Contingent Profit: Dousing a Political Firestorm

Canadian brokers appear confident that cooler heads will prevail on the issue of contingent profit agreements between brokers and insurers, even as New York state Attorney General Eliot Spitzer continues to stoke the flames of the political firestorm he sparked last year. In mid-September 2005, Spitzer’s office issued a press release that triumphantly announced “the indictment of eight former executives of the nation’s leading insurance brokerage firm for their roles in a massive bid-rigging scheme that defrauded clients of millions of dollars.” The announcement came nearly a year after Spitzer filed a civil lawsuit in 2004 that included allegations of fraud and anti-competitive practices against brokerage firm Marsh Inc., a subsidiary of Marsh and McLennan Inc.. Marsh has since settled the matter with the New York attorney general and faces no criminal sanctions. The settlement contained conditions that required Marsh to agree to replace the top management in the company, apologize for “unlawful” and “shameful” business practices, implement reforms designed to improve transparency and service for insurance customers, establish an $850-million restitution fund for policyholders – and agree not to accept contingent commissions.

The political wildfire sparked by Spitzer – not to mention the brushfires that developed after Marsh’s agreement not to accept “contingent commissions,” an otherwise unremarkable and widespread practice in the insurance and other industries – quickly spread across the border and gained the attention of Canadian insurance regulators. Suddenly, Canadian brokers and insurers had to answer to the Canadian Council of Insurance Regulators, the Canadian Insurance Regulatory Organizations (CISRO), and various provincial regulators as to whether they accepted “contingent commissions.”

WHAT ARE CONTINGENT COMMISSIONS?

The CCIR defines a contingent commission as a payment of a benefit by an insurance company to an intermediary – such as a broker – that depends “on one or a combination of performance-linked criteria such as sales volume, profitability, growth, or retention.” A survey developed in October 2004 by the CCIR found that more than two-thirds of P&C insurers in Canada offer contingent commissions to their agents or brokers.

But as many Canadian brokers will tell you, contingent commissions suddenly developed a very serious optics problem when they became entangled in the New York settlement between Marsh and Spitzer.

To make matters worse from a broker’s point of view, one provincial regulator, the Autorite des marches financiers (AMF) in Quebec, took a hard-line view and suggested contingent commissions and ownership concentration combined to make brokers the creatures of insurance companies. In mid-April 2005, the AMF stunned brokers in Quebec with a press release that ran the following headline: “Large majority of brokers not independent.” As a result, the AMF called for investigations into several matters, including “the effect of commercial practices in the insurance industry [read: contingent commissions] on the advisory relationship between representatives and their clients.”

THE CALL FOR DISCLOSURE

Canadian insurance industry regulators started calling for disclosure and transparency of contingent agreements between insurers and brokers. “Disclosure is one regulatory tool that can be used to address conflicts of interest,” the CCIR said in a 2005 Consultation Paper, released prior to public hearings on the issue. “The fundamental premise underlying disclosure is that a sales intermediary [i.e. a broker] has the responsibility to ensure that his/her client is fully informed of all information that pertains to the intermediary’s advice, so that the client is in a position to make an informed purchase decision.”

Suddenly, the Canadian insurance industry found itself trying to douse the burning flames of regulation that threatened to engulf them. “We began building our fight for the Bank Act [review] and all of a sudden, out of the blue, Spitzer came along,” Insurance Brokers of Canada (IBAC) outgoing president Keith Williams told the organization’s AGM in Quebec City last month. “And it’s really amazing how he has Spitzer-ized the entire world.”

Nevertheless, brokers are publicly expressing confidence that the political wildfire spreading from New York is starting to burn out. The CCIR is wrapping up consultations on disclosure and transparency, during which they received 68 submissions from brokers’ groups, insurers, and consumers. The CCIR also sent out questionnaires in the summer of 2005 to stakeholders across Canada, soliciting their input. According to the CCIR’s consultation paper, “the responses to the questionnaires did not provide evidence of any illegal insurance related activity.” The news came as a relief – even if it wasn’t a surprise – to Canadian brokers. Brokers say they don’t believe a New York-style scenario is likely to happen in Canada, in a small part because “contingent commissions” in Canada are primarily profit-driven, not volume-driven.

