The Insurance Scandal: Just How Rotten?

The insurance industry is the latest financial sector to have its darkest secrets exposed to the light.

As bad as this may seem, the most damning allegation is that Marsh took its desire to steer business to insurers one step further and actually rigged bids. The complaint describes a series of schemes whereby AIG would submit an uncompetitive “B Quote” against a rival’s bid at a rate suggested by Marsh. Marsh would then show its customer what were apparently competing quotes, knowing that invariably the rival’s cheaper quote would be accepted and that it would later pocket a contingent commission. In return, AIG would be allowed to win business in the future on similar terms.

Mr. Spitzer cites a specific example of ACE making a bid more costly at Marsh’s direction to allow AIG to provide the low offer on renewal of a policy with Fortune Brands, an American conglomerate. The Hartford, another American insurance giant, went along with similar schemes, according to the complaint, “because Marsh was its biggest broker, and it felt that Marsh would limit its business opportunities if it refused.” Munich-American RiskPartners, the American subsidiary of Munich Re, was asked so frequently by Marsh for a “live body” to attend client presentations for the sake of appearing to provide competition that a manager sent a message to Marsh: “While you may need ‘a live body’, we need a ‘live opportunity’.” In an internal memo, a Munich-American manager characterised quoting artificially high quotes as “basically dishonest” and “awfully close to collusion or price fixing.”

After the charges were announced, shares of ACE and AIG fell by more than 10 percent and Marsh’s by more than one-third. Tellingly, the share price of every other insurance company and broker fell as well. Marsh’s market value has now halved, while AIG’s is lower by $24 billion.

However, it is unlikely that any company will be driven out of business as a result of the scandal. Even Marsh might not be hit as badly as it may deserve. Typically, the risk departments of companies begin discussions about renewing their annual policies on September 1st, in order to allow for an orderly transfer at the end of the year. It may already be too late for them to go through the lengthy assessment and solicitation process with another broker. There is also a scarcity of choice. Consolidation has boiled down the number of truly global brokers to just three — Marsh, Aon and Willis. There could be a big shift if one of these were to be given a clean bill of health. In the meantime, Marsh, unlike an insurance company, faces no counterparty risk and thus should avoid the kind of fatal spiral that can hit a leveraged financial firm during a panic.

Marsh’s Quadruple Whammy

Whether Marsh survives in its current form, however, is another question. Mr. Spitzer says Marsh’s bosses have not been “sufficiently forthcoming, open or honest to persuade me that they are the appropriate leadership if this is to be a reformed company.” Marsh’s Putnam asset-management division was caught up in the mutual-fund scandal and its Mercer consulting unit is currently being investigated for its pension recommendations and also played a controversial role in the huge compensation package that was awarded to Richard Grasso, former boss of the New York Stock Exchange who is also being prosecuted by Mr. Spitzer.

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