all think about, in
1980, Congress passed a law that forbade the Federal Trade
Commission, which enforces our antitrust laws, from even doing
studies of the insurance industry? Do you care to comment on
that?
Mr. Garamendi. Is that the only mistake Congress has made
in the intervening 24 years?
Senator Fitzgerald. It looks like it, yes, but what do you
think of that?
Mr. Serio. Whether it is the FTC or it is the GAO or any
other arm of the Federal Government, the opportunity to study
insurance and to make recommendations is not a bad thing, and
the Congress has been doing this more and more. The Congress
has become a regular partner in insurance, certainly in
insurance policy making, given the discussions we have been
having on SMART, the discussions we had on the Fair Credit
Reporting Act, where the NAIC and the commissioners endorsed
the preemption of the Fair Credit Reporting Act and the study
of the FTC on the use of Fair Credit Reporting standards and
creating a uniform standard across the spectrum.
That would not necessarily--I obviously haven't spoken to
my colleagues in the commissioner's rank on this, but I don't
think that would necessarily be an invasive step into State
regulation. In fact, if it can help to earmark and identify
those areas where either stronger regulation is needed or that
trade-off between McCarran antitrust protection versus greater
regulation, because that really was the trade-off in McCarran,
is that they were given certain antitrust exemptions because
there was a body of State regulation, and that was, as you
said, Mr. Chairman, really focused on the companies, not on the
other players in the insurance marketplace.
And now we need to reevaluate that trade-off and if they
are subject to McCarran, make it so, or to antitrust rules,
make it so. Or if you still, and you clarify the rule that they
are exempt from antitrust through McCarran, then there has to
be a coordinated or consequent improvement in the State
regulatory tools that we have at our disposal to better
regulate the broker community.
The size, as Commissioner Garamendi said, is not really the
important part of this. In New York, people have gone to
prison, State and Federal prison, because of the inappropriate
use of brokerages and the influencing, controlling, tying,
whatever you may call it of the insurance business between the
broker operation and the insurance or the underwriting
operation that they controlled jointly.
Frank B. Hall is a name that we all knew in the 1980's,
where you had a broker control problem. The issue was addressed
by the States in that case. There have been, perhaps, new ways
found to coordinate, as Attorney General Spitzer said, to
interlock the various parts of the insurance process. But the
fact of the matter is that we really are dealing with a lot of
the same issue here, and whether the size became a controlling
issue or just the ownership became a control issue between the
broker side and the insurance or the reinsurance operations.
Senator Fitzgerald. In a moment here, I am going to allow
Senator Akaka to give his opening statement. I do want to ask
Attorney General Spitzer, you have said that you favor a
greater Federal role here, but are you sure that is the best
way when, after all, it was you, not the Federal Government,
that uncovered the conflicts in the securities analyst world?
It was you, not the Federal Government, that discovered and put
a spotlight on the problems in the mutual fund industry. And
now it is you, a State Attorney General, who has shaken the
insurance brokerage world.
Are you sure--what if the Federal Government came in--this
is the Federal Government that has tied its hands with respect
to even studying the insurance industry--what if they pass
something that preempts people like you from identifying a real
problem and acting vigorously?
Mr. Spitzer. First, I would much prefer the Federal
Government do it. It would make my life much easier. I would
have an easier time getting out of this room. [Laughter.]
Obviously, I do not support a preemption amendment that
would preclude the capacity of State inquiry into these various
areas. Having said that, I certainly think we need the
additional scrutiny that can be provided by the FTC, by
Congress in the areas that I laid out, because your
investigative powers are enormous. The areas where we have seen
interlocking relationships that are injurious to competition,
to a certain extent have a nexus offshore precisely because it
is very often harder for State entities to inquire with respect
to those jurisdictions. Congress, on the other hand, has a
greater capacity to do so. The FTC does.
So we would welcome your joining us in this effort. I
certainly am not guarding with such loyalty our exclusive
jurisdiction. I would love to see other entities join this
investigation, join in the legislative effort, because although
the State entities have had some success recently, I would hope
that dynamic would change and that we would see vigorous
efforts at the Federal level, as well.
Mr. Blumenthal. And I would just add, if I may, Senator,
because I think that the sentiments that Attorney General
Spitzer has just articulated are common to most attorneys
general, that preemption is the anathema here. We have very
cooperative relationships, particularly in antitrust
enforcement, with the Federal Government already and a lot of
what we are discussing here really constitutes per se
violations of our antitrust laws. Collusion, tying, price
fixing, bid rigging are simply against the law, end of
sentence. To ask the questions that you asked really, in many
ways, is to answer them, that we need a stronger Federal role
in these areas where in other industries that role would be a
given and we would be working together.
All of that said, if there is a Federal role, it ought to
be a constructive and helpful one, and in so many other areas,
unfortunately, in recent years, we have seen a lack of Federal
activism, a laxity, and even an attempt to inhibit State
action. The environmental area is the best example, but there
are others.
Senator Fitzgerald. I am not sure all of that is going to
change anytime soon.
At this point, I will allow Mr. Garamendi, if you have
something, to join in.
Mr. Garamendi. My good friend, Senator Akaka, please take
the floor. I will be happy to follow you.
Senator Fitzgerald. Let me just say I would like to
recognize the Subcommittee's Ranking Member, Senator Akaka. We
have worked closely together the last few years. In fact, I am
told that we held 13 hearings together in the 108th Congress.
We have worked together on many financial issues, such as the
mutual funds, insurance now, and also financial management
bills that have installed better audits and chief financial
officers in some of the Federal agencies, such as Homeland
Security and the National Intelligence Director CFO.
It may surprise you, but until about 15 years ago, none of
the Federal agencies were ever audited. Then they started
requiring audits of the largest departments, and when I came
in, the Agriculture Department was missing $5 billion. It was
just missing. They couldn't find it--in cash. They later worked
that difference down to only $200 million, but that is a lot of
money. If we complain about Enron having bad accounting,
sometimes the Federal Government needs to look in the mirror.
But we have worked very hard to extend audit requirements
to all Federal agencies. We are now having audited any agency
that spends more than $25 million a year, and it has been a
pleasure working with Senator Akaka these years and I want to
thank him for allowing me to have such a collegial and
productive working relationship with him these years. And he
kindly every once in a while sends me some macademia nuts from
Hawaii, which are very good---- [Laughter.]
So I want to thank you for that, too. Thank you, Senator
Akaka.
OPENING STATEMENT OF SENATOR AKAKA
Senator Akaka. Thank you very much, Mr. Chairman, for
calling this hearing today. I want to take a moment to pay
tribute to our Chairman.
This is the Chairman's final hearing as Chairman of the
Subcommittee on Financial Management, the Budget, and
International Security. Mr. Chairman, I want you to know that I
really appreciated working with you. You have done a great job
here. Your leadership has been impeccable, and you have been
very productive. We have done so many things together and I
attribute that to your leadership and your focus on the
concerns and issues of this whole industry. As you mentioned,
some of this goes back years. With your leadership, we are
changing some of that which will really help our country in its
accountability.
I want you to know, Mr. Chairman, that I have enjoyed
working with you on a number of important issues relating to
financial management and transparency, and I want you to know
also that I will miss you and you will be missed by the full
Committee, as well.
Mr. Chairman, with that, I have a lengthy statement that I
ask to submit for the record.
Senator Fitzgerald. Thank you. We will make your statement
a part of the record.
[The prepared statement of Senator Akaka follows:]
PREPARED STATEMENT OF SENATOR AKAKA
Thank you, Mr. Chairman, for calling today's hearing. This is your
final hearing as chair of this Subcommittee and I want you to know how
much I appreciate the work you have done as Chair of this Subcommittee.
I have enjoyed working wit you on a number of important issues relating
to financial management and transparency. You will be missed.
Mr. Chairman, today, we focus our attention on another scandal--
this one involving alleged bid rigging and secret commissions in the
insurance industry. This issue has been brought to light by the actions
of a group of State attorneys general and insurance commissioners.
I realize that investigations are still pending, but I am
interested in learning how widespread the abuse is in the industry. I
am also interested in learning more about how the insurance industry
operates and, in particular, whether certain types of compensation
agreements are a potential conflict of interest for brokers because if
these agreements are a potential conflict of interest, we need to know
if enough is being done to protect insurance buyers.
Insurance buyers trust their brokers to search the market for the
policy that best suits their needs. Brokers should be required to not
only disclose the total cost of coverage, and also to disclose all
compensation received from an insurance company. This disclosure must
be in plain language so that buyers can make informed decisions. I am
troubled that, in the New York lawsuit, it appears that even
knowledgeable, corporate, buyers of insurance have been taken advantage
of and presented with policies that best suited the needs of the
broker. Today's heari8ng will explore options to make the process more
transparent.
I also want to know whether the deceptive and questionable
practices found in commercial property and casualty insurance are also
found in other lines of insurance, such as health insurance, where
premiums continue to rise.
Employer-sponsored health insurance premiums increased an average
of 11.2 percent in 2004 according to the Kaiser Family Foundation and
Health Research and Educational Trust. For many working families, these
increase have made it more difficult for them to make ends meet and to
retain their health insurance coverage. If a portion of the increase in
premiums for health insurance may be attributed to deceptive and opaque
practices among insurance brokers, steps must be taken to make sure
that families are not overpaying for their current coverage due to the
questionable activities of some insurance brokers.
Mr. chairman, another area we will examine is the ability of the
states to provide defective oversight for the insurance industry. We
need to determine whether the Federal Government should be more
involved in the regulation of insurance activities which are now
regulated at the state level. I expect some of our witnesses will
discuss various legislative proposals including the optional Federal
insurance charter and the so-called SMART Act (State Modernization and
Regulatory Transparency). There are also suggestions that the Federal
Trade Commission be empowered to investigate unfair and deceptive
practices within the insurance industry.
I want to thank all our witnesses for coming today and I look
forward to their testimony. Mr. Chairman, thank you again for holding
this timely hearing. I have truly enjoyed working with you during the
108th Congress.
Senator Fitzgerald. We have been joined by Delaware Senator
Tom Carper, and Senator Carper, we appreciate your being here.
OPENING STATEMENT OF SENATOR CARPER
Senator Carper. Thanks, Mr. Chairman. I apologize for not
being here earlier. As Senator Akaka may have explained, the
Democratic Senate Caucus has met this morning to elect our new
leadership to begin the next Congress and to put the elections
of 2004 behind us. So I apologize.
