NEW YORK -- Risk managers are praising J&H Marsh & McLennan Inc.'s agreement to disclose contingent commission revenue when requested by risk managers as a big step toward more open dealings between insurance buyers and large brokers.

J&H Marsh & McLennan and the Risk & Insurance Management Society Inc. last week agreed on a new procedure the broker will implement to let clients receive information on contingent commission arrangements.

Other major brokers are not expected to make similar announcements. Two say they already disclose the information to clients who request it.

Risk managers say the issue isn't so much the money involved in such commissions, but rather the openness of dealings between risk managers, brokers and insurers.

"It opens everything up so that we're operating in the sunshine," said Mark A. DeLillo, president of RIMS. "The amounts are not the important issue; it's that everything is open."

Susan R. Meltzer, assistant vp-insurance and risk management at Sun Life Assurance Co. of Canada in Toronto, said it's the "general aura of disclosure" that makes the J&H Marsh & McLennan move important. "Risk managers will feel more comfortable in asking."

Robert J. Newhouse III, president of J&H Marsh & McLennan (Americas) in New York, said the broker now has in place procedures to respond to risk managers' requests for information on contingent commissions paid by insurers.

"We're optimistic," Mr. Newhouse said, that with RIMS' involvement in shaping the new policy, "the client will say, `This is what we need' " to satisfy concerns regarding the commission payments.

Risk managers have voiced concerns that the commissions, which are paid by insurers to brokers based on volume targets and the profitability of the business, may create a conflict of interest. Risk managers have said they would like to know when the arrangements are in place, as a way to understand how much money their broker is making off their accounts.

Under J&H Marsh & McLennan's policy, at a risk manager's request, the broker will identify the names of insurers that pay it contingent commissions. The client then can apply a factor, which is updated annually and is currently set at 0.0062%, to the premiums it pays those insurers to come up with an approximation of the contingent commission earned by J&H Marsh & McLennan on the risk manager's account. For example, on $1 million in premium, the broker would report a contingent commission of around $6,200.

If, however, the approximated amount is substantial and the client requests additional information, J&H Marsh & McLennan will do further calculations. The broker will identify each insurer on the risk manager's account that pays contingent commissions and the amount of premium paid by the client to that insurer.

Under the contractual terms that determine how an insurer calculates J&H Marsh & McLennan's contingent commissions, the broker will determine how much each pays related to the account in question. To protect the confidentiality of competitive information, the risk manager will be given the aggregate number, but not the individual totals for each insurer.

"If it is a significant number or it raises questions in the buyer's mind, it could lead to additional discussions," said Mr. DeLillo, who is vp-risk management at Celotex Corp. in Tampa, Fla.

Mr. DeLillo said buyers shouldn't press J&H Marsh & McLennan beyond asking for the factor and the names of insurers that pay contingent commissions unless their "level of concern is serious and the amount of contingent revenue significant" with regard to their account.

Gathering the additional information would be "extremely burdensome" for the broker, he said.

Risk managers concerned about a large approximation of the contingent commission revenue generated on their account could choose to renegotiate their fees, Mr. DeLillo said.

"I'd be less than honest if I didn't say it was a concern," Mr. Newhouse said, referring to the prospect of renegotiations with clients. "It's a concern, but that's a competitive marketplace situation that we are more than happy to deal with."

Mr. Newhouse said the results of a client survey show that only 3% of J&H Marsh & McLennan's clients consider contingent commissions a "critical issue," leading him to believe risk managers won't be rushing to find out how much contingent commission is related to their accounts. The survey indicated another 17% felt the issue was "of concern," he said.

"Based on that, I'm hoping we don't get a deluge of requests, because it is pretty onerous to go through the process," Mr. Newhouse said.

Ms. Meltzer, who with Mr. DeLillo negotiated the agreement with J&H Marsh & McLennan, praised the broker for its initiative in creating the new policy. "They came to us," she said, and "established a good business practice where there was none."

The new policy "reinforces the fact that insureds are supposed to be the highest priority for the broker," said Mark Lefenfeld, Austin, Texas-based managing director for Russell Miller Inc., a San Francisco investment bank specializing in insurance.

