Nearly a year has passed since New York Attorney General Eliot Spitzer charged insurance brokerage firm Marsh & McLennan with rigging bids to maximize its commissions with insurance carriers.Allegations against Aon, AIG, ACE and other brokers and insurers followed-and within weeks, the country's largest insurance brokers-Marsh, Aon and Arthur J. Gallagher-as well as AIG and ACE had ceased the practice of accepting (or paying) contingent commissions.
More recently, the National Association of Insurance Commissioners (NAIC), Kansas City, Mo., adopted amendments to its Producer Licensing Model Act, calling for producers who do continue to accept contingency fees from carriers-and who are also paid by their clients-to disclose those fees to their clients and document proof of that disclosure (see "NAIC amends the Producer Licensing Model Act," below).
What does all this activity mean to carriers and brokers? What effect will "Hurricane Eliot" ultimately have on producer compensation in the industry?
Contingent commissions probably won't cease to exist, industry experts concur, but Spitzer has forced the industry to examine how it manages producer compensation.
In particular, carriers need to make sure they have the internal controls in place to document and audit their compensation practices-as do those brokers who collect the fees in question.
"Brokers and carriers have to make sure the right disclosures were made by the right people at the right time-and that they can document it," says Donald Light, senior analyst at Celent Communications Inc., a Boston-based research and advisory firm to the financial services industry.
"That takes time and costs money, but there's no big mystery about how to do that," he says. "Between document management, workflow and business process management systems, it's fairly easy."
More interesting is the challenge that faces the country's largest brokers to find ways to recoup the revenue they previously collected from contingent commissions, Light says. And smaller brokers and carriers will eventually be faced with process and technology fixes to accommodate new regulations and the migration of less profitable, smaller commercial accounts to regional distributors.
A lot like SOX
"This issue is very much like Sarbanes-Oxley," says Greg Wynne, director of product and industry marketing for Callidus, a San Jose, Calif.-based incentive management system provider.
A lot of companies want to have stronger incentive compensation systems in place, but they often put the decision off until next year, he says. "But then the SOX auditors came in and said, 'Gee, you're running $2 billion worth of commissions through spreadsheets. How are we supposed to audit that?'"
Indeed, because of Sarbanes-Oxley, companies were already examining their "information supply chains" to identify any exposure to errors, inaccuracies or chicanery and build the necessary controls to eliminate those gaps, according to sources.
"Spitzer just heightened the urgency and focused attention on finite reinsurance and contingency commissions," notes Andrew Whalen, vice president, insurance and healthcare, at Unitech Systems Inc., a Naperville, Ill.-based automated control firm.
By and large, insurance brokers will be more affected than carriers when states begin adopting the NAIC amendments to producer compensation regulations. They'll be the ones responsible for disclosing their commissions and obtaining their clients' consent, notes Gary Gummig, vice president, e-government, at Sircon Corp., an Okemos, Mich.-based producer management system provider.
"But most carriers-at the bare minimum-will want some mechanism in place to flag those brokers who receive contingent commissions and ensure they're in compliance," Gummig says.
Depending on the carrier, those internal controls may reside in their commission system, in an incentive management system or in a producer management system.
"The real work and effort for carriers is going to revolve around integrating those systems so they have an enterprise view of their sales force," Gummig adds.
The largest brokers, on the other hand, are faced with recovering the revenue they lost when they forfeited contingent commissions. According to WFG Capital Advisors, a Harrisburg, Pa.-based investment banking firm that focuses on insurance and financial services, 7% of Marsh's 2003 revenue came from contingent compensation-as did 2% of Aon's and 3% of Gallagher's. Plus, contingent commissions have a very high profit margin.
"The [additional services] brokers were providing haven't changed, but the compensation they're getting has been reduced," notes Celent's Light.
"Brokers have this challenge now of how to create a new business model that will put them close to-or better than-where they were before the storm broke. And that is still unresolved," he says.
In addition to ousting executives, laying off employees and devising alternative fee structures for their services, the large brokers are realizing technology will play a role in their restructuring strategies, says Light.