Mr. Spitzer, I understand you have testified already, is
that correct, and I apologize for having missed your testimony.
We are delighted that you are here and we thank you for the
input you have provided for us here today and, frankly, on a
number of other occasions, as well.
I want to thank our Chairman as he prepares to ride off--
sometimes when people leave here, they ride off into the
sunset. I think when Peter Fitzgerald rides off, he will ride
off into the sunrise because he is still among the youngest
members of the U.S. Senate. It has been a privilege for me to
have served with you for these last 4 years. As Senator Akaka
has said, we wish you only good things in the years to follow.
We will miss your intellect and we will miss your determination
just to figure out what is the right thing to do and to do it.
We will miss your fairness and your even-handedness in
approaching the issues with a real open-mindedness.
The investigations by, I think, two of the attorneys
general that are here today have revealed some disturbing
information about current practices, both legal and illegal
practices, that have been occurring in the insurance industry.
They have caught none less an observer than 14-year-old Ben
Carper, my son, who is in a stock market course at his high
school, the Charter High School of Wilmington in Wilmington,
Delaware, and every morning, one morning every week, usually
Monday mornings, they present from the previous week's news a
story that has a real bearing or implication, a significance to
the stock market. The issue that you have been testifying to
today, the issue about which this Subcommittee is holding this
hearing, has not just caught the eye of this Subcommittee and
its Chairman and Ranking Member, but also our youngest son. We
have had some interesting conversations. I don't know what
everyone else has been talking about around their dining room
table in recent weeks, but we have been talking a bit about
these matters.
I would just say these revelations raise questions about
the roles of brokers and agents. They raise questions about the
protections that exist for consumers, or don't exist for
consumers, and the general regulatory framework for insurance
itself. As we delve into these issues, they are going to lead
to bigger questions and bigger issues for us to address in the
next Congress.
So, again, we welcome all of you today. To our Chairman, we
wish you, as you say in the Navy--I am an old Navy guy--as you
say in the Navy, fair winds and a following sea. God bless.
Thanks.
Senator Fitzgerald. Thank you very much.
I have two final questions before we allow you to have a
break and invite the second panel up here. I want to know
whether there is any information that consumers of residential
insurance policies or automobile policies, if they need to be
concerned here. Have either of the attorneys general or the
insurance commissioner from California found any problems with
agents or brokers or personal lines of insurance, steering
their clients to carriers who give them, I don't know, free
trips to Hawaii?
My own insurance agent came out here with his daughter from
Elk Grove, Illinois, and he has assured me that he has never
accepted those forms of compensation that are sometimes offered
by the carriers, maybe free trips to Hawaii, for example, if
you place a number of your policies with a specific carrier.
Have any of you done any work in this regard?
Mr. Garamendi. Mr. Chairman, indeed, it is probable that
there will be and do exist problems in the personal line
insurance sector. We see this in--the potential to be there.
These additional compensations, whether they are called
contingency commissions or the like, in all probability exist
in the personal lines area. We are looking into this in
California. We have concerns about it.
The way we are going about it is two-fold. First, with the
regulations that we want to put in place to provide clarity
that all fees, whenever an individual is acting in a broker's
capacity, as distinct from an agent capacity, but in a broker's
capacity, that all fees be fully disclosed and then to draw a
bright line about what the proper activity of a person acting
as a broker could engage in.
Senator Fitzgerald. Are there greater disclosure
requirements for the individual lines of insurance, typically?
Mr. Garamendi. When a producer, a licensed person, whether
that person is an agent or a broker--as I said, in California,
it is a dual license. You can be either, and you may be one in
one circumstance, as an agent, and in a different circumstance,
acting as a broker. But there is clarity in at least California
when a person begins to act as a broker. That is, they offer
themselves as representing the interest of the consumer as
opposed to an agent who is offering themselves to represent the
interest of an insurance company. So there is a very clear
distinction.
We want to further clarify that with the language of the
regulations and also to make it clear what activities would
fall within or without the appropriate fiduciary
responsibilities of a person acting as a broker. So we want to
do that. That is the reason for the regulations.
As I said, we are now engaged with other insurance
commissioners around the Nation through the National
Association of Insurance Commissioners to propose a model,
which could be a law in certain States that don't have that
clarity in their law, or a regulation for those that have a
legal foundation to write a regulation. So that is underway.
Investigations are also underway and will undoubtedly play
themselves out.
Now, we are being assisted by private attorneys who are
bringing suits on behalf of individuals, companies,
corporations who have been wronged by this entire practice
which is being discussed here. We will, in California,
undoubtedly join with some of those private attorneys. We will
also join with our Attorney General in looking into all of
these matters and probably bringing suit in various areas. We
consider it to be a very serious problem.
I know you are on this question, but before I leave this
panel, I would like to comment on the proposed SMART
legislation if you intend to come to that.
Senator Fitzgerald. Well, we will be interested--Senator
Akaka has some questions and I would like to allow him and
Senator Carper, if he has questions, too.
Senator Akaka. Thank you very much, Mr. Chairman. I would
like to ask two questions.
One is to Attorney General Spitzer. My constituents are
increasingly concerned about the rising costs of their health
insurance, and it is not only Hawaii but across the country. My
question is, are the deceptive and questionable practices found
in property casualty insurance also found in other lines of
insurance, such as health, and what impact have these practices
had on the rising costs of health insurance?
Mr. Spitzer. Senator, it is a little question. I would be a
little cryptic, only because I don't like to state conclusions
until we have completed an investigation and filed a
litigation, but suffice it to say we are finding the types of
practices that are laid out in both the Marsh and the ULR
complaints and the various civil and criminal complaints, as
well, in other lines of business, as well. The various form of
the overrides, the forms of the incentives may differ, but the
underlying economic impact is ordinarily the same. It is both
to create misincentive, distortive incentive, and then to drive
the cost of premiums up.
I would just say in response to the Chairman's question
about how does this manifest itself in other lines of the
insurance sales marketplace, we have found not only trips as an
incentive, but also loans and offers of stock that are made to
individual brokers or agents and repayment for either the loan
or the stock is contingent upon the magnitude of commissions
that are generated for the company or sales or the volume----
Senator Fitzgerald. Stock in the insurance company being
offered back to the agency?
Mr. Spitzer. That is correct, and often, whether or not
there is required repayment----
Senator Fitzgerald. Stock or stock options?
Mr. Spitzer. It can be both. But as I say, we are just
beginning to delve into some of these areas, and sometimes it
is loans outright, loans of cash, capital, and again, repayment
schedules and obligations are contingent upon how much business
is generated in terms of the volume of product of the
underlying carrier that is sold. So this manifests itself in
many different ways. But as I said, we have only begun and we
have limited personnel, so we are delving into this now and we
will get into it in due course.
Mr. Garamendi. Just very briefly, we have reason to believe
that this issue spills over into employee benefits, and that
would be health care plus other kinds of employee benefits,
disability and the like.
Mr. Blumenthal. And in answer to your question, Senator,
these kinds of arrangements directly raise the cost of
insurance to your constituents because they add a level of
private gain that goes into somebody else's pockets. The
corrosive, corrupting effect on the entire health care system
cannot be underestimated. I would agree with both of my
colleagues here that we will see evidence of the same kinds of
practices in other lines, not just employee benefits, but
health care and automobile insurance, as well.
Mr. Serio. If I may, Mr. Chairman and Senator Akaka, one of
the distinctions, though, for some States on health insurance
as compared to property casualty, or even other forms of
employee benefits, such as in New York, we have specific
statutes with respect to how much commission can be paid on
certain health insurance products. There are caps. It is
generally about 4 percent.
So that gives us at least a bright line standard that you
don't have that has complicated some of these other issues
about what is an appropriate compensation level, and that has
created a statutory model. We put that model into place, first,
because of the concern over the high price of health insurance,
and second, because of the large number of not-for-profit
health insurers in the marketplace. And so we have actually
been regulating commission structures in the health insurance
field for a very long time that we do not do in other areas.
Senator Akaka. Thank you for those comments.
Mr. Serio, I understand that NAIC is doing much to
modernize State insurance regulations through efforts such as
an Interstate Insurance Product Regulation Compact. I am
pleased that Hawaii is one of nine States, I understand, that
have enacted this compact legislation. What are the biggest
challenges to reaching the goal of regulatory uniformity?
Mr. Serio. I think one of the biggest challenges to
achieving regulatory uniformity has been the push-back by a
number of interests in the industry who have been looking for
regulatory uniformity as a way to get to less regulation.
We have had an interest. In fact, we have had good
conversations, both here in the Senate and over in the House,
on what the commissioners need in terms of creating a better
and a more modern regulatory structure. In fact, we were very
pleased that Chairman Oxley over in the House put many of the
things that appeared in what we called the NAIC road map into
the first SMART bill draft, including greater financial
surveillance, including greater oversight in receiverships and
things of that nature, because those are things that we have
identified to the Congress, shortcomings in the current State
legislative structure for powers to the regulators.
This is actually very relevant to the conversation we are
having here today because a lot of these problems that have
come up in the past have usually found themselves in the forms
of insolvencies, that people had been untowardly using the
insurance process to drive a company into insolvency. In the
1980's, it was broker control that led to insolvencies of
insurance companies. In the early 1990's, we had the same
problem.
This situation is a little different, but as I said
earlier, I think broadening out the financial surveillance
powers of the insurance departments as is being proposed in the
SMART bill will give us a great leg up from where we currently
stand with respect to being able to modernize State regulation.
Senator Akaka. Thank you very much, Mr. Chairman.
Senator Fitzgerald. Thank you very much, and I want to
thank this panel. I think you have been terrific. It strikes me
as I listen to the testimony that there could possibly be no
end to the amounts of conflicts that you might find, especially
the attorneys general, in other industries, as well. I was
thinking about the real estate brokerage area, areas where
people aren't necessarily fiduciaries.
I even thought of another one that you may not think of
very often, but in the media. Last week, I was at the St. Louis
Post Dispatch at an editorial board interview and they reminded
me that in 1949, the St. Louis Post Dispatch, together with a
now-defunct paper, the Chicago Daily News, won a Pulitzer prize
for uncovering that 32 newspaper editors and publishers in
Illinois were on the then-Governor Dwight Green's State
payroll, typically for $10,000 a year, which in 1949, that is
like $100,000 today, and they won a Pulitzer prize for that.
