Managing the Risk Manager

Challenged to ask brokers about contingency-fee payments, corporate insurance buyers dropped the ball. Finance chiefs would be wise to take a fresh look at the coziness of that relationship.

CFOs should look very closely at their corporate insurance buyers — and at how hard-nosed they are when it comes to negotiating cheaper, better-quality coverage — if the evidence heard at last week’s yearly conclave of risk managers is any indication.

Risk managers like to portray themselves as skillful architects who shape coverage based on their organizations’ appetites for risk. When insurance is too dear or isn’t on the market, they take pride in helping their companies do quite well without it, thank you, by means of self-insurance or captive insurance subsidiaries.

But a fair number of risk managers don’t appear to have been as independent of the insurance industry — of insurance brokers, in particular — as they’ve portrayed themselves to be. Given the opportunity to have their brokers disclose contingency-fee arrangements with insurers, for instance, many risk managers fell asleep at the wheel.

In the worst case, some corporate buyers might have been unwitting enablers of serious broker conflicts of interest, according to leaders of the Risk and Insurance Management Society, the prominent association of corporate risk managers that met last week in Philadelphia. Over more than five years, despite warnings from leaders of RIMS, risk managers’ lack of vigilance gave their brokers a free pass to steer corporate business to insurers who were guided by the fees insurers paid rather than by their clients’ needs. At the very least, some risk managers arguably lacked crucial knowledge of how the coverage they bought for their companies was being priced.

To many, the contingency-fee controversy was spawned last October, when New York State Attorney General Eliot Spitzer sued Marsh, the biggest insurance brokerage, for bid-rigging. Under contingency arrangements, insurers typically agree to pay fees to brokers based on the amount or the profitability of the business the broker places with the insurer.

The fees aren’t illegal in themselves. But Spitzer charged that they “created an improper incentive for Marsh” to maximize profits, sometimes moving brokers to get “fictitious high quotes from insurance companies in order to deceive its clients into believing that true competition had taken place.” Without admitting guilt, Marsh settled for $850 million, issued an apology, and undertook governance changes. Later, Spitzer reached similar settlements with the other two largest brokers, Aon and Willis North America, for $190 million and $50 million, respectively.

Long before the Spitzer investigation, however, RIMS had warned its members about the fees. In 1998, the society was already worrying about their effect on “a broker’s motivation for recommending or placing business with particular insurers” and supporting the disclosure of all broker compensation arrangements before insurance is bought. In 1999, RIMS struck a deal with Marsh (then called J&H Marsh & McLennan) in which the broker would identify — at the client company’s request — the clients’ insurers with which the broker had contingency deals. The risk manager could then estimate the contingency revenue generated by those agreements.

The problem was that the risk managers did very little requesting. To their credit, RIMS leaders who spoke in Philadelphia excoriated their peers for dropping the ball. “In 1998 and 1999, we challenged everybody [to press brokers for] transparency, and most of you did not insist on it,” said incoming RIMS president Ellen Vinck in a speech. Vinck, the vice president of risk management and benefits at United States Marine Repair, wondered if contingency fees would have become such a problem “if we had been more vocal.”

Discuss

Your email address will not be published. Required fields are marked *