Mr. Lefenfeld said he doesn't expect risk managers to rush to get their hands on some of the payments made to J&H Marsh & McLennan. Rather, the change is "more of an attitudinal issue" that shows the broker's response to the buyers' concerns.

Stephen Finley, director of risk management for Denver Public Schools, said he favors the move toward increased disclosure.

Contingent commissions aren't necessarily a problem, but Mr. Finley said he wants to know when they are involved. "I don't know that I would be unhappy about it, but I want it disclosed."

"I think these disclosures should happen and they should happen in a friendly atmosphere and not be contentious," Mr. Finley remarked.

It's not yet clear whether other brokers will follow with similar announcements regarding their disclosure of contingent commissions.

As the controversy over the commissions grew, RIMS put out the word that it was interested in working with brokers that wanted to address the issue, Ms. Meltzer said. "We haven't heard from anyone else yet."

Some brokers already have such a policy in place.

"We've had a full disclosure policy for some time," said James F. Murphy, chief operating officer of Willis Corroon Corp. of New York, which has responsibility for New York and New Jersey.

Mr. Murphy, who noted that he spoke only for his unit and not Willis Corroon's entire operations, explained that when clients ask, "We divulge whether there is an agreement, the nature of the agreement, and we attempt to quantify it as far as mathematically possible."

It's rare that risk managers ask, he said, and contingent commissions represent only about 0.3% of the premiums placed by the New York unit.

Aon Corp. won't be making an announcement similar to J&H Marsh & McLennan's because "we've been living and practicing that approach from day one," said Michael O'Halleran, president and chief operating officer at Aon. "We've been totally transparent when asked on any of these issues and will continue to be."

Mr. O'Halleran said his reaction after reading a statement released by his competitor announcing the disclosure policy was: "While I support it, it's not very definitive." The issue of calculation and disclosure of contingent commission revenue is "a very difficult issue to define," he acknowledged.

He said Aon rarely is asked by risk managers for an accounting of the contingent commission revenue related to their business.

The Council of Insurance Agents & Brokers doesn't expect brokers to rush to imitate J&H Marsh & McLennan's initiative, because what works for one broker doesn't necessarily work for all, said Ken Crerar, president of the Council.

Mr. Crerar emphasized that the Council has long urged its members to disclose arrangements that involve contingent commissions. "It's all part of building relationships between the broker and the client."

However, he said, "Beyond that, you get into details that might not work for every broker."

CONTINGENT COMMISSIONS UNDER RENEWED SCRUTINY

SARAH GODDARD

27 April 1998

LONDON-The heated international debate over brokers' contingent commissions grew more intense in the London market last week.

Recent U.K. media reports have implied that large brokers, unbeknownst to their policyholder clients, have been using size and market share to strong-arm insurers into entering incentive commission arrangements.

The brokers strenuously deny these assertions.

"Of course we are committed to transparency in all of our dealings with our clients," said a spokesman for Aon Group Ltd. in London.

But less than 4% of U.K. risk managers polled in a survey released earlier this month by the London-based Assn. of Insurance & Risk Managers said that they were aware of incentive payments from insurers to brokers, and none said that they were given full information about contingent commissions.

"The view of risk managers internationally is that this calls into question the principle of `best advice' and transparency," an AIRMIC statement said. "This is of particular concern in the light of the rules of agency and the code of conduct of the Insurance Brokers Registration Council and the Lloyd's code of practice for Lloyd's brokers."

The U.K. risk managers echo concerns voiced by their U.S. counterparts over whether some forms of contingent commissions could lead to brokers placing their business with an insurer that is not necessarily providing the best coverage for their exposures.

Volume override commissions, under which an insurer pays a broker a pre-agreed commission if that broker produces a certain amount of business for the insurer, are a long-standing feature of the insurance market. However, they tend to become more prevalent when rates are cheap and capacity is high-as under the current market conditions.