So the possibilities of conflicts are almost endless here
and you give us a lot of food for thought and I think that it
has been very helpful hearing the testimony from you both for
Congress and for consumers nationwide. So thank you all very
much for being here.
At this point, I would like to take about a 2-minute break
and then we will reconvene with the second panel.
[Recess.]
Senator Fitzgerald. I would like to reconvene this hearing,
if we could have order in the hearing room.
I now call on our witnesses for panel two. Our first
witness is Albert Counselman, President and CEO of Riggs,
Counselman, Michaels and Downes in Baltimore, and I guess you
go by Skip, is that right?
Mr. Counselman. That is right, Mr. Chairman.
Senator Fitzgerald. Mr. Counselman is appearing today on
behalf of the Council of Insurance Agents and Brokers, which
represents the largest of all commercial insurance agencies and
brokerage firms. Mr. Counselman is a former Chairman of the
Council. His other insurance industry affiliations include Vice
President and Director of Professional Agencies Reinsurance,
Limited, former Chairman and Director of Assurance Global, and
Director of the American Institute for Chartered Property
Casualty Underwriters.
Our second witness is Alex Soto, President of InSource,
Inc., of Miami, Florida. Mr. Soto is representing the
Independent Insurance Agents and Brokers of America, known as
the ``Big I,'' for which he currently serves as Vice President.
Mr. Soto was elected to the organization's Executive Committee
in 2001 and has served as Chairman of its Communications
Committee and the Branding Task Force and Natural Disaster
Committee. He also served as Chairman and State National
Director of the Florida Association of Insurance Agents.
Our third witness is Ernie Csiszar, the President and CEO
of Property Casualty Insurers Association of America, which is
headquartered in my home State, in Des Plaines, Illinois, not
too far from my home. Mr. Csiszar previously served as
President of the National Association of Insurance
Commissioners and as South Carolina's Director of Insurance.
Originally from Romania, Mr. Csiszar has an extensive
background in business and investment banking.
Our fourth witness is Janice Ochenkowski--I hope I
pronounced that right?
Ms. Ochenkowski. You did.
Senator Fitzgerald [continuing]. Who serves as Vice
President for External Affairs for the Risk and Insurance
Management Society, known as RIMS. She currently is Senior Vice
President and National Director of Risk Management at Jones
Lang LaSalle, Incorporated, a global real estate services
company that is headquartered in Chicago. Ms. Ochenkowski has
been responsible for risk management at Jones Lang LaSalle and
its predecessor companies since 1980.
Our fifth and final witness on this panel is J. Robert
Hunter, Director of Insurance at the Consumer Federation of
America. Mr. Hunter has served as Texas Insurance Commissioner
and as the Federal Insurance Administrator, which handles the
flood insurance program, I believe?
Mr. Hunter. It was then, but yes, it does now. It was at
HUD when I was----
Senator Fitzgerald. Oh, OK. You were in that position as
Federal Insurance Administrator under Presidents Ford and
Carter. Mr. Hunter is an actuary and he is well known as a
long-time consumer advocate. They could use you to solve our
pension problems, too. We need some actuarial help on Capitol
Hill.
Again, I would like to thank our distinguished witnesses
for being here today to testify. In the interest of time, your
full statements will be included in the record and we ask that
you limit your opening remarks to 5 minutes. Please watch the
light. Since we have such a large panel, we will adhere to the
5-minute rule to ensure that there is sufficient time for
questions.
Mr. Counselman, you may begin.
TESTIMONY OF ALBERT R. COUNSELMAN,\1\ PRESIDENT AND CHIEF
EXECUTIVE OFFICER, RIGGS, COUNSELMAN, MICHAELS AND DOWNES,
INC., ON BEHALF OF THE COUNCIL OF INSURANCE AGENTS AND BROKERS
Mr. Counselman. Thank you, Mr. Chairman. As you stated, I
am representing the Council of Insurance Agents and Brokers
today. The CIAB member firms employ more than 120,000 people
and annually place more than 80 percent of all of the U.S.
commercial property casualty insurance products.
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\1\ The prepared statement of Mr. Counselman appears in the
Appendix on page 96.
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Insurance brokerage is highly competitive and it is built
and relies on trust, trust between the broker and the client,
trust between the broker and the carrier, and ultimately
through those two relationships, trust between the carrier and
the client. The ultimate trust between carrier and the client
is essential because the insurance business is one of promises,
including the promise of the clients to detail the nature and
the extent of its risk exposures and the promise of the carrier
to cover those exposures in case of trouble, accident, or
tragedy.
At the outset, we are deeply troubled by the charges of bid
rigging and fraud brought by Attorney General Spitzer. Such
activity is not only outrageous, but it is illegal and it has
no place in an industry that is based on trust. These
individuals have not only severely damaged their own brokerage
firm, but they also have cast an undeserved pall on an entire
industry. They besmirch the reputations of honest brokers
throughout the country and they have undermined the trust on
which our industry was built.
While bad actors created a corrupt scheme to limit real
choices for some customers, the role of contingent commissions
in this evil equation has been irresponsibly represented.
Contingent commission payments were not central to the alleged
fraud despite the connections that some have claimed.
Contingent commissions are legal and proper methods of
compensation that have been used throughout the industry for
decades. Although they are not a significant source of income
in most firms, they are nonetheless well understood and
accepted by the commercial marketplace.
It is lack of effective disclosure, in some cases combined
with the intent to defraud, that is at issue, not a systematic
industry-wide failure to disclose fees or a failure of the
entire business model, as has been suggested.
Even so, we realize that there is increased concern and
confusion in the marketplace and we support clear disclosure of
this income. The Council had such a policy in place since
October 1998, recommending precisely such disclosure.
It is most important that the solution to these examples of
fraud and this chance to improve disclosure be developed in the
legislative and in the regulatory cycle and not in the news
cycle. Contrary to recent news stories, isolated examples of
abuse should not be equated with an industry-wide system of
``secret payoffs and conflicts of interest.'' While such
overheated charges create good headlines and produce new class
actions for lawyers, they do not represent grounds for a
stampede to judgment on a wrong-headed solution. Solutions
should be based on facts and on deliberation, not headlines.
We don't believe that the fraud Attorney General Spitzer
uncovered resulted from a failure of the State-based insurance
regulatory system. The toughest of regulations or laws will not
stop an individual intent on malfeasance. That said, we also
believe that regulatory reform is essential for the industry's
long-term viability because of the inherent inefficiency and
the confusion stemming from a vast array of overlapping and
sometimes conflicting regulatory requirements imposed from
State to State.
As public policy objectives are pursued, we believe
lawmakers and regulators must be mindful that the development
of a relationship between broker and carrier is essential to
enable brokers to provide the best possible products and
services to their clients. A strong relationship with the
carrier gives the broker clout that benefits the customers for
lower premiums, better coverages, specialized coverages, and
quicker service and claims payment.
This is why the characterization of the client-carrier
relationship as adversarial is misguided. At the end of the
day, the carrier partners with the client through the broker
intermediary, not as opponents but in a cooperative way to
ensure that the risks that a client presents are properly
covered.
All the compensation paid to a broker is funded by a
client, either through direct payments or through the client's
premium payments. Contingency arrangements established by
insurers have been a feature of the compensation landscape for
decades and generally have been well understood and accepted by
the commercial client base. They replace a portion of the up-
front commissions previously paid to producers and on average
contribute approximately 4 to 5 percent of a brokerage firm's
income. On average, for most firms, this represents 1 percent
of premium volume. Again, we support and encourage client
disclosure of such commissions.
To conclude, let me say I am deeply troubled by the
evidence of egregious conduct uncovered by Attorney General
Spitzer. Bad actors should be prosecuted to the fullest extent
of the law and this pattern of behavior must never be repeated.
But contingent commission arrangements, when properly
constructed, disclosed, and utilized, fulfill a need in the
industry to help foster a cooperative insurance environment
that works to benefit all participants, the commercial client,
the carriers, and the producers. We strongly support improved
disclosure and heightened transparency in these arrangements in
order to remove any potential specter of conflict.
As I said at the outset, this industry is based on and
committed to trust, trust between broker and client, broker and
carrier, and ultimately carrier and client. We stand ready to
work with the appropriate committee of jurisdiction in the
Congress and the States to find solutions to the issues raised
at this hearing to ensure that this trust is maintained and the
important work of the insurance industry, which is protecting
people and the economy, continues.
Thank you, Mr. Chairman.
Senator Fitzgerald. Thank you, Mr. Counselman. Mr. Soto.
TESTIMONY OF ALEX SOTO,\1\ PRESIDENT, INSOURCE, INC., ON BEHALF
OF THE INDEPENDENT INSURANCE AGENTS AND BROKERS OF AMERICA
Mr. Soto. Chairman Fitzgerald, I am delighted to be here.
As you already stated, I am Alex Soto. I represent the
Independent Insurance Agents and Brokers of America. I am a
volunteer leader within that organization. We have more than
300,000 independent agents and employees that work and are
located in practically every town throughout America.
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\1\ The prepared statement of Mr. Soto appears in the Appendix on
page 107.
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The way I make my living is as an independent agent in
Miami, Florida. As you stated earlier, I am president of an
agency called InSource, Inc. We are primarily a property
casualty agency, where we sell commercial insurance products as
well as personal insurance products to customers in our general
area.
I echo the comments made by Mr. Counselman in that our
organization obviously deplores the activities that you have
uncovered and that Mr. Spitzer has uncovered, issues such as
bid rigging and market manipulation. Unfortunately, not only
are they illegal, but they have given all of us, brokers and
agents and everyone in the industry, a black eye.
I also concur with the fact that those who are proven
guilty should be punished swiftly, and again to the full extent
of the law. And quite frankly, we applaud the efforts of the
regulators and the attorneys general.
Senator my world is completely different from that which
you were describing earlier today of the mega-brokers that have
the ability and the power to influence and manipulate the
marketplace. My world, and I want to take a moment to share it
with you, is one of extreme and high competition.
