Who pays for your broker?

It didn't take long for New York Attorney General Eliot Spitzer to turn his ethical business practice attention to insurance brokers and their Placement Service Agreement policies. The latest debate focuses on whether insurance brokers can best serve their clients' interests when the broker is also rewarded financially under a PSA, the contingency-based financial incentives that insurance carriers use to compensate brokers for reaching volume and profitability targets.

It's a double-edged sword because customers pay their brokers to secure suitable and competitive insurance coverage, yet to whom is the broker loyal when both the buyer and seller compensate him? Is the broker's self interest compromising the risk manager's interest?

Spitzer has set his sights on the propriety of PSAs, issuing subpoenas to a number of large brokerage firms, including Marsh, Aon Corp., Willis Group Holdings and Kaye Insurance Associates. If top law enforcement is scrutinizing these practices, perhaps risk managers should follow suit.

Brokerage firms claim that contingent commissions are a longstanding practice, and that they adequately disclose PSAs to buyers via invoices, Web sites and public filings. Indeed, PSAs are permissible under insurance law in several states--including New York, California and Pennsylvania--allowing brokers to receive both commissions and fees in certain situations as long as disclosures are made upfront.

However, despite those disclosures, a recent study suggests that PSAs may influence broker behavior. Jeffrey Wilder, formerly of MIT's Department of Economics, analyzed broker placements from 1994 to 2000 and concluded that contingency fees "distort" broker behavior and are "an important determinant" of where brokers place their clients' business. But the study did not demonstrate that such placements actually harmed buyers.

Spitzer's investigation into the "allegedly" improper fees is still in the early stages, so it's too soon to speculate on the potential outcome. On the heels of Spitzer's mutual fund probe--which yielded hundreds of millions of dollars in settlements, fines and penalties--the economic impact on brokerage firms could be substantial. For example, a 1998 report from Marsh disclosed that PSAs accounted for 5 percent of its annual income, equal to $400 million based upon this year's expected revenue.

Economies aside, Spitzer's investigation has undoubtedly already achieved one major goal: widespread exposure of PSAs to insurance buyers. And, given the public spotlight, brokers may be more likely to disclose PSAs. Risk managers are in a stronger position to investigate this issue and to ensure they are getting fair and diligent representation.

Risk managers can determine whether a broker is a party to PSAs by requesting information about the broker's PSAs with carriers, ensuring that any disclosure contains information relative to their accounts, asking brokers to provide portfolios showing the carriers with whom they place business, requiring that the broker justify the decision to obtain quotes from some carriers but not others, securing a detailed explanation of the recommendation, insisting upon a breakdown of the insurance premium, documenting the fee arrangement with the broker in writing and evaluating whether the services received are in line with the fee charged.

LINDA S. KAISER is a member of the insurance practice group with Cozen O'Conner. She wrote this piece with Cozen associate JOSEPH A. ARNOLD.

COPYRIGHT 2004 Axon Group
COPYRIGHT 2004 Gale Group