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The Problem of Relationship Inertia with the Reinsurance Broker
THE PROBLEM OF RELATIONSHIP INERTIA WITH THE REINSURANCE BROKER
If you have to overpay for your reinsurance to maintain a ‘long term relationship with your broker’, can’t you find a less expensive relationship?
Reinsurance Intermediaries (brokers) are licensed and supposedly regulated by the various States’ Insurance Commissioners. However, substantial enforcement action against intermediaries historically comes via various States Attorney’s General. In insurance circles, it is common knowledge and well remembered that Elliot Spitzer, then AG of NY took Marsh to task for its broker subsidiary, Guy Carpenter’s alleged self-serving practices, and for the $850,000,000 settlement. Another settled allegation against Guy Carpenter come from Attorney General Richard Blumenthal of Connecticut. Guy Carpenter again denied any wrongdoing, but settled for $4.25 million dollars.
In the Attorney General Settlement Agreement for the Attorneys General of Florida, Hawaii, Maryland, Michigan, Oregon, Texas, West Virginia, Massachusetts and Pennsylvania, Marsh settled for its alleged deceptive practices in the amount of seven million dollars ($7,000,000).
A federal judge approved an $88 million settlement between Marsh & McLennan Cos. and a group of plaintiffs in a lawsuit stemming from bid-rigging investigations in 2004 and 2005. The settlement approved by Judge Garrett E. Brown Jr. of the U.S. District Court for New Jersey in Newark, provided $69 million in payments to the plaintiffs, including $7 million in administrative costs, and $19 million in legal fees, according to court documents. The settlement resolved federal class-action claims by policyholders against Marsh arising from the events of the fall of 2004, Marsh Inc., MMCs brokerage unit, (Guy Carpenter).
The above list is not exhaustive, but what I find interesting is, it is the Attorneys General taking the lead and not the Insurance Commissioner in bringing enforcement actions against the reinsurance broker. The allegations include that Guy Carpenter conspired with reinsurers to fix prices, rather than seeking competitive quotes. As a result of the alleged schemes, insurance buyers allegedly paid up to 40% more for coverage. Perhaps there are political reasons why the AG takes the lead on reinsurance broker enforcement actions, for while less than 25% of Commissioners are elected, most AG’s are elected.
In the recent case Workmen’s Auto Insurance Co. v. Guy Carpenter & Co., B211660 (c/w B213853)) Guy Carpenter argued that it does not owe a fiduciary duty to the ceding company, including the duty to NOT inflate its commissions, and the court agreed.
If it has no duty to not inflate its commissions, what is the basis for the Attorneys General law suits? The weight of the suit by the Connecticut Attorney General is not based on fiduciary breach, although breach of fiduciary duty is alleged, but statutory – including violation of the State’s Deceptive Trade Practices and Price Fixing. (Herein for CT – Connecticut Unfair Trade Practices Act §§ 35-32(a) and (c) (2), 35-38, 42-100m and 42-110o.)
How and why did this happen? – The Connecticut Attorney General provides in his summary of the case:
1. “Because of the unregulated nature of the reinsurance industry”. (ie, and apparently the “laissez faire” attitude by the Commissioner in regulating licensed reinsurance brokers.)
2. “The specific clientele at which the conspiracy was aimed” – (ie, not sophisticated).
3. “Guy Carpenters dominant position as a broker in the United States for small to mid-sized insurance companies.”
4. “The inertia inherent in the industry” (ie. The long-term relationship of the Broker with the ceding company and over reliance on the broker by the ceding company)
The complaint summary further provides: “As part of the scheme, Guy Carpenter exploited a group of approximately 170 insurance companies by withholding critical information and leading them to believe that Guy Carpenter was acting in their best interests when in fact Guy Carpenter was at all times working to enhance and maintain the profitability of the reinsurers and of course, itself” (Emphasis added)
Understanding the mindset that the broker believes it has no fiduciary duty to the ceding company, and the realization that the small to mid sized company’s inertia with its reinsurance broker, the criticism expressed in the October 14, 2007 issue of Business Insurance by the Insurance Information Institute (III) when speaking of the Connecticut Attorney General’s suit that “…it is difficult to believe that these organizations were systematically being overcharged for decades and didn’t go off with another broker”, demonstrates the widespread ignorance within the insurance industry itself. The III obviously is unaware of what “inertia” in the reinsurance brokered market entails. It is not difficult at all to understand why small to mid-sized companies can be overcharged for decades by its broker.