You know, in the State of Florida, there are more than
50,000 licensed agents and solicitors. In my county, Miami-
Dade, we have 5,000 licensed agents and solicitors who I
compete with every day. On top of that, I am in competition
with the direct sellers of insurance, those mechanisms that do
not use an agent. I am in competition with the Internet,
everyone that is putting wares on the Internet. I am in
competition with affinity groups, such as the AARP. I am even
in competition with credit unions that have tie-ins with
insurance companies.
And on top of that, one of my major insurance companies
informs me that more than half of all the business that they
write in my State, in the State of Florida, is written by
brokers and agents outside of the State of Florida. So I am not
only competing with the people in my State, but elsewhere.
Every day, I must prove myself and the people in my office,
not only with our prospects, but we must prove ourselves with
our current customers. When a client invites us to bid on their
insurance, that is precisely what we are doing. We get no up-
front fee. We get no payment from that client. We simply are
given an opportunity to do a great deal of work to prove
ourselves, that there is more value in doing business with me
and with InSource than their current relationship.
They define value in being the best price, the coverage
that they are looking for, the best coverage, the quality of
the insurance company that is being offered, and the services
that I provide, my agency will provide to them. If I do not
prove myself to be a better value in those terms to that
prospect, I will not be selected. If I am not selected, I do
not get paid by the client or anyone else and my expense is one
that I have to eat.
If I do get paid, obviously, I get paid a commission by the
insurance company that we place the business with. The
competitive marketplace keeps agencies responsive and
accountable, and I think you hit it on the head. More
competition is better for the consumer. It is the best. What I
have found over my years in the business are the checks and
balances.
We do support, where the brokers are concerned, we do
support transparency. It goes without saying that those people
that are paid by the clients and also paid by the insurance
companies need to make sure that all parties clearly understand
where the money is, what the money is, and where it is coming
from, and clearly, those must be agreements that must be
reduced to writing and approved by both the client and the
broker. The client obviously can dispute them and simply decide
to do business with somebody else.
We do support and we use them, independent agents
throughout America, contingencies. Contingency is agreement. I
cannot comment on PSAs or MSAs because I do not receive those,
and candidly, I am almost embarrassed to admit to you that
until this all emerged, I really had practically no familiarity
with even those terms.
But contingency agreements are legal. They reward
excellence, as they do in every other transaction, promotional
transaction in the United States. They are good business
practices and they do serve a legitimate purpose. It creates an
incentive for the agent to be a good front-line underwriter in
the selections of risk and it also incents the agent to be a
good risk manager in helping the client to put in place
measures that will help them reduce their losses. When that
occurs, everybody wins. The client wins, because on an ongoing
basis, fewer losses will translate into less expensive premiums
in the future. The insurance company pays less claims and they
share a little bit of that profit if, indeed, the lower losses
are there.
Finally, we believe in State regulation. It has been my
experience that regulation closer to home is the best
regulation. Insurance commissioners in my State have taken
numerous steps to protect the citizens of the State of Florida
after the four hurricanes that we had, and I saw it firsthand
after Hurricane Andrew. However, the system needs modernization
and uniformity, and thus we support the SMART Act. In concept,
it is a good venue because it will leave regulation at the
State level, but there will be a certain amount of uniformity
and modernization. Now, I underscore that this is a draft
proposal so it needs to be worked on. This will provide
targeted Federal tools with uniform standards to keep State
regulations. Thank you, Mr. Chairman.
Senator Fitzgerald. Thank you very much, Mr. Soto. Mr.
Csiszar.
TESTIMONY OF ERNST N. CSISZAR,\1\ PRESIDENT AND CHIEF EXECUTIVE
OFFICER, PROPERTY CASUALTY INSURERS ASSOCIATION OF AMERICA
Mr. Csiszar. Mr. Chairman, thank you for the invitation to
appear today. I am so sorry that this is your last session. I
would have been delighted to serve as one of your constituents.
I am a new resident of Chicago, the proud owner of a new
mortgage in Chicago, so----
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\1\ The prepared statement of Mr. Csiszar appears in the Appendix
on page 115.
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Senator Fitzgerald. Are you registered to vote?
Mr. Csiszar. Yes, absolutely. [Laughter.]
Absolutely, so I am so very sorry to see you go because I
think your leadership role on this Subcommittee in terms of the
investigation that you have carried on, whether it be with
respect to Enron, whether it be with respect to the bond
market, with respect to the investment banking industry in
which I had a few years' experience a few years ago, I think
they have been very valuable and have been of extreme
usefulness, I believe, in bringing abuses to light that
otherwise might not have been done so.
I will tell you that, speaking on behalf of over 1,100
members of the PCI, we welcome your oversight. In fact, we
encourage your oversight because I, like all the panelists that
I have heard this morning, I, too, am here to condemn in the
strongest of terms any criminal--and I will go beyond
criminal--any criminal, any deceptive, any anti-competitive
conduct on the part of any member of a market.
We truly have a large market in the insurance industry and
it is a market that is based on trust, public trust in
particular. Any activity that impedes on that public trust is
activity that must be condemned and it must be stopped.
In addition to that, any activity such as criminal,
deceptive, anti-competitive activity also impedes on that free
flow of information, that free flow of accurate information
that is the very foundation of an efficient market, if you
will.
So we really think that these allegations, and I think they
certainly look like they are going to be proven, are
allegations that point to conduct that is absolutely
deplorable. As I said, my 1,100 members welcome this.
Having said that, I also want to make a few comments about
the industry itself, because I have heard you and others this
morning speak about this cartel arrangement and so on. To some
extent, I think there is a good deal of truth in that. But what
I would like to draw the Subcommittee's attention, and Mr.
Chairman, you in particular, your attention to is the fact that
there are over 2,700 companies that compete in this business.
There are over 1.9 million people who are involved directly in
the distribution of insurance products. It is a highly
fragmented industry when you look at it overall.
Now, in this particular segment of the market, of course,
the brokerage market, it is very true that three players, from
what I understand, controlled 80 percent-plus of the market. So
it is very highly concentrated. But overall, the market is very
fragmented and the returns in that market prove it. If you look
at insurance returns over the long term, they tend to be in
single digits. In fact, some would argue that there is an
inverse risk relationship at work when it comes to the
insurance market, too much risk for too little return, if you
will.
So it is a market that is very competitive, not just from a
distribution standpoint but from a carrier standpoint as well
as a reinsurer carrier. There are any number of reinsurers in
the United States. There are a number of reinsurers in Bermuda.
The Lloyd's market is also very active in this. The London
market, in general, is active. So overall, it is a very broad
industry. It tends to be a highly competitive industry and our
point very simply is that what we are seeing here emanates in a
very specific and a very narrow segment, albeit a very
profitable segment of the insurance industry.
As regards contingency fees, our view is, first of all, one
of the problems with these agreements is I swear they shouldn't
even be called contingency fees because they are taking the
contingency out of it. In fact, if anything, there was a good
deal of certainty attached to some of these agreements that the
commissions would be payable. There was very little about them
to be contingent.
A true contingency agreement, however, such as the one
described by Mr. Soto here, truly addresses a maybe, a perhaps.
It is not tied to a specific policy. It is not tied to the
placement of a specific policy. It is tied to overall volume,
and quite often it is also tied to overall profitability, and
oftentimes that profitability doesn't emerge until years later.
Workers' compensation, for instance, it is a long tail line. So
whether it is profitable or not sometimes takes years to
determine.
So it is not as simple as Mr. Spitzer would like it to be,
perhaps, and quite frankly, we see contingent commissions as
nothing more than mutual instruments. They can be used and they
can be abused, as they were in this case, I believe. There is
no reason to ban contingent commissions. What we suggest, of
course, is that we take a true transparency, a true disclosure
route to this, and that, in fact, we take one that is
relatively uniform.
One of the problems with State regulation, and I believe,
having been a regulator, I wholeheartedly agree with the need
to modernize State regulation. The fact of the matter is, a
uniform approach in terms of good, solid transparency and
disclosure, we believe would solve the problem.
My time has run out and I will leave it at that. Thank you.
Senator Fitzgerald. Thank you very much. Ms. Ochenkowski,
thank you for being here.
TESTIMONY OF JANICE OCHENKOWSKI,\1\ SENIOR VICE PRESIDENT, RISK
MANAGEMENT, JONES LANG LASALLE, AND VICE PRESIDENT FOR EXTERNAL
AFFAIRS, RISK AND INSURANCE MANAGEMENT SOCIETY
Ms. Ochenkowski. Good afternoon, Mr. Chairman. As a
lifelong Illinoisan, I, too, would like to thank you for your
efforts on this Subcommittee and the work that you have done to
restore integrity into the governmental process. We all
appreciate it.
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\1\ The prepared statement of Ms. Ochenkowski with an attachment
appears in the Appendix on page 123.
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I am here representing the Risk and Insurance Management
Society, which is the largest professional organization for the
risk management community. We appreciate the opportunity to be
heard on this issue.
Our member companies, which number over 4,000, are
commercial insurance consumers and we are directly affected by
the issue of broker compensation and placement practices. Our
membership spans the country and consists of entities in all
different industries and sizes, including 84 percent of the
Fortune 500 companies as well as approximately 950 small
businesses, which we define as those with fewer than 500
employees. Many of our member companies have full-time risk
management departments, while some rely solely on brokers for
services.
RIMS has always believed that the relationship between
brokers and insurance consumers should be governed by the
principle of complete transparency. We emphasized this position
initially in 1999 and again in a statement issued in August of
this year that provides that broker compensation and placement
agreements should be transparent, with all sources of
compensation, direct and indirect, disclosed without client
request prior to the placement of business and annually by line
of coverage. A complete copy of that statement is attached to
my testimony.
RIMS is shocked by the recent allegations of illegal
activities by certain brokers and insurance companies in the
placement of insurance contracts. We have been particularly
distressed by the findings and allegations of New York Attorney
General Spitzer that insurance brokers have violated their
position as trusted advisor to their clients by steering
clients to favor the insurance company and engaging in bid
rigging schemes. Such activities undermine the trust and
confidence that are at the heart of the customer-broker
relationship. Our President, Nancy Chambers, issued a statement
addressing this issue on October 22, a copy of which is
attached to my testimony.\1\
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\1\ Exhibit A and B appears in the Appendix on page 128.
