'Hiring subsidies' may be terminated amid investigations

State prosecutors' investigations into broker compensation practices, which have curtailed the use of contingent commissions, may end another form of undisclosed compensation from insurers: hiring subsidies.

For years, insurers have offered their most productive agencies and brokerages a variety of programs or agreements to help finance everything from acquisitions to office expansions to marketing efforts to producers' salaries.

While these agreements, both formal and informal, have been portrayed as a way for insurers to support and reward productive brokerages, some attorneys general say the agreements offer incentives for brokerages to improperly steer business to the insurers providing the hiring subsidies without disclosing the subsidies to clients.

As a result, many of these subsidies have been put on hold and, like contingent commissions, their future looks bleak, observers say.

Hiring subsidies first came to light in connection with the ongoing industry investigations in March when New York Attorney General Eliot Spitzer alleged in his complaint against Aon Corp. that the Chicago-based brokerage entered into "producer funding agreements" with select insurers. Under these agreements, the insurers directly funded the hiring and salaries of Aon personal lines brokers and the arrangements were not disclosed to clients, according to the complaint.

In 1999, 2000 and 2001, for example, Chubb Corp. paid 50% of the salary and benefits for certain Aon personal lines brokers to sell Chubb products, Mr. Spitzer's complaint alleges. Chubb also played an active role in the recruitment and oversight of Aon producers, at one time being charged $18,800 in fees by a recruiting firm to staff a personal lines position in Aon's Chicago office, the complaint says.

The producer funding agreements contained incentives for Aon producers to recommend Chubb's policies, according to Mr. Spitzer. For example, the complaint highlights a 2000 employment letter from Aon to a Chubb-funded producer in Aon's Cleveland office that said in part: "You are eligible for an annual bonus once you have reached your annual sales goal of $300,000 in new Chubb personal lines premiums."

Aon also accepted producer funding from Fireman's Fund Insurance Co. in 1999-2001 to fund 50% of compensation for up to 15 Aon producers, the complaint says.

"These individuals held themselves out as Aon employees in every respect, without disclosing that insurers were funding their salaries as part of an Aon commitment to steer business to those insurers," the complaint says.

Aon said in a statement: "It was never Aon's policy to have insurers pay for brokers' remuneration. Aon's brokers are dedicated to serving their clients by finding them the best coverage available. These agreements were few in number, were limited to a very small Aon subsidiary and expired long ago."

Chubb and Fireman's Fund declined to comment on the producer funding agreements.

Aon agreed to pay $190 million as restitution to policyholders and to revamp its business practices to jointly settle a series of fraud and anti-competitive practices charges with Mr. Spitzer and other state authorities (BI, March 7).

In addition to Aon, Illinois Attorney General Lisa Madigan last month said her investigation into Arthur J. Gallagher & Co. revealed that the Itasca, Ill.-based brokerage accepted "hiring subsidies" from certain insurers in return for the assurance that more business would come their way.

"We found evidence that Gallagher and the carriers reached an understanding that the subsidizing carrier would receive a 'fair share' of business from Gallagher, or a 'first right of refusal' on insurance placements," said Michael Fridkin, deputy bureau chief of the special litigation bureau in the office of the Illinois attorney general in Chicago.

American International Group Inc., for one, paid $4.5 million in hiring subsidies to Gallagher over a two-year period, to help fund producers who sold directors and officers, errors and omissions and fiduciary liability insurance policies, according to Chaka M. Patterson, Illinois assistant attorney general and bureau chief of the special litigation bureau. He noted that the "policies were underwritten by AIG in part and, Gallagher has maintained, also by some AIG competitors."

Gallagher agreed to pay $27 million in restitution to policyholders last month in its settlement with Ms. Madigan and Illinois Insurance Director Michael McRaith over concerns that the brokerage steered business to insurers in return for "huge payments" that were not fully and clearly disclosed to clients (BI, May 23).

Officials from Gallagher and AIG declined to comment on the hiring subsidies.

Alternative compensation

While prosecutors condemned insurers' paying hiring subsidies to producers, some observers say the subsidies are just another form of compensation that doesn't necessarily pose a conflict of interest.

Although hiring subsidies may include an agreement whereby an insurer receives a share of business or a first right of refusal from the brokerage on certain lines of business, the marketplace ultimately controls any improper steering, said Timothy J. Cunningham, a principal with OPTIS Partners L.L.C. in Chicago.

"Never say never. I'm not naïve, but 99% of the time, the agency would instruct the producer to present the best program (to clients) and if it happened to be with the company that provided the subsidies, then so be it," he said.

"An agent is not going to go through all the work and effort without putting the best deal on the table," he said. "And the only reason they're going to do that is because they want the business."

"Clearly, when we would negotiate (with insurers), whether it be commission rates, contingent rates, there was that third bucket," said Rob Lieblein, president and managing principal with WFG Capital Advisors L.P. in Harrisburg, Pa., which provides advisory services to brokerages. Hiring subsidies or producer funding arrangements "were looked upon as other forms of the carrier helping or subsidizing a broker" that generated premium volume.

The agreements were not reached necessarily to steer business to those insurers, it was just another form of compensation, he said. "The insurer was making money, the broker was making money and you could pay it through commissions, you could pay it through contingents or you could pay it through other forms of subsidies."

But at least one risk manager says that undisclosed compensation paid by insurers to brokers is bound to lead to conflicts of interest.

"Individuals usually don't bite the hands that feed them," said James E. Crockett, manager of risk and benefits at Denver Water.

"It sounds like if you're getting paid by the insurer, you're certainly going to owe an obligation to that insurer providing you with a full or partial paycheck and you would direct business that direction. I just don't know how you couldn't," he said.

"If it was disclosed, it wouldn't be a problem, but I don't know if that's something you would find out," Mr. Crockett said.

Disclosed or not, the practice is being shelved and may ultimately come to an end, observers say.

While brokerages may have been able to secure such arrangements in the past, "I can tell you that none of them have been able to take place in the last 12 months because of the whole issue of contingents," said Mr. Lieblein, referring to his clients. "People have recognized that even though it can be a legitimate business relationship that is above board, the apparent conflict of interest at this point has basically minimized the use of those."

"I think what we're seeing in the post-Spitzer investigation is a pull-back from all these soft-dollar arrangements, not because they are fundamentally improper, but I think they are too hard to explain," Mr. Cunningham said. "My prediction is that they will be put on the shelf until the dust settles and may be eliminated simply due to the perception that they create a conflict."

"People are looking real hard at whether or not (hiring subsidies are) a smart thing to do going forward," said Chris Burand, president of Burand & Associations L.L.C., an agency and insurer consulting firm based in Pueblo, Colo. "I think it's too early to say if they're going away, but I would be really surprised to see any companies I work with offering it. They'd find something else to do before they'd do that, I think."