While the effects of vertical integration in the insurance industry have yet to unfold, risk managers are raising some concern over potential conflicts of interest between brokers and their insurer investors.

Risk managers generally welcome the investments if the purpose is to keep choice in the distribution system, but they wonder whether the moves are more of a strategic deal to control where insurance products are placed.

Whatever the outcome, in a market where prices are soft, consolidation is key and two behemoths are dominant, this vertical integration is likely to continue, observers say.

Late last month, Willis Corroon Group P.L.C. announced that a consortium of investors, led by U.S. private equity firm Kohlberg Kravis Roberts & Co. L.P. and including five insurers, made a $1.56 billion offer to acquire a majority stake in the world's fourth-largest broker. The deal, if completed, would end speculation over Willis' future and take the company to private ownership, allowing it to focus more on long-term shareholder value (BI, July 27).

At about the same time, San Francisco-based USI Holdings Inc. announced that a consortium of seven insurers and Chase Manhattan Corp. made a private equity investment of more than 50% in USI, the world's 11th-largest broker. That strategic deal allows USI to meet its objective of offering various financial products and services to its middle-market clients (BI, July 27).

Warren, N.J.-based Chubb Corp. asked not to be identified as one of USI's investors in USI's announcement due to its limited investment but did confirm last week that it was "a very small participant" in the consortium.

Observers say the vertical integration is part of the ongoing consolidation of the brokerage marketplace, where J&H Marsh & McLennan Inc. and Aon Group Inc. now dominate. By investing in other brokers, namely Willis, which was frequently cited as a potential acquisition target, insurers are ensuring they will not be dependent on just a few players to distribute their products.

"There is tremendous concern that the increasing market share held by brokers has given that segment too much control over access to the customer," said Scott K. Lange, director of risk management at Microsoft Corp. in Redmond, Wash.

"Naturally, insurers are attempting to preserve some degree of control, and it appears they are concerned enough to purchase their own distribution channels," he said.

Jay Cohen, who tracks brokers as a vp with Merrill Lynch & Co. in New York, agrees. "Insurers are somewhat concerned about the size of large brokers and how much business they control and the possible shift in the balance of power," he said. These insurers "may be examining ways to control more of the distribution."

Mr. Cohen said he views Willis' deal as similar to that of American International Group Inc.'s 1994 $200 million cash infusion into then-struggling Alexander & Alexander Services Inc. At that time, AIG said it wanted to invest in A&A to enable it to remain independent, and A&A was clear that AIG was making a passive investment and that any favoritism toward AIG by any of its producers would result in immediate termination (BI, July 18, 1994).

The five insurers proposing to invest $317.3 million in Willis -- Guardian Royal Exchange P.L.C., Royal & SunAlliance Insurance Group P.L.C., Chubb Corp., Hartford Financial Services Group Inc. and Travelers Property Casualty Corp. -- are doing so "not so much to control the broker, but to make an investment in the broker," Mr. Cohen contends.

He added, however, that it would be interesting to have compared A&A's production for AIG before and after the cash infusion.

At a time when potential conflicts of interests in broker relationships with insurers have been heightened by a resurging controversy over contingent commissions and whether megabrokers are wielding clout with insurers due to their size, risk managers are concerned over whether the investments have strings attached in terms of where their business will be placed.

"Day to day, I think the deals are not a significant event for the industry," said Timothy J. Cunningham, a principal in Chicago with Insight Management Group. "In the longer term for larger buyers, however, it has to give them pause in terms of where the brokers' allegiance shakes out. . .to their clients or to the insurers they have some link to?"

Kenneth Pinkston, chairman of Willis Corroon Corp. in Nashville, Tenn., and group executive director of Willis Corroon Group, said: "We've tried to be quite clear that it's not a means to an end to get more business to the carriers. The objective is to remain independent and to preserve choice for risk managers."

A spokeswoman for USI said the broker's seven new insurer investors -- Chubb, CNA Financial Corp., Equitable Cos., Orion Capital Corp., Provident Cos. Inc., Travelers Insurance Cos. and Zurich Centre Investments Inc. -- will not dictate where business will flow.

"It is true that we do have solid relationships with all the carriers," she said. "But there is no contract requirement to place business with the carriers as part of the investment. The investment is strategic, that's true, but it's not quid pro quo."

"Our job as brokers is to identify the right opportunity for clients to evaluate. We will make sure we do that," she said.

For the most part, risk managers are taking a wait-and-see attitude.

"I was very nervous when AIG made its investment years ago in Alexander & Alexander, but give them credit, as AIG went to great lengths to assure the risk management community that it was an investment made for the economics and to support the brokerage industry as a whole by keeping a number of players involved," said Stephen M. Wilder, vp-risk management at The Walt Disney Co. in Burbank, Calif. "To the extent that the current investments in Willis are to ensure that at the end of the day the brokerage industry remains competitive, it is good. If the investment is made to exert any control over the placing of business, then I think risk managers will object."

Mark DeLillo, vp-risk management for Celotex Corp. in Tampa, Fla., and president of the Risk & Insurance Management Society Inc., said he personally is not concerned "because of the relationship I have with my brokers, but in general I am" concerned over potential conflicts of interest in various broker/underwriter relationships.

Whether the Willis deal creates such a conflict of interest remains to be seen, he said. "I'm not sure if the investment is an opportunity to exert control of the delivery mechanism of insurance products or simply an investment," Mr. DeLillo said.

If it is the latter, it would "be great for the industry," he added. "If Willis was in a position of non-growth because of financial resources, the investment opportunity gives them those resources, which adds to the competition within the industry," he said.

Stephen Finley, risk manager for Denver Public Schools, said he is concerned over where the risk manager fits into the equation.

"A typical broker arrangement is that a broker works for me," he said. "I don't know if a broker can be owned by a major underwriter and still work for me."

"It's really going to become part of the job to find out who owns whom," Mr. Finley said. "I'm not interested in becoming an expert in that."

While any effect from the insurers taking financial stakes in the brokers will be seen in time, observers say more vertical integration and various other strategic alliances will take place.

"The reality in today's marketplace is that primary insurers and reinsurers are truly starved for premium. No other time have you seen greater interest on the part of primary insurers and reinsurers in controlling the flow of business at the fountainhead," said John Wicher, managing director for Russell Miller Inc. in San Francisco.

"Disintermediation has been going on for at least 15 years," Mr. Wicher said, referring to the blurring of the lines between brokers and underwriters. Willis' and USI's deals are "two more transactions, neither of which in and of themselves are defining events, but rather events continuing to underscore a trend of integration and rationalization of the insurance distribution system," he said.

"I think vertical integration will continue for a while because there is a disproportionate amount of power in the marketplace with two large brokers," said Microsoft's Mr. Lange. "I think we'll see all kinds of reactions and countermoves," whether they are affiliations with regional brokers or technology-based distribution, he said.

Mr. Cohen of Merrill Lynch said he also expects more integration, but "it will happen in a very measured fashion," he predicts.

"I don't expect, for example, AIG to buy Aon or Marsh & McLennan or for Chubb to buy (Arthur J. Gallagher & Co.)," he said. Instead, "we might see more investments in MGAs, or we might see some select investments in some good regional brokers.'