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Insurance brokers are an integral part of the insurance
placement system. Brokers serve as intermediaries between
commercial customers and insurers. Traditionally, brokers
represent their customers while insurance agents represent
insurance companies. Commercial insurance transactions are
often very complex and brokers are essential to finding
available insurance coverage to meet their customers' needs.
RIMS, itself, is not a standard setting body for the
insurance industry. RIMS does, however, place great emphasis on
educating and advising its members about current issues and
providing them with useful tools to deal with these issues, and
this is the approach taken by RIMS with respect to contingent
fees.
As the use of placement service agreements and contingency
arrangements became popular with some insurance brokers and
insurance companies in the 1990's, RIMS advised its members of
these practices. In 1999, RIMS issued a disclosure statement
whereby brokers would disclose insurers with which they had
contingency fee agreements upon the clients' request. Brokers
and insurance companies declared at that time that contingent
fees represented only a small part of total fees, and as such,
our approach seemed appropriate.
RIMS followed up on that 1999 statement through institution
of a quality improvement process in 2000, which is a
comprehensive program designed to guide and facilitate quality
improvement for risk managers. We use these guidelines to
improve communication, develop performance expectation
agreements, and to evaluate broker performance under these
agreements. This agreement states that all remuneration for
services should be disclosed to the client while complying with
local insurance laws.
Further, in representing the interest of risk managers,
RIMS provides workshops, discussion groups, and other
educational programs that address the most pressing issues of
the day. In fact, for the past 3 years, at its annual
conference, RIMS has explored the many facets of the client-
broker relationship through a series of sessions. We believe
that by educating our members, they will be fully equipped to
evaluate potential conflicts of interest in the placement of
insurance policies.
As the facts are becoming known and the investigation into
placement service agreements continues, in an effort to address
the potential conflict of interest issue, RIMS would support a
prohibition on the use of placement service agreements by
insurers and brokers. Three of the largest brokers have
publicly stated they will no longer enter into placement
service agreement or accept contingent fees. Such actions,
coupled with compensation disclosure, should bring greater
transparency to the broker-client relationship and help to
restore trust and confidence.
Whatever actions legislators and regulators decide are
appropriate to address the issues of placement service
agreements and contingency compensation, the interests of
insurance consumers must be considered. Consumers should not
have to pay higher costs for insurance because of abusive
actions that may have been taken by some brokers and some
insurers. And hopefully, any remedial action will result in
lower costs for insurance for consumers by eliminating improper
actions that might have increased these costs. The recent
allegations against several insurance brokers in New York have
been very troubling. These allegations have not only undermined
the broker-client relationship, but they have wider
implications for the industry as a whole. And any penalties
that may ultimately be levied against these companies involved
should be used to offset consumer losses that have resulted
from these deceptive practices.
We understand that the NAIC is preparing to address the
broker compensation issue and that one approach in their agenda
is the adoption of a model law on disclosure of broker
compensation arrangements. RIMS believes that a national
uniform approach should be taken to address this issue.
Regulatory clarity and uniformity are needed, not 51 different
approaches.
Thank you for this opportunity to testify on this important
issue. RIMS looks forward to working with you and your
Subcommittee and with Congress to address this issue and we
appreciate your time and interest and leadership. Thank you.
Senator Fitzgerald. Thank you very much. Mr. Hunter.
TESTIMONY OF J. ROBERT HUNTER,\1\ DIRECTOR OF INSURANCE,
CONSUMER FEDERATION OF AMERICA
Mr. Hunter. Mr. Chairman, on behalf of CFA's 50,000
Americans, we would like to thank you for what you have done in
your tenure. It has been terrific. You are one of our heroes
and we would like to publicly say that.
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\1\ The prepared statement of Mr. Hunter appears in the Appendix on
page 130.
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Senator Fitzgerald. Thank you.
Mr. Hunter. There are four major issues that we see from
the Spitzer investigations.
First, and of greatest importance, the investigation
reveals how easily sophisticated buyers of insurance can be
duped by brokers, agents, and insurers. Imagine the potential
for abuse with small businesses and individuals as they try to
manipulate the insurance marketplace. It is a highly complex
marketplace. They are buying legal documents they don't
understand. They need help, so they go to people and say, take
me. Help me. They are vulnerable.
They have to not only find out whether they are comparing
like policies, they have to look at the solidity of the
insurer, they have to look at the service record because they
can't kick the tires. They may not have a claim for years. They
have to go through the underwriting process. And then they have
the complex pricing systems, credit scoring, where you live,
all these things, many determining price.
This complexity causes weak competition at all levels of
this business, not just for large businesses. CFA review of
rates charged, for example, show that it is easy for the exact
same insured to pay two to three times within the market. A
competitive market should have a narrow range, not a range like
that. In Hawaii, for example--I wanted to use Illinois, but
they don't produce this information--in Hawaii, a clean auto
risk, buying liability coverage, can pay $397 from USAA or $993
from Geico Casualty--same exact risk. Figure that out.
In 2003, the property casualty insurance industry paid
contingency commission kickbacks of $4.2 billion.
Second, the findings of bid rigging are a reflection of the
deeply rooted anti-competitive culture that exists in the
insurance industry. The culture derives from what you pointed
out, the antitrust exemption in McCarran. We still see cartel
rating organizations setting large parts of insurance rates for
many companies, determining what future costs will be, and the
FTC is handcuffed.
Thus, in November 2003, industry executives could freely
meet to discuss pricing. ``Let us not get pulled into a soft
market. We are not ready for a soft market. We can't afford
one. We need several more years of profitability,'' said James
Schiro, CEO of Zurich Financial. Responding, Maurice Greenberg,
Chairman and CEO of AIG, said, ``As an industry, we saw much
further to go to even get to a marginally acceptable return. We
absolutely need to hold the line on pricing and not give in to
competition.'' That is the industry.
Third, the Spitzer complaint shows that insurance
regulators have utterly failed to protect consumers and to
properly regulate insurers and brokers in a number of key
aspects. To make matters worse, many of these regulators
recently collaborated with insurance interests to deregulate
particularly commercial insurance and especially the so-called
sophisticated lines that we are now seeing were abused.
Finally, the Spitzer investigation makes clear that
consumer protection standards must be raised, not lowered as
the industry is pushing for.
There are five steps we would ask you to consider, three of
which you mentioned, so I am going to go short on those.
One, you should do no harm. Congress should do no harm. You
should stop consideration of bills that would weaken consumer
protections. We urge Congress not to enact optional Federal
charters that would result in concentration, as it did in
banking, or create a rush to the bottom as regulators compete
to get share.
We also urge that Congress stop consideration of the so-
called SMART Act. The SMART Act actually goes so far as to
completely deregulate the cartel rating organizations but leave
the Federal antitrust exemption intact. That is crazy, but that
is what is in it.
Senator Fitzgerald. If I can interject, what are the rating
organizations----
Mr. Hunter. The rating organizations are like the Insurance
Services Office and the National Council on Compensation
Insurance. They establish loss costs, the major part of the
rate. They do it jointly. They project the future for what are
the costs going to be next year. They get together and do this.
It would be like building contractors getting together and
agreeing on the price of bricks for next year and labor. It is
clearly, if you look at the House Judiciary Committee hearings,
it clearly would violate antitrust law if the antitrust law
were applied, but it is not.
The insurers do need to have some joint historic data, but
all the testimony was that you don't need the antitrust
exemption for that. As long as you truly use historic data and
don't manipulate it, you can have that. But the manipulation of
data is where the problem lies.
Second, we suggest considering a Federal minimum standards
bill for States to enforce. States have been gutting consumer
protections in recent years in an attempt to hold off the
Federal interest. They have been trying to keep the insurers on
their side by saying, look, we can go even lower than those
guys are willing to go, and they have been gutting regulations.
It has been interesting since Spitzer's investigation to see
them sort of get almost a stiff neck as they try to turn around
to go back and say, we are trying to regulate.
They have market conduct studies. They should have caught
this. They go in with these market conduct and financial
investigation studies and they catch nothing. The same thing
happened with life insurance abuses a few years ago, when
Prudential and all ended up having to pay billions because of
lawsuits. They don't catch anything.
If there is to be a Federal standards approach, the
standards need to be high. I list some in my testimony. I
hasten to say, even with high standards, a Federal approach is
fraught with risk since the Federal regulatory expertise and--
there is a strong possibility that any Federal regulator would
be subject to regulatory capture just as the States have been.
Therefore, there needs to be well-funded approaches so that
there can be a consumer advocate representing consumer
interests.
Third, unleash the FTC. I am not going to say any more
about that. You have already talked about that.
Fourth, repeal the antitrust exemption. I am not going to
talk any more about that. I just think it is obvious that this
industry has an anti-competitive history and it still functions
that way.
Fifth, require transparency. For over 20 years, consumer
advocates have called for disclosure similar to an energy
efficiency ranking you see when you shop for a refrigerator. We
suggest that Congress would require a point-of-sale disclosure
of the insurance policy value. The disclosure would show the
expected payout per dollar of premium--how much you are going
to pay out in claims, commissions, contingency commissions,
overhead, profit, etc., and the actuaries know the figures
because that is the way they set the rates.
Right next to it, you would display the same information
for this product for the overall industry. Consumers could
focus on, for example, the part of the premium expected to be
paid out in losses. If the consumer was considering a policy
that would pay out 50 cents per dollar but the industry average
was 70 cents, the consumer would know this is a bad deal and
ought to drop it.
I am way over my time. Sorry.
Senator Fitzgerald. Thank you very much.
All of you have had great testimony, all a little bit
different angles, and all of you represent different
constituencies. Just for the sake of our audience and people
who may be watching this on C-SPAN at home, Mr. Counselman, you
represent the Council of Insurance Agents and Brokers.
Essentially, you represent the larger brokers----
Mr. Counselman. We include in our membership the larger
brokers, but our members include small brokers, as well. But
our distinctive character is commercial insurance.
Senator Fitzgerald. But Marsh and McLennan and AON----
Mr. Counselman. They are also members.
Senator Fitzgerald. Mr. Soto, you represent the Independent
Insurance Agents and Brokers of America, the smaller agents, is
that correct?
Mr. Soto. That is correct. The average size of our
membership is probably 10 to 12 employees.
Senator Fitzgerald. Are Marsh and McLennan and AON, are
they also members of your association?