CONTINGENT PROFITS

In fact, instead of using the term “contingent commissions,” Canadian brokers noticeably refer to the less politically loaded term “contingent profits.” Perhaps that’s because the public can better understand that “profits” – unlike the broader term “commissions” – are more obviously based on a wide variety of factors over which brokers have no control.

As the Toronto Insurance Conference (TIC) told the CCIR in an August submission, “In our business, the risk assessment and product decision-making role that insurance brokers perform for their clients is not influenced by the potential for annual contingent commissions, for the following reasons:

* Contingent commissions are based on insurers’ results, not volume.

* Contingent commissions are based on the aggregate results of a broker’s entire portfolio, not on an individual client’s policy.”

It is a bit of a semantic debate, concedes Louis Bois of the Insurance Brokers Association of the Province of Quebec. But the distinction between profit and volume is important. If brokers can’t control an insurance company’s profits – which are based on the profits or losses generated by an entire book of business – then it makes no sense to direct a single client’s business to any given insurer, brokers say.

“When you look at what happened in the states, some of the illegal activities did not have a risk component attached to them,” Randy Carroll, the chief operating officer of the Insurance Brokers Association of Ontario (IBAO), says. “When you take a look at contingent commissions that brokers work with in Ontario, there is a risk component attached.”

For example, says David Hare, president of IBAO, contingent profits in Ontario are calculated mainly on the basis of an insurance company’s loss ratio. “You try to do the best thing you can [by placing a client with a particular insurer],” Hare says, “but we’re involved in a no-fault market in Ontario, and if your best client is involved in a no-fault accident at 11:59 p.m. on New Year’s Eve, that could skew your [insurer’s] loss ratio for three years.”

What’s more, most brokers don’t even know whether or not their company has a contingent payment arrangement with an insurance company, says Justin MacGregor, president of the TIC.

“In many cases, the existence of contingent commissions, the details of any contingent commissions that are in a agreements that are in place are generally only known by the principal broker, the owner of the company or maybe someone on the finance side,” says MacGregor. “In reality, the staff that conduct business on a day-to-day basis and make recommendations to clients as licensed brokers consistently get direction from their owners to do the right thing for their client. And they don’t know what the contingent commissions are. So we’re very comfortable that there isn’t a conflict of i nterest in terms of contingent commissions and that they’ve been unreasonably targeted as an improper practice. And in fact the weight of argument that’s been provided in terms of response to the CCIR review clearly indicates that the entire Canadian industry stands behind that.”

Brokers also point out that although disclosure and transparency has temporarily captured the hearts and minds of the regulators, members of the public, on the other hand, are in no way clamoring for disclosure of contingent commissions or profits. “We had 1.2-million clients that were represented by brokers, and of those 1.2 million, there were only 267 phone calls from consumers saying ‘What’s this all about?'” Carroll says. “There was really nothing to concern us complaint-wise.”

“I felt it was a Toronto issue,” IBAO president David Hare added.

REGULATION OF DISCLOSURE

A Toronto and Quebec issue?

Certainly the further out from Ontario and Quebec you travel, the less of an issue regulation of contingent profits appears to be.

“We’ve had transparency and disclosure rules in B.C. for about 15 years now, Doug Guedes, first vice president of the Insurance Brokers Association of B.C., says. “The government identified this as a problem some years ago to answer another crisis they were facing back in the middle-’80s….

“I was always amazed when this [issue] started turning on contingent profit and making everyone look bad, when in fact [contingent commissions in U.S. and Canada] are completely different situations. If Mr. Spitzer hadn’t brought the issue forward and if there hadn’t been egregious activities by four or five different parties in New York and other different parts of the states, you wouldn’t have heard anything. This issue is driven by regulators who feel compelled to make sure they have protected the public, and that’s fine. But the reality is there’s been no consumer injury.”