For many small to mid-sized companies there is the overriding element of misplaced trust in the broker and a gross misunderstanding of their own duties. The broker rolls into town several times a year, and schmoozes the directors and officers and in the minds of these naïve clientele, they become vast forever friends. The officers and directors believe that the broker is working for them concerning a subject they know too little about (reinsurance), and they would never dream that their good buddies would overcharge them or allow them to overpay. Such naivety might be less of an issue if the officers and directors were spending their own money, but they are running a business and have a fiduciary duty to the policyholders or stockholders. It would also have less impact if rates charged policyholders did not include an element for the costs of reinsurance.
Clearly, apart from a fiduciary duty to the policyholders or stockholders as a reason to recover what it overpaid, the Commissioner should very much take an interest in the subject of Broker inertia and overpayment recovery. Insurance Companies take into account the costs of reinsurance; if the insurance company mistakenly pays too much for reinsurance, then the rates it charges may also be too high. The commissioner is charged with assuring that rates are adequate yet not excessive. Failing to adequately regulate brokers provides the means and opportunity for overpayment by inertia bound small to medium sized ceding companies, albeit it often by ignorance on the part of such ceding company. According to the Casualty Actuarial Society’s Principles of Ratemaking, a rate is “an estimate of the expected value of future costs, provides for all costs associated with the transfer of risk, and provides for the costs associated with an individual risk transfer.” (Emphasis added) Reinsurance is a cost of doing business associated with the transfer of risk.
I can attest to the misplaced blind loyalty of the small to mid sized ceding company to its broker, and how it will ignore its own fiduciary duties in recovering overpaid funds because as some have been told by the broker, if recovery of overpaid funds is perused:
1. The reinsurers will immediately file for arbitration; and/or
2. The reinsurers will immediately increase its rates.
That is, when there has been an overpayment for the treaty for years because of improper inuring and/or accounting in determining the subject base, and this is in fact even confirmed in writing by the broker to the ceding company, the ceding company is “advised” that to try to recover the over payment will lead to increased reinsurance rates.
Is this correct, do reinsurance companies really depend on ignorant ceding companies overpaying them in their rate setting process or is something else at work here? The reinsurance companies I checked with actually prefer accuracy to ignorance. Additionally, how is it that the broker allegedly speaks on the behalf of the reinsurers? That should be the “inertia bound small to medium companies” big clue that their broker may not actually be “working for them”. Why would your long-term best buddy be trying to talk you out of getting a refund for what you overpaid?
Herein the interests of the broker and the interests of the inertia bound small to medium sized ceding company are in conflict, and it is entirely appropriate for Commissioners to forcefully address this conflict. At the same time advice is given to the small to mid sized ceding company that recovery of overpaid premiums will result in their rates being increased, Guy Carpenter is being quoted as:
1. “Guy Carpenter & Co. has reported that reinsurance rates-on-line fell at the January 1, 2014 renewal in nearly all classes and regions.” (Insurance Journal, December 30, 2013)
2. “Plentiful capacity kept rates in check across most business lines and geographies during the April 1 reinsurance renewals”, reinsurance intermediary Guy Carpenter & Co., L.L.C. in a statement Thursday. (Business Insurance April 10, 2014)
3. “Guy Carpenter & Co. L.L.C. on Tuesday said downward pressure on reinsurance rates has increased since the June 1 renewal.” (Business Insurance, June 3. 2014)
The stability and downward trend is stated as due to “alternative sources of capital, strong reinsurer balance sheets, low loss levels, plentiful capacity, and an unprecedented influx of convergence capital” – If this is all true for the general market as stated by Guy Carpenter, I find it hard to believe that if the small to mid sized ceding company recovered what it overpaid, that this trend would be reversed and its rates would go up.
The fact is, the broker is paid a commission on the premium amount paid, and lower premiums mean lower commissions. It actually means that the broker could have to give back its commission on the overpayment if the ceding company pushed to get its overpayment back. The ceding company’ usually expresses its reluctance to recover overpaid premiums after speaking with its broker as “we really value our relationship with our broker”… how is that relationship threatened by recovering what was never owed? (They are really expressing Inertia – a body at rest tends to remain at rest & status quo is more comfortable than change, as well as expressing ignorance and fear). The Connecticut Attorney General correctly identified the inertia problem. As if the relationship with a reinsurance broker is a personal friendship and not business relationship.
Suppose that instead of an overpayment of premium, the ceding company underutilized the treaty program. For example, suppose a ceding company misclassified losses and failed to include some losses in a cat recovery. Recovery on missed claims is generally met with a lot less resistance from the broker than recovery due to overpaid premium…and you may have already guessed why, there is no negative commission incentive for the broker to argue otherwise.
The Connecticut Attorney General recognizes that inertia is an issue, lending itself to decades of misplaced loyalty… so why not do something about it? It is a fact that there is nothing like a little sunshine to cleanse away stain.