Mr. Soto. Some of their branch offices have joined our
State organizations. On a national basis, they are not a
member, the parent companies. Neither are those large brokers.
Senator Fitzgerald. OK. Mr. Csiszar, you represent the
Property Casualty Insurers Association of America. You
represent the carriers as distinct from the brokers, correct?
Mr. Csiszar. Yes.
Senator Fitzgerald. Now, Ms. Ochenkowski, you represent the
Risk and Insurance Management Society, which is, you said, 80
percent of Fortune 500 companies. These are the purchasers of
large corporate insurance policies, and so you are representing
clients of insurance brokerage firms and underlying carriers.
Mr. Hunter, you represent the Consumer Federation of
America, which represents the little guy, the ordinary
consumer. So I just wanted to have that straight for all our
audience members.
Mr. Counselman, you defended the contingent commissions.
Ms. Ochenkowski, you said you would be happy to see the
elimination of the placement service agreement, which is the
form of contingent commission agreement or arrangement that
Marsh and McLennan specifically had. You weren't as clear about
whether you support--you didn't say, if I listened carefully,
that you support prohibiting contingent commissions. You said
you support prohibiting placement services agreements. Do you
still think contingent commissions should be allowed?
Ms. Ochenkowski. To be clear, we would support the
prohibition of all of those forms of the contingent commission
as well as the placement agreements. We have found through the
information that has been provided in recent weeks that all
forms of this compensation seem to put people in the position
of behaving differently than they would if these agreements
didn't exist. And as has been pointed out, the existence of
contingent agreements in theory has not been illegal and we
have not supported their abolition. But when we look at this
entire issue, we think that--our position has evolved over time
and we are in support of abolishing all of----
Senator Fitzgerald. And you would like your members, these
big companies that are trying to get insurance now, you think
you want the brokers to clearly be working on their behalf, not
be also accepting compensation from the insurers, is that
accurate?
Ms. Ochenkowski. Yes.
Senator Fitzgerald. Now, Mr. Counselman, what do you say to
your customers? They don't want you getting payments from the
insurance carriers as well as from the buyers of the policies.
Mr. Counselman. Mr. Chairman, you raise a good point. My
concern is that there is an understanding of what a contingent
commission is versus a placement service agreement which could
be called a form of contingent compensation. But the contingent
compensation that I am focusing on in particular in my
testimony is loss ratio driven. It is provided by the insurer
as part of the commission compensation package.
Senator Fitzgerald. OK. Let me stop you right there. There
are different types of contingencies. Typically, you can get
paid for bringing in business to the insurance carrier that has
a low loss ratio. In other words, the carrier is trying to
incentivize you to go out and bring them good customers who
aren't going to run up the losses.
Mr. Counselman. Correct.
Senator Fitzgerald. There are other types of contingent
agreements that just pay you for bringing more policies from
wherever it comes, revenue.
Mr. Counselman. Correct.
Senator Fitzgerald. Now, you run an insurance brokerage,
correct? What is the name of it?
Mr. Counselman. Riggs, Counselman, Michaels, and Downes in
Baltimore.
Senator Fitzgerald. OK. Do you accept contingent
commissions?
Mr. Counselman. Yes, we do.
Senator Fitzgerald. And how are they based?
Mr. Counselman. They are based--there are many, because the
companies present them to us, so we have many from many
different companies. The majority, more than 50 percent, are
loss ratio based. They are not all loss ratio based----
Senator Fitzgerald. Do you deal with any carriers who don't
pay you a contingent commission?
Mr. Counselman. Some carriers do not. The majority of the
major carriers do----
Senator Fitzgerald. And do you steer many of your clients
to those? Do you put many of your clients into the carriers who
don't pay you a contingent commission?
Mr. Counselman. Absolutely, because the primary concern,
and this would be true for all agents and brokers, the primary
concern is to place the proper client in the proper insurer for
their situation. The secondary concern for all agents and
brokers is what is the compensation. But as has been pointed
out, disclosure and transparency are what allow that to happen.
Senator Fitzgerald. Do you disclose your arrangements to
your customers?
Mr. Counselman. Yes, Mr. Chairman, we do, and we----
Senator Fitzgerald. You are not required to, though, unless
they ask, is that correct?
Mr. Counselman. That is correct, but we think it is a good
practice to do so.
Senator Fitzgerald. Do you even if they don't ask?
Mr. Counselman. If they don't ask, we still think it is a
good practice to do so.
Senator Fitzgerald. But do you?
Mr. Counselman. We do on the majority--many of our
commercial presentations. We do not typically on small
commercial, meaning very small clients who don't seem to have
interest in that. But if they did, we would be pleased to
provide that information, and we don't on personal lines.
Senator Fitzgerald. But you always put your clients in the
policies with the carriers that are best for them. You don't
let the extra payments from the carriers influence or cloud
your judgment?
Mr. Counselman. If we didn't do the latter, if we didn't
always put clients in the best insurer for their circumstance,
we would not be in business for very long because our
environment is--it is a competitive environment and it is the
right thing to do. I mean, if I were a client, I want to be
treated that way.
Senator Fitzgerald. I tend to agree with it with respect to
the smaller commercial clients. Now, do you have any Fortune
500 clients?
Mr. Counselman. We do have a handful, but not very many.
Senator Fitzgerald. OK.
Mr. Counselman. We do have some, however.
Senator Fitzgerald. OK. But below the Fortune 500 or the
Fortune 1,000 companies, there is a lot of competition amongst
insurance brokers and I would have to say that my conclusion
would probably be that contingent commissions, if there is a
firm consistently steering their clients to poor policies in
consideration of the contingent fees that they are receiving,
they are not going to do very well for very long as an
insurance brokerage, and----
Mr. Counselman. There is also the distinction of
contingents are different in different lines of business. In
some lines of business, they are paid. In other lines of
business, they are not paid.
Senator Fitzgerald. Where are they paid and where are they
not paid?
Mr. Counselman. They are, for example, typically paid for
property insurance, automobile, general liability. They are
typically not paid for what are considered the higher risk,
less predictable lines of coverage, like umbrella excess
liability, the high limits of excess exposure or umbrella
liability exposure. They are not paid typically in professional
liability lines of business, directors and officers----
Senator Fitzgerald. How about health insurance?
Mr. Counselman. Health insurance, they are quite often paid
and they are quite often--they are more often in health
insurance related to premium volume and not to loss ratio.
Senator Fitzgerald. OK.
Mr. Counselman. So that is why I say that more than 50
percent in the business are loss rated, but there are many that
are not.
Senator Fitzgerald. OK. Continuing my thought, I think
there is, for the smaller companies and for individuals, there
is plenty of competition, but with respect to the largest
companies, the Fortune 500 companies, it appears two insurance
brokerage firms, Marsh and McLennan and AON, have 70 percent of
the business. So companies in RIMS, Ms. Ochenkowski's
association, you are typically going to have a choice of just a
handful of insurance brokers and they have an awful lot of
leverage with you. Why is it that your members don't go to
other smaller firms? Or why is it that they stick with Marsh
and McLennan or AON?
Ms. Ochenkowski. Well, Mr. Chairman, we have not done a
study of this, but my own observations would be that most of
the larger companies have much more complex insurance
placements and so they have more sophisticated advisory needs.
It has been perceived, rightly or wrongly, that the larger
insurance brokers are capable of delivering that more
sophisticated analysis. They have additional ancillary services
such as loss control services, actuarial services, etc., that
are available to commercial insurance buyers and those have
been helpful in assessing the underlying risks.
Senator Fitzgerald. So your biggest members of your
association feel they have to go to one of these really big,
behemoth insurance brokerage firms like Marsh, AON, or Willis
in order to get the services they need? That doesn't give you
many options, does it?
Ms. Ochenkowski. It does not.
Senator Fitzgerald. Are you worried about the concentration
amongst the large insurance brokers?
Ms. Ochenkowski. We certainly are becoming more concerned
about it. However, as we have seen competition and we have felt
that in terms of risk management and the quality process that
we have, in terms of the way in which risk managers have
evaluated the bids that have been placed with them, the
procedures that we have used internally, until the recent
Spitzer allegations, we felt that those practices were
sufficient to steer us in the proper direction.
Quite frankly, I think that is still truly the case except
for those extraordinary incidences of fraud, where there is
price steering and bid rigging. We are very closely watching
the investigations that are going on so that we can better
understand what the implications are for us as a whole.
Senator Fitzgerald. Now, Mr. Csiszar, you represent the
insurance carriers themselves. Aren't you worried about the
concentration at the insurance brokerage level for large-dollar
corporate policies? Isn't there a danger for some of your
association members who refuse to play ball with a Marsh and
McLennan or an AON, that they could simply move the whole swath
of customers away from you and put them with another insurer
who pays them a higher commission?
Mr. Csiszar. Let me make it clear, Mr. Chairman, that in
the case of our members, and I think this applies to the
industry in general, we deal with agents as well as brokers and
the brokers are but one small part of that business. I don't
have the numbers, but my estimate would be that, by far, the
largest amount of business comes in either through your
employees as agents or captive agents. By far, the largest
volume of business would come from either a Geico-style
operation, where your own employees are agents, or you have
captive agents, or you have independent agents. The brokerage
business is but one part, a separate part, of what the carriers
do.
To the extent that you would have anti-competitive behavior
of whatever kind going on in that segment of the market, yes,
indeed, we would be very concerned about that.
Senator Fitzgerald. How many of you have read the Spitzer
complaint against Marsh and McLennan? Have you all read it?
Mr. Soto. Parts of it.
Senator Fitzgerald. Parts of it. There is a section in
there in which the New York Attorney General's Office describes
how Marsh and McLennan ordered their people to yank policies
from carriers who weren't giving them much in the way of
contingent commissions and move it over to carriers who were
paying them more of a commission. That is pretty incredible,
isn't it?
Mr. Csiszar. Very much so. Very arrogant behavior, I would
say--beyond arrogance.
Senator Fitzgerald. Now, it seems to me that this kind of
rogue behavior would not succeed for very long in a very
competitive market, but where you have two big brokerage firms
with 70 percent of the market and the top three maybe 80
percent of the market, they can behave in this kind of abusive
way. Do you agree with----
Mr. Counselman. Mr. Chairman, I don't agree that is a
prevalent practice, what has been described. I don't disagree
that it occurred and I don't disagree that it is a problem. But
Marsh and AON have a large percentage of the market--I have
heard 80 percent said several times today--of a certain segment
of the business. That may be 80 percent of the Fortune 1,000
business. It may be 80 percent of the Fortune 500 business. I
don't know which it is.
