N.Y. Insurance Department Questioned Contingent Fees Years Before Spitzer Investigation Made Headlines

While it did not begin boiling over until last October when charges were brought against Marsh, the controversy over brokerage contingent fees has actually been simmering for more than a half dozen years in New York insurance circles.

Back in 1998, the New York State Insurance Department ordered brokers and insurers to disclose to policyholders all compensation agreements between brokers and insurers and to keep a record of these fees. The regulatory order, known as Circular Letter No. 22, even warned that the department would inquire about these agreements in future market conduct exams.

The letter states that a broker is a legal representative of the insured, and that the undisclosed receipt of additional compensation from an insurer is sufficient to create the perception that brokers are conflicted in their loyalties. It says that such conduct may constitute a violation of state insurance law and raise issues of trustworthiness.

Circular Letter No. 22 was a pioneering effort by then Superintendent of Insurance Neil Levin and it met with opposition at the time and for years thereafter from brokers who argued that it exceeded his authority.

Today that regulatory letter has resurfaced as Exhibit A in the debate over the future of contingent commissions and, some would add, the future of state regulation.

Last October, New York Attorney General Eliot Spitzer charged that contingent fees paid by insurers to brokers under so-called market service or placement service agreements led to illegal activity, including bid-rigging and account steering. Several of the largest insurance brokers have voluntarily discontinued MSAs and PSAs but others inside and outside the industry have been grappling with whether contingent fees should be outlawed or if simply requiring their disclosure is enough protection against conflicts of interest.

Last month, when the New York Assembly Committee on Insurance held its first public hearing on brokerage practices, Assemblyman Alexander “Pete” Grannis, chairman, suggested that the New York department had effectively given contingent fees its approval in 1998 with the circular letter.

“The department saw no inherent conflict, right?” Grannis asked then-Superintendent of Insurance Gregory Serio, who testified in one of his last appearances as the state’s regulator. Serio stepped down on Jan. 18 for a job in the private sector.

“At the time, we did not see the improper behavior behind the contingent fees but the potential was there so the department absolved the conflict by requiring disclosure,” Serio acknowledged.

Grannis pressed Serio on what the department did after 1998 to enforce the policy set forth in the circular letter.

Serio told Grannis that the department held meetings to discuss the fees and monitored whether brokers had disclosure standards. But the department did not pursue the matter in market conduct exams, he acknowledged.

“Circular Letter No. 22 shows disclosure doesn’t work,” Grannis declared at one point, adding that a legislative ban on contingent fees may be needed.

While Grannis used the circular letter to question the effectiveness of the state’s regulation, Serio used it in his department’s defense, noting that no other state regulator had gone as far to draw attention to potential conflicts with contingent fees.

Even Attorney General Eliot Spitzer acknowledged the importance of Circular Letter No. 22 before the committee.

“The insurance department properly identified trustworthiness as a primary concern arising from insurance brokers’ receipt of undisclosed compensation,” he said. “However, at the time, the direct connection between a broker’s receipt of undisclosed compensation and the widespread market manipulation, fraud and steering practices that result from such compensation, was not fully understood.”

This is an excerpt from a more complete story that appears in the Jan. 24, 2005 print edition of Insrance Journal East.

Topics New York Agencies Legislation