The issue has gained more attention recently in the United Kingdom, particularly because of comments made by Jardine Lloyd Thompson Group P.L.C. Chief Executive Ken Carter in JLT's recently issued annual report.

Mr. Carter comments, "We are aware of the debate within part of the risk management community regarding incentive commissions paid by some insurers. These incentives in general terms reflect factors such as profitability, premium volume and administrative efficiencies across the entire business portfolio between a broker and an underwriter."

Noting that less than 2% of JLT's 1997 revenue came from these arrangements, Mr. Carter said, "We will operate a policy of transparency with our clients by providing, where requested, appropriate disclosure of incentive commission whilst, at the same time, separately identifying the total remuneration which the group derives from these incentive commissions in future report and accounts."

The JLT statement has prompted other brokers to make similar statements. At the end of last month, Lloyd's of London broker Berry Palmer & Lyle Ltd. issued a letter saying that the broker "does not accept incentive payments from insurers, though we have been offered them on a number of occasions." In addition, "It is our policy to advise our clients of any such remuneration we receive in addition to brokerage or fees, as we are conscious that we are the agent of the insured, even though commission is usually payable by the insurer," BP&L said.

Still, some risk managers in the United Kingdom and in the United States are not convinced that they are being given the whole picture of their brokers' compensation. Buyers question the potential conflicts of interest brokers may face in also receiving payment from insurers.

By law, a broker's principal client is the policyholder. Even so, when the intermediary receives payments for services or business provided to insurers that may jeopardize that relationship with the policyholder, assert some risk managers and insurance executives.

Liz Taylor, a former chairman of AIRMIC, is against a broker receiving any commissions from insurers at all, since it provides little incentive for the broker to act in their client's best interests. She said she is concerned about the lack of transparency these arrangements represent and added she would happily pay a higher fee in return for greater disclosure.

Commented Scott Lange, director of risk management at Microsoft Corp. in Redmond, Wash.: "If a broker has a better override with one market than with another. . .it would be interesting to see which the preferred market (for a piece of business) is."

Stephen M. Wilder, who completes his presidency of the Risk & Insurance Management Society Inc. this week, agrees with the view that volume override commissions may provide incentives to brokers that are at odds with the best interests of the insurance buyer.

Mr. Wilder, vp-risk management at The Walt Disney Co. in Burbank, Calif., said he expects the issue of broker compensation to be raised at the RIMS conference this week during a debate on consolidation.

"If I pay a broker a fee for services they deliver, that ought to be the only compensation they earn based on my book of business," Mr. Wilder said. "If they are doing work for an insurance carrier which is to my benefit, it should be reflected in my fees."

Earlier this month, Lloyd's director of regulation, David Gittings, issued guidelines to Lloyd's brokers on the regulatory requirements for broker remuneration. In these guidelines, Mr. Gittings reinforces that the broker's responsibility is to the policyholder, though the full extent of the broker's fiduciary obligations "depends on the nature of the individual relationship and the circumstances in which the broker is acting."

The guidelines also say that an agent must disclose to the policyholder "all benefits received or receivable when acting in the capacity of an agent on behalf of his principal. Such benefits may only be retained if disclosed to the principal and with the principal's agreement."

If commissions are within what Mr. Gittings describes as "the usual range of the market," then the broker doesn't need to tell the policyholder unless the policyholder specifically asks. But if they are outside that range, the policyholder must be informed. In addition, a policyholder must be informed by a broker if there is any conflict of interest.

In an interview with Business Insurance, Mr. Gittings said, "There is nothing illegal in any of this," referring to the fees for services and volume override arrangements. "It is purely a disclosure issue."

However, Lloyd's broker regulators will analyze the different payments made for different activities in the light of proposed changes in the U.K. government's broker regulation. Currently, the treasury is consulting with the insurance industry on broker regulation, intending to repeal the current Insurance Brokers Registration Act and include brokers within the Financial Services Reform Bill. The consultation period runs until the end of next month, with draft legislation expected in the summer and a bill expected to be presented to Parliament in the fall.

"We are not in the banning mode" over these arrangements, said Mr. Gittings. "We are in the understanding and disclosure mode."