But in many markets, our members, the Council of Insurance
Agents and Brokers members, are the dominant or the largest in
their market. There are some cities where Marsh or AON are the
largest. There are many cities where they are the largest. But
there are many other cities where they are not dominant. That
may mean there is different behavior that we observe in
different cities.
Senator Fitzgerald. How about where you are in Baltimore?
Mr. Counselman. They are not the dominant----
Senator Fitzgerald. Are you dominant?
Mr. Counselman. We are dominant in our market.
Senator Fitzgerald. What market share do you have in
Baltimore?
Mr. Counselman. I don't even know, but it would be probably
well less than 10 percent. It is probably less than 5 percent,
if even--it is probably less than 1 percent. I don't know the
numbers, because it is the kind of market that Mr. Soto
described, where there are thousands of agents who are
competing every day.
The Washington, DC market, which is not very far from where
I live, is a different market and that market tends to be more
dominated by a few small brokers. So the market is different.
My point is that in the whole commercial marketplace, Marsh
and AON are significant because they are so large, but so are
all of the others collectively. And so whatever rules or laws
may need to be amended, we also need to understand what is the
impact on the rest of that market, which may be as large as 50
percent. It is not that Marsh and AON have 80 percent of the
total market. They may have 80 percent of their target market.
Senator Fitzgerald. Now, you defend the contingent
commissions and you don't believe that it led to the bid
rigging, but in the Spitzer complaint, he talks about the added
fees as being a big incentive, and it is clear if you read the
complaint that the added fees they could get from contingent
commissions were one of the reasons they tried to rig bids in
certain circumstances so that they could place the insurance
with a carrier who would give them more of a kickback.
Let me just read one paragraph from the Spitzer complaint.
This is paragraph 35 on page 12. ``Marsh executives have issued
directions about specific companies, as well. For example, in
April 2001, a global brokering managing director in the excess
casualty group in New York wrote to the heads of regional
offices. She asked for, 1,920 accounts that you can move from
an incumbent insurance company to a company that had just
extended its contingent commission agreement.' She warned,
however, `You must make sure that you are not moving business
from key contingent commission companies.'' So she is saying,
just move it from the companies that aren't paying us big
contingent commissions. Highlighting the incentive represented
by her directive, she concluded, ``This could mean a fantastic
increase in our revenue.''
Mr. Counselman, you don't believe this is a conflict of
interest when the broker is accepting payments from the
carriers to steer business to them?
Mr. Counselman. What you just described to me is a conflict
of interest. But Marsh and AON--I presume AON. I don't know if
AON has global brokering like Marsh did as described in
Attorney General Spitzer's suit. But what is described in
Attorney General Spitzer's suit is the centralization of the
marketing or placement of the business in conjunction with
these placement service agreements. What goes on in the
majority of our members' offices is placements in different
companies, insurance companies, are done in those individual
offices throughout the country where the client is located.
Senator Fitzgerald. Each office may have their own
contingent commission agreement. And Marsh used to be that way
and then they centralized it in New York and then they sent out
directives from New York to all the branch offices that are
here, are the ones who are paying us the most nationwide and
you need to steer your customers to buy their insurance from
these carriers.
Mr. Counselman. That is what I have read and that is what
is quite different from what we experience day to day in the
marketplace, which is why I am urging caution, because we are
in numbers more firms and more individuals and a very
significant part of the insurance marketplace and how insurance
is placed in individual offices close to the client with
individual agreements.
Senator Fitzgerald. Mr. Soto, in the small insurance
market--you represent the smaller agents--does your office in
Miami, do you accept contingent payments from insurers?
Mr. Soto. Yes, we do, Senator.
Senator Fitzgerald. Would you accept them on, say, an
individual coming in to place automobile insurance with you?
Mr. Soto. We have insurance companies that pay us
contingency commissions in commercial lines as well as in
personal lines.
Senator Fitzgerald. So should consumers of personal
insurance around the country be worried that their small broker
is getting a contingent fee from the insurance carrier?
Mr. Soto. Excellent question. In theory, yes. In actual
practice, that marketplace dictates that I have got to come up
with the very best or I will lose it. If you look at the
history----
Senator Fitzgerald. Because you have lots of competition.
Mr. Soto. Yes, and if you look at the history of what has
happened in personal lines in the United States, about 30 years
ago, the independent agency system actually dominated personal
lines, and then a number of direct writers and captive agents
created a model which was very competitive. They drove down the
cost not only in terms of the overhead, but loss control, and
over time, because of competition, because insureds over the
years found that that model was very attractive, books of
business shifted over to the point that we now control about 30
percent of the marketplace. The companies that we do business
with have reacted to that and become more competitive, more
aggressive, and I can give you a couple of examples.
For example, there is one company that sells directly to
the clients and pays no commission and has no contingency
arrangement, but we can beat and love to compete against that
particular company because those expenses have not disappeared.
They have internalized them and they spend a substantial amount
of the premium dollar in advertising, which is not an arena
that we are talking about here.
The companies that I do business with, the model that they
have created is one where I go out and get the client. I do
some individual advertising in my community, in the churches,
in the Kiwanis and all of that and I attract business and I can
compete very well with those individuals. But at the end of the
day, if I don't bring more value, they will not change their
insurance to me so it is hari kari, economic hari kari for my
office to not look at the bottom value.
Senator Fitzgerald. Mr. Hunter, what about that? If we
eliminated or prohibited contingent commissions, do you think
consumers would really wind up saving money, and are you sure
they wouldn't suffer by not having as good of services on the
part of their agent or on the part of their broker?
Mr. Hunter. There is no doubt they save money because,
first of all, the individual and small business market is not a
sophisticated market and it frequently doesn't do much
shopping. It goes to an agent and the agent says, I represent
ten companies. They think the agent will shop. There are no
suitability requirements. If they have a captive person, they
can put them in the higher-price company. That is why you have
rates so incredibly wide apart.
I had a dean of a law school call me. He was furious
because he was in AllState and he thought he had a good rate
but he was in the AllState. He was not in insurance, he was in
indemnity and he had been in there for 10 years, but he always
qualified for the low rate. He was paying twice as much. He
only found out by chance. He brought a lawsuit and he got his
money back. But that is a sophisticated consumer who thinks
they are doing well. This is a complex thing, a lot of same-
name companies and all that.
But even more concerning than the sales incentives are the
profitability contingent commissions, and I think we are going
to see something about that. Lots of people have been told not
to file small claims lately by insurance agents and brokers,
particularly in the last few years. So you can easily devise a
hypothetical where someone coming in late in the year might be
the--that $1,000 fender bender might lose the contingency for
that loss ratio profitability. It is a danger. It is a
temptation. I don't know of anybody doing it, but I didn't know
what was going on with Marsh and McLennan, either.
Senator Fitzgerald. Perhaps we should be more concerned
about the contingent fees being charged of ordinary consumers
than we are concerned about contingent fees being charged of
the large Fortune 500 or 1,000 companies. Should Congress
really care if Marsh and McLennan or AON skin IBM or
Caterpillar? Should we care about that?
Mr. Hunter. Absolutely, from a consumer point of view,
because they are going to pass through the cost to us.
Senator Fitzgerald. They are going to pass it on to us, OK.
But certainly we should be concerned about it in the case of
ordinary consumers getting their homeowners' or automobile
policies. Mr. Csiszar.
Mr. Csiszar. Mr. Chairman, I think--I keep coming back to
the fact that let us not mix apples and oranges here. Mr.
Hunter talks very broadly about contingent commissions. I think
it is important to distinguish between agents and brokers and
make it very clear that the agent represents a company and
there is a contract between the company and the agent and the
best cure for the consumer--do you know when I was a regulator
what I would tell my consumer? When I had 225 companies writing
automobile insurance in little old South Carolina? I told them
to go shopping around because by shopping around, they got the
best rate, and there were plenty of places to go for shopping.
So if the law dean has a problem, the answer is go shop around
and you will find out that you will have more than one choice.
Senator Fitzgerald. Isn't that right, Mr. Hunter? If you
are going to a State Farm agent, you know they are selling
State Farm policies and probably everybody recognizes that is
the only thing you can get there and they are trying to get
more business for State Farm. They work for State Farm.
Mr. Hunter. There is no State that doesn't have an Unfair
Claims Practices Act. If an agent or a broker--it doesn't
matter in this example--if an agent or broker delays my claim
to get it past the reporting period so that they can keep their
override contingent commission on profitability, or tells me
not to submit it because it is not covered when it is, or tells
me not to submit it because my rate will go up when you
shouldn't tell me that, that is illegal in every State for
agents as well as brokers.
Senator Fitzgerald. Mr. Soto.
Mr. Soto. May I comment on the issue of the claims
reporting? First of all, it is, and I almost hate to use the
term, ludicrous, and if you notice, Mr. Hunter indicated that
he has not heard of any single incidence, but in theory,
something could happen at the very end of a year. Somebody
might not report a claim if you are on December 31. And yes, in
theory, that can happen.
In actual practice, the reality is that part of my process
of proving myself every day is one where the moment that a
claim occurs, that client is looking to me to be prompt about
reporting, to explain the process, to be an ombudsman if the
claims adjustor is not calling them, and it is difficult to
envision that if you have a kitchen fire, I am going to delay 2
weeks in reporting it and either win brownie points with you or
get away with it. It is almost impossible to imagine on a
Workers' Compensation claim that every State has a
responsibility and a law under penalty that it must be reported
within 24 hours. And you can go on and on with every line of
insurance. It just really in actual practice doesn't happen.
Could you find one or two examples of somebody who may have
done that? I suppose you could, but I think that you set the
standard early on when you said, are some of these problems
individualized or are they systemic and do we need to make
radical changes in the system because we have uncovered a few
malfeasances? I think that is an excellent standard to look at
this. Could that happen? Yes, it could happen. Does it happen
in real life? I would suggest to you that practically never
happens.
Mr. Hunter. I would suggest to you I would expect that
practically it was impossible for Marsh to bid rig, but there
was an incentive and they did. If the agent or a broker has an
incentive not to file a claim, they might do it.
