The Small Laws: Eliot Spitzer and the Way to Insurance Market Reform
31 Pages Posted: 25 Jan 2006
In 2004, the property-casualty insurance industry was roiled by a scandal unparalleled in its history, with the world's largest insurance broker, Marsh & McLennan, accused of defrauding customers by rigging bids to maximize its own profits. In addition to its sensational bid-rigging charges, New York State Attorney General Eliot Spitzer's October 2004 suit against Marsh challenged insurers' long-established practice of paying insurance brokers and agents (or producers) additional compensation contingent on their sales volume and the profitability of their risks. Spitzer argues that such contingent commissions are not adequately disclosed to insurance buyers and can have anticompetitive effects. Indeed, in Spitzer's view, a broad spectrum of financial arrangements entered into by carriers and independent producers threaten the competitiveness of the P&C insurance market. But I argue that, rather than promoting competition, an industry-wide ban on contingent compensation might instead undermine the financial stability of small insurance agencies in communities throughout America. Ironically, this could well lead to the further consolidation of insurance brokerage business in large global firms like Marsh. Indeed, the state of affairs that first drew Attorney General Spitzer's attention--large commercial insurance brokers allegedly manipulating the market for their own benefit--was the result of nothing so much as the coupling of time-honored sales incentive practices developed on Main Street, USA with an unprecedented level of market power attained by a few global mega-brokers following a consolidation spree in the 1990s. It would be an expensive mistake, however, to jump from that observation to the conclusion that all contingent compensation of all insurance producers is necessarily harmful to insurance consumers. This article (i) traces the history of Attorney General Spitzer's investigation into insurance market practices, (ii) offers an overview of producer compensation practices as they have evolved in the U.S. P&C market, (iii) outlines recent regulatory and legislative responses to the Spitzer investigation, and (iv) suggests a simple, voluntary reform that would increase transparency for insurance consumers while avoiding the pitfalls likely to attend more draconian solutions.
Keywords: insurance, Spitzer, competition, insurance agent, insurance broker, insurance producer, producer compensation, commissions, contingent commissions, disclosure, bid-rigging
JEL Classification: G22, K20, K21, K23, K42, L84
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