For example, in March, Marsh decided to shed smaller, unprofitable accounts (under $50,000 in annual premium) unless those accounts could be served by the broker's technology-driven service center in Texas, or through a program or affinity structure.
In the same vein, in June, Bill Pieroni, former global insurance industry practice leader at IBM Corp., Armonk, N.Y., joined Chicago-based Aon Corp. as global CIO. And Gregory Case joined the firm in April as president and CEO.
"Both of these individuals are 'fix-it' guys with consulting backgrounds," says Light, noting that Pieroni worked for Accenture before joining IBM and Case came from McKinsey & Co. where he headed the financial services industry practice.
"What do McKinsey and Accenture do?," says Light. "Essentially they create new strategies or business models for their clients. So we might see some bolder initiatives coming out of Aon."
Under the radar
As the large brokers remake their business models, many of the smaller accounts will inevitably fall to smaller, regional brokers, according to Celent.
The premium from roughly 20,000 jettisoned commercial accounts from Marsh, Aon and Willis could amount to as much as $720 million-or 4% of the total small/mid-commercial market.
If a significant amount of that business is diverted to any particular regional broker, that broker will face the tough technology challenge of scaling up to process and service those new accounts, according to Light.
"These regional brokers fly under the radar," he says. "There aren't many vendors serving this market." Agency management systems cater to insurance agencies, and the large insurance brokers have their own IT groups, he notes. "These regional brokers have had to put together their own applications. They've sort of been limping along."
Similarly, insurance carriers will face operational changes as the commercial market shifts from a few national brokers handling those smaller accounts to many regionals and independents, according to a Celent report titled, "Draining the Marsh: Preparing for Increased Fragmentation in the Mid-Commercial Market."
"With more distributors and lower volumes, there is less margin for inefficient communication and business practices," notes Matthew Josefowicz, manager of Celent's insurance group, and author of the report.
Specifically, he says, carriers will have to design better products, develop more personal relationships between underwriters and brokers, and design better online tools for submitting applications to attract these new distributors.
In addition, carriers will likely have to invest in improvements to their commission systems.
Most insurers still manage their commissions using siloed, legacy applications, which are complex and difficult to integrate with new technologies, such as Web services, sources concur.
"One of the big concerns I hear from our customers is: 'I have duplicate commission payments. I drop commission payments. I send commission payments to the wrong producers,'" notes Unitech's Whalen.
Brokers, too, find these systems inadequate, says Celent's Light.
"There are a lot of agents who say, 'Whatever commission the company sends, I take-because I don't have the time or the energy to try to figure out this hideous statement they sent me," he says.
Even if those statements are accurate, from a customer service perspective, carriers who may be competing for business from more regional brokers and independent agents will want them to "feel happy and good" instead of frustrated with those statements, he adds.
Incentive compensation management vendor Callidus has seen its insurance business double in the last two years.
Many of those customers are large carriers, according to Wynne. So far, efficiency and revenue growth, not Spitzer, have been the driving forces behind those investment decisions, he claims. If the states adopt the NAIC's proposals, it will simply add a sense of urgency.
"Carriers want the ability to take a newly acquired broker channel and very quickly get it up to speed and provide the appropriate incentives to sell their products," he says.
What's more, "with such commoditization in the insurance industry, one of the main weapons an insurance company has is the packaging of incentives to sell their products."
NAIC amends Producer Licensing Model Act
In June, the National Association of Insurance Commissioners (NAIC), Kansas City, Mo., adopted changes to its Producer Licensing Model Act, which the states can review and consider adding to their existing regulations.
Without forbidding producers from accepting incentives or contingency fees from insurers, the act now calls for those agents and brokers who receive any compensation from the customer for placing insurance--or who represent the customer--to add the following procedures before the customer purchases that insurance:
* Obtain the customer's documented acknowledgement that the agent or broker will receive compensation from the insurer or third party for selling the insurance.
* Disclose the amount of that compensation, or, if the amount isn't known, disclose the specific method used for calculating that compensation--and, if possible, a reasonable estimated amount.
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