Comparing the ethical standards required of a CPA and those of a reinsurance broker, we find that:
The AICPA has code of professional conduct of 176 pages of rules and standards. The reinsurance broker has an attitude and it has been confirmed in court that it owes the ceding company no fiduciary duty. To become a CPA demands a rigorous system of educational pursuits simply to qualify to take the exam. A reinsurance broker has no standardized demands for educational pursuits.
Knowing this, we must ask the NAIC – why must a ceding company change its leading CPA for its annual statement purposes at least every five years (NAIC Annual Financial Reporting Model Regulation Section 7 D (1)) and yet the reinsurance broker may remain the broker for an unlimited amount of time? Why is it that the broker who has no fiduciary duty, no written rules of professional conduct, no rigorous educational standards and who is responsible for year in and year out selling the ceding company its largest purchase able to maintain such inertia and yet the highly trained and ethics bound CPA must be changed at least every five years? What sense does that make?
Why does the Connecticut Attorney General recognize the specific problems associated with reinsurance broker inertia and the NAIC not?
Why does the NAIC imagine a danger of overfamiliarity by a CPA with a ceding company, and yet not address the very real danger of overfamiliarity of a reinsurance broker with a ceding company, even after the issue is pointed out by various Attorneys’ General?
From my own experience I know that reinsurance brokers will rise to the occasion of competition when it is introduced; however, the inertia of the small to mid-sized client in the broker relationship stifles the introduction of competition. Getting the Insurance Commissioner more actively involved in the oversight of the reinsurance broker will spur competition.
One manager I know initiated a “sunset” review on every vendor the company uses, be it claims, accounting or reinsurance broker. Every vendor relationship is put out for bid every several years. That is a very good risk management technique; it keeps the vendors on their toes. She realizes that she is running a business, she may like the vendor, but the relationship is not a personal friendship and it ends when another vendor can provide better or less expensive service to the company she is managing.
Indeed the company she runs is very small, she does not depend on the Commissioner to oversee the reinsurance broker, and she had no hesitation in recovering what the company overpaid. She also did not have her broker telling her that her premiums would be increased and in fact a Lloyds syndicate advised her that the credit she showed from them had never been paid, and so it sent funds beyond what she asked for. Kudos to the Lloyds Syndicate for its honesty and for a clear indication that the Broker does not speak for them on the issue of recovery for overpayments.
From a business perspective, these small to mid sized companies understand their upstream position in their downstream to their policyholders. They would never dream of telling their marketing force that if a policyholder downstream overpays his premium and then seeks a refund of the amount overpaid, you are to advise them that we will increase their rates. That is an absurd position to take and an even more absurd position to express. So why do many of the small to mid sized companies not realize that they are the downstream consumer for the reinsurance product? Why do many of them accept what a broker tells them that which they would not tolerate coming from their own marketing force?
If they did understand their position as the downstream marketing stream, these small to mid sized companies would be exhibiting cognitive dissonance. Cognitive dissonance refers to a situation involving conflicting attitudes, beliefs or behaviors. This normally produces a feeling of discomfort leading to an alteration in one of the attitudes, beliefs or behaviors to reduce the discomfort and restore balance The absence of widespread feelings of discomfort leading to changed behavior amongst these small to mid-size companies tells me that they do not fully comprehend their position as the downstream consumer.
The longer customers stay with a company, the more likely they are to pay more than they need to, said the Texas Office of Public Insurance Counsel. In a survey released in 2012, Deloitte, the accounting and consulting firm, found that 30% of auto owners and 45% of homeowners had never switched insurers, with people under 35 years old twice as likely to change auto insurers as those over 50. About 60% of consumers said they never or only rarely shopped for alternatives to their auto or homeowners’ insurance.
The reason? Inertia… sound familiar? Why do small to mid sized companies know and believe this when it applies to their consumers, but somehow that it does not apply to them as consumers?
Thank goodness for the Attorneys General! But like the oncologist, he can only “after the fact” addresses the problem. In my opinion, preventive medicine is called for. I propose that a model law similar to that applied to CPA’s, needs to be applied to reinsurance brokers. I also suggest that Commissioners need to be aware of and get involved quickly if the ceding companies they regulate do not pursue recovering known overpayment of reinsurance premiums.
While the duties of the Commissioner position vary from state to state, their general role is as a consumer protection advocate and insurance regulator. Sometimes it’s easy to forget that the domestic companies they oversee are also consumers that need protection. Clearly, as demonstrated by the various settlements, there is a need for the Commissioner to be pro active and more effectively regulating reinsurance brokers.