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Questions linger over proposed broker payments

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The world's three largest brokerages are not convinced that performance-based supplemental commissions are any less problematical than the contingent commissions they are designed to replace, but the fourth-largest intermediary has embraced them.

A growing chorus of critics, including Joseph Plumeri, chairman and chief executive officer of London-based Willis Group Ltd., is questioning whether the kind of supplemental commissions that two insurers have proposed paying brokers still may influence brokers to consider their own interests over their clients' when placing coverage.

Unlike contingent commissions, which are not paid until brokers reach certain volume or profit thresholds with insurers, proposed supplemental commissions would compensate brokers based on their past performance with insurers and would be calculable for a buyer before any coverage is placed.

Both Marsh Inc. and Aon Corp. said they are still reviewing the structure of the proposed commissions. A spokesman for Chicago-based Aon said: "We don't want to do anything that could be perceived as a conflict of interest by our clients."

But, J. Patrick Gallagher, president and CEO of Arthur J. Gallagher & Co., says the brokerage has negotiated supplemental commissions with numerous insurers over the past year and the fully disclosed arrangements have not caused any problems with clients.

Regarding whether those or similar performance-based commissions could be perceived as potentially influencing a broker's behavior, Mr. Gallagher said: "All conflict of interest is waived through disclosure, in my opinion."

Mr. Gallagher and brokerage consultants assert that supplemental commissions are necessary to fairly compensate brokers that provide client services on behalf of insurers.

Contingent commissions are not illegal, and the arrangement continues to be used throughout the industry.

But their image has been severely tarnished in the wake of client-steering and bid-rigging investigations by state attorneys general that ensnared several large brokers and insurers. Authorities charged that brokers based their account placement decisions on how the placements would maximize their contingent commissions rather than what would best serve their clients.

As a result of the investigations, the four largest brokers agreed to abandon contingent commissions. Several insurers also agreed to either abandon or limit the use of contingent commissions.

The agreements have wiped out more than $1 billion of combined annual revenue for the world's four largest brokers, and several brokers and insurers have been trying to develop a replacement compensation system since then.

Since December, insurers Chubb Corp. of Warren, N.J., and Travelers Cos. Inc. of St. Paul, Minn., have developed new supplemental commission arrangements that provide brokers fixed compensation based on the brokers' prior performance with the insurers (BI, January 8).

Neither insurer will outline in detail its commission formula; each says its formula is proprietary. But state attorneys general have reviewed both programs and have said they do not represent contingent compensation as defined in settlements of client steering charges.

Attorney General Richard Blumenthal of Connecticut, who said he would like contingent commissions banned, said he is not troubled by supplemental commissions generally, because they would be based on a broker's past performance and must be disclosed to insurance buyers before a placement is completed. However, he said he would not issue a blanket pass to "every supplemental plan that could be devised."

Meanwhile, the New York Insurance Department is "actively studying the issues presented by both contingent commissions and supplemental commissions," a department spokesman said.

Willis' Mr. Plumeri and some risk managers are not convinced that supplemental commissions are substantially different than contingent commissions.

"I can't tell the difference, frankly, between that and a contingent," Mr. Plumeri said during a presentation last week at the Assn. of Insurance and Financial Analysts' conference in Boca Raton, Fla., according to a recording provided by Willis.

Unless the commission formulas he has seen are modified or he comes to understand them better, Mr. Plumeri said he will not accept them.

Mr. Plumeri, though, said Willis is not swearing off supplemental compensation paid by insurers.

Some risk managers say any performance-based compensation arrangements between brokers and insurers present inherent conflict-of-interest problems for risk managers.

"The new framework of the commissions is not different from contingent commissions enough to remove the inherent conflict of interest," because the broker performance element of the arrangement is still designed to influence broker behavior, said Beaumont Vance, senior enterprise risk manager for Sun Microsystems Inc. of Broomfield, Colo.

"If brokers aren't influenced, then why would insurers do it?" he asked.

Mr. Vance compared the arrangement to allowing one's attorney to accept a form of remuneration from an opposing party.

Sheila Small, assistant vp-risk management and insurance at New York-based Verizon Communications Inc., said performance-based supplemental commissions would put brokers "back in a place they don't want to be."

"Any type of arrangement that could be perceived as attracting a broker to one carrier more than to another carrier is not good. That's the bottom line," said Ms. Small.

Janice Ochenkowski, vp of the New York-based Risk & Insurance Management Society Inc., said she is "very puzzled" by the commission vehicle that Chubb and Travelers have developed and their unwillingness to divulge their commission formulas. In an environment of "transparency and open disclosure," their approach appears to be "a step backward."

But Ms. Ochenkowski, who also is a managing director at Chicago-based Jones Lang LaSalle Inc., said, ultimately, she does not need to know the formulas. She said she needs her broker to disclose only the amount of commission her account generates and how big a piece it is of the broker's overall supplemental commission revenue.

Defending commissions

Supplemental commissions already are in use at Gallagher and have not created a stir among the broker's clients, Mr. Gallagher said.

Over the past year, Gallagher has negotiated such commissions with 25 insurers—including Chubb and Travelers, he said. The commissions have replaced "some, not 100%" of the nearly $30 million of contingent commissions Gallagher has lost, Mr. Gallagher said.

While attorneys general have approved of brokers receiving remuneration for the services they provide insurers, if a client is not happy with the commission, it is "negotiable," he said. "As long as they're willing to pay me a decent wage to do my business, I'm happy."

Two agency consultants agree that supplemental commissions should not alarm risk managers and suggested that any discomfort risk managers might have with them could be allayed by demanding full disclosure, negotiating a fee arrangement or changing brokers.

Timothy J. Cunningham, a partner with OPTIS Partners L.L.C. in Chicago, described supplemental commissions as being "like a contingent in a different wrapper."

But neither commission is "evil," and risk managers' criticism of them now is "disingenuous" because they knew their brokers were receiving that compensation, he said.

John Wicher, a principal with John Wicher & Associates Inc. of San Francisco, does not agree that supplemental commissions based on a broker's past relationship with an insurer is anything like a contingent commission.

He also said varying supplemental commissions would not influence an account representative's behavior because the market is too competitive to risk losing an account over minor differences between the commissions.

Although that kind of behavior did occur at Marsh, Mr. Wicher said the difference is that some Marsh employees were engaged in outright illegal behavior—not just placing coverage only for a small additional amount of commission.