Senator Fitzgerald. Now, on the bid rigging--I have found
in these Senate hearings that for every villain, there tends to
be a hero. There were some insurance carriers that refused to
go along and I believe one of them was CNA, is that correct?
Mr. Csiszar. Yes.
Senator Fitzgerald. CNA wouldn't touch that. Were there
others, Mr. Csiszar? Who were they?
Mr. Csiszar. There were others who are members of our
association.
Senator Fitzgerald. Would you like to name them, because it
is in a positive light.
Mr. Csiszar. I would rather not because there have been
subpoenas issued----
Senator Fitzgerald. OK, but CNA Insurance, I recall, was
one that refused to go along with the charade.
Now, wouldn't the insurance carriers like to get rid of the
whole contingent commission arrangement? Isn't it kind of a
shakedown of the insurance carriers when Marsh and McLennan
comes to you and says, hey, if you don't play ball with us and
give me part of your revenue, kick it back to us, we are going
to move insurance business?
Mr. Csiszar. Again, I would like to distinguish between
agents and brokers. For a company to pay contingency fees to an
agent is a way to incentivize the agent. That is something--
that is what you see with the car salesmen. That is what you
see with a food broker, for instance. That is what you see in
other industries, where you are incentivizing your own agent,
independent or otherwise.
On the brokerage side, I will give you an example. I just
bought that famous house in Chicago and it so turns out that
after looking at 50 homes, I kept coming back to the same house
and it had only been listed the day before or 2 days before.
Well, as we are looking at that house, my agent informs me that
she is also the listing agent on that house. Did I object to
that? No. She had done a tremendous job taking us through 50 or
100 different homes. She was very clear in disclosing it to me.
And, in fact, I appreciated the fact that she disclosed it and
I don't mind her double-dipping on the commission because she
has actually done a good job.
I keep coming back to that on the brokerage side, it is the
disclosure issue that is the real problem, true enforced
disclosure. And, in fact, we have enough laws on the books to
force that disclosure now. If the SMART Act were to pass, for
instance, we would have even more tools in our hands. We would
homogenize and make it uniform, make it the same disclosure
everywhere.
So I think we have got the tools to do this work and what
happened is the enforcement process fell apart and you had a
few arrogant players in the market who took advantage of it and
had the market power to do it.
Senator Fitzgerald. OK. So we have greater disclosure, but
you still have two large brokerage firms with 70 percent of the
large corporate market. That is enough leverage to exact other
types of payment probably out of the insurance carriers. Are
you worried about the concentration in the insurance brokerage
industry?
Mr. Csiszar. I think that even the large clients will
discover that there are other brokers out there who could do as
good a job as the large brokers. Do I know the tie-ins?
Oftentimes, they stem from the fact that an AON or a Marsh can
do catastrophe modeling for you. They can do financial modeling
for you. They have other value-added services.
I think that if General Motors wants to shop around, they
can actually shop around and find another broker to deal with,
because while there is concentration, I think that competition
will break that concentration.
Senator Fitzgerald. What do you think about that, Ms.
Ochenkowski? He is saying that General Motors, IBM, or
Microsoft, they can probably go ahead and use a smaller
insurance broker who can provide the same services. Is there
maybe an attitude in the largest corporations in America, the
Fortune 500 companies, for example, whoever is the risk
manager, just in order to cover himself or herself, feels safer
going to a larger insurance brokerage firm? I had better use
Marsh and McLennan so nobody else questions me when I am in
the--is there that kind of mentality, do you think, going on?
Ms. Ochenkowski. There may be some of that, and I think
there are also true services. If you are global or
multinational or even a national company, it is helpful to deal
with a national or multinational broker so that there are
service offices in the various cities in which a client also
has operations. And that is one area in which----
Senator Fitzgerald. Does anybody besides Marsh and McLennan
and Willis have international reach, or global----
Mr. Counselman. Mr. Chairman, yes----
Ms. Ochenkowski. Some do, yes.
Senator Fitzgerald. You do?
Mr. Counselman. Yes, many of our members do go through
other members who are members of networks that operate in other
countries.
Senator Fitzgerald. So you could help somebody in London?
Mr. Counselman. Absolutely.
Mr. Soto. And you can contract for the service. You know, I
am dying to slide one of my business cards to her----
[Laughter.]
Senator Fitzgerald. There you go.
Mr. Soto. The reality is that as I have read this material,
I have been flabbergasted by the fact that you have that kind
of power to control large segments of business, and I am trying
to raise my hand--I am talking about the mega-brokers--and I am
trying to raise my hand and say, the reality is that we can
either directly through alliance or through contracting, you
can contract services such as loss control analysis and all of
that. It doesn't really have to all be housed in-house.
Senator Fitzgerald. Well, it is----
Ms. Ochenkowski. Perhaps there ought to be better
marketing, too, from the smaller regional agencies to larger
insurance consumers. They don't think that sophisticated
insurance buyers would choose to close the door on any viable
options, although part of what you suggested in your question
may be true, and that is that the senior management of our
firms as well as shareholders sometimes respect the placement
of coverage with other well-known names because there is a
feeling of competence that comes from a household name.
Senator Fitzgerald. Ms. Ochenkowski, your members are not
exempt from Federal antitrust laws.
Ms. Ochenkowski. That is correct.
Senator Fitzgerald. Do you think insurance brokerage firms
should be exempt from Federal antitrust laws?
Ms. Ochenkowski. Well, that is something you raised earlier
and it is not something that RIMS as an organization has
considered. It is a very interesting question and I think we
would like to think about it a little bit and come back to you
with our response.
Senator Fitzgerald. I am not suggesting the repeal of
McCarran-Ferguson with respect to insurance carriers. That is a
totally different thing, but specifically with respect to
brokers. It is not clear to me whether the McCarran-Ferguson
Act, which provides an immunity from antitrust for the business
of insurance, meant to apply to insurance brokerage services.
Mr. Counselman. We believe that brokers are subject to
antitrust laws----
Senator Fitzgerald. You do?
Mr. Counselman. Yes, and that the insurance--the McCarran-
Ferguson Act protects or provides, has provisions for certain
activities of insurance which allows rate making, for example,
collecting data.
Senator Fitzgerald. So you think the Justice Department
could bring an antitrust lawsuit against Marsh and McLennan or
AON just as the State of New York has brought an antitrust
lawsuit against Marsh and McLennan?
Mr. Counselman. I think that is conceivable.
Senator Fitzgerald. You do? Mr. Csiszar, would you care to
comment on that? It wasn't clear to me by reading the McCarran-
Ferguson Act.
Mr. Csiszar. It is not clear, though certainly--and there
has been no court case that I know decides it, either. But I
think the thrust of McCarran-Ferguson had to do with the risk
taking side of the business, not the insurance side.
Senator Fitzgerald. By the carriers, not the brokers,
correct?
Mr. Csiszar. Right.
Senator Fitzgerald. And so we are sitting here where there
are two companies with 70 percent of the large corporate market
and some of the panelists are suggesting that the McCarran-
Ferguson Act was not meant to provide immunity from antitrust
to insurance brokers. Maybe this is something the Justice
Department should take a look at, because I don't believe these
kind of abuses could have gone on successfully or had much of
an effect in driving up prices if there were more competition
at the very large level.
I don't think the contingent commissions that smaller
brokerages, like Mr. Soto's firm, may be accepting at the end
of the day, because there is so much competition in the
marketplace, people can just move to any other brokerage firm,
are going to drive up prices all that much. But where you have
two players with 70 percent of the market, it definitely could.
Mr. Counselman. Mr. Chairman, I think that contingent
commissions also drive down prices when they are applied
properly because they incent lower loss ratios. They incent my
firm and individuals at member firms of the council to go out
and find those insureds, those clients, prospective clients,
who are interested in controlling their losses and will take
the steps, the known steps that a client can take to reduce
their losses. So when used properly, they incent positive
behavior. Now, obviously, what has been described earlier today
was not incenting positive behavior.
Senator Fitzgerald. Mr. Hunter, do you believe they incent
positive behavior, the contingent commissions?
Mr. Hunter. It is possible that they could incent going out
and finding some better business, but it is also possible it
could incent holding down claims when they hand it in, so it
has both incentives.
Senator Fitzgerald. Should politicians be raising the issue
of conflict of interest with anyone when, after all,
politicians who run for office are taking campaign
contributions from the very same people that they are
regulating and passing laws on, correct? [Laughter.]
Mr. Counselman. We are speechless. [Laughter.]
Mr. Hunter. You need to have a hearing on that next.
[Laughter.]
Senator Fitzgerald. We have covered lots of ground. I would
finally--we raised the antitrust issue. What about allowing,
Mr. Csiszar, and I know this is sensitive, what about just
allowing the FTC to study the insurance industry?
Mr. Csiszar. In fact, they are doing a study now, I
believe. They are doing a study on credit scoring. So they have
got their foot in the door. I am not sure how they got it in,
but----
Senator Fitzgerald. Now, there was a prohibition from 1980.
Do you think they should be allowed--we should repeal the
prohibition enacted in 1980 that forbade the FTC not just from
enforcement actions with respect to the insurance industry, but
from even studying the insurance industry?
Mr. Csiszar. I think anybody ought to be able to study it.
I know that as a regulator, I dealt constantly with GAO on
studies. So from my standpoint, studying the industry is
something that is of value.
Senator Fitzgerald. Does anybody else care to jump in on
the FTC?
Mr. Hunter. The credit scoring study was specifically
authorized under FCRA. That is why it is an exception to the
rule. They can't do anything else. In fact, I sat at a table
with the chairman of the FTC testifying like this and the
chairman was asked about insurance and he said, Mr. Chairman,
if I knew the answer to that, I would have broken the law, and
that is the problem.
Senator Fitzgerald. Well, listen, you all have been
terrific witnesses. I appreciate your candor and your
willingness to speak your positions very forcefully.
The record will stay open for 1 week, until the close of
business next Tuesday, November 23, in case any of my
colleagues have any written questions they may want to give to
you or you have any further information that you would like to
provide the Subcommittee.
Thank you all again for being here. I appreciate your
patience for this long hearing. The hearing is adjourned.
[Whereupon, at 1:32 p.m., the Subcommittee was adjourned.]
A P P E N D I X
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