Similarly, Jamie Reid, director of the Insurance Brokers Association of Nova Scotia, says the political fires sparked in New York haven’t yet moved their way into the Atlantic Canada jurisdiction. “In Nova Scotia, and I think similarly in the other three Atlantic provinces, from the government’s standpoint, there’s really nothing happening,” Reid says. “A lot of them are sitting and waiting and watching for whatever may come out of the CCIR meetings.

“The opinion of the Nova Scotia government, as we understand it, is that we’re searching for a solution to a problem that doesn’t exist. They’ve been very supportive of our stance on the issue, which is: Why dig through all of our laundry when there’s really nothing negative or improper or illegal going on?”

As soon as the issue exploded on the scene, Nova Scotia brokers created a brochure that explained what a broker does and provided information about how brokers are paid. The contents of the brochure were also run in the form of a newspaper ad. “We received no comments or complaints or question or inquiries or anything,” said Reid. “From that standpoint, we see it as a dead issue.”

ANSWERING REGULATORS: ONTARIO AND QUEBEC

Ontario concluded early that the best defense against regulation of disclosure and transparency is a good offence. Early in 2005, IBAO worked closely with the provincial Ministry of Finance, the Registered Insurance Brokers of Ontario (RIBO), a self-regulatory body, and the Insurance Bureau of Canada to develop voluntary guidelines. The guidelines called on brokers to disclose a written declaration to the client at the point of sale. The guidelines include a statement on services, which, among other things, discloses to the client:

* personal lines automobile and property compensation,

* commercial lines compensation,

* contingent (profit) commission, and

* information about ownerships and other financial links.

In addition, Ontario brokers developed a Code of Consumer Rights and Responsibilities, which outlines the client’s rights to be informed, to ask questions, to receive professional service, to resolve disputes through a complaint resolution process, and to privacy.

RIBO is a self-regulatory organization in Ontario responsible for regulating the conduct and financial affairs of more than 15,000 of the province’s brokers and 1,200 firms licensed as property and casualty brokers in Ontario. RIBO, which enforces the protocol and the guidelines, indicated in its submission to the CCIR that “RIBO Council is of the opinion that the model in use in Ontario is working in a way that provides more material information to consumers.” RIBO went on to say it conducted spot-checks of 145 Ontario brokerages since the guidelines came into effect in January 2005. “The results of our request for production of the firm’s disclosure document from these 145 firms indicated 138 firms, or 95%, in satisfactory compliance. Six had a disclosure document, but some fine-tuning was required to bring it into standard compliance.”

The written form of disclosure implemented in Ontario, however, does not appear to be enough to placate Quebec’s regulator, Bois says. “We offered the regulatory body in Quebec the same kind of transparency tools as in Ontario, but they want verbal disclosure,” he says. “They want people to tell a few things to the client up-front. They don’t want an after the fact letter saying who you are. They consider that to be too late.”

DOUSING THE FINAL FLAMES?

It’s this kind of detailed negotiation and back-and-forth that has brokers sitting on pins and needles. It is unclear what the CCIR is going to do now that it has received its submissions during the public consultation. Some say the CCIR will have more public input later in the process. Others say the CCIR will be preparing some kind of interim report before the end of this year.

In the meantime, brokers seem to feel they have reduced the New York conflagration to a series of local brush fires – if they haven’t put out the flames altogether. Bois says even the Quebec regulator seems to have toned down its position as a result of the public hearings. “After the April 14 report, the bomb that it created in the market, the Quebec government has started to talk to the different players in the industry. About 14 or 15 organizations presented their submissions regarding the finding of the government. And really the findings are a lot less dramatic than I think it was shown in the report.

“If you look at the entire industry, a lot of players are saying the main aspect we have to look at right now is disclosure. The government is willing to look at this point at simple disclosure, but a disclosure that will inform clients who they are dealing with. I think brokers in general don’t have anything to hide.”