Morris Manning & Martin, LLP

Gallagher Gets Okay to Accept Contingent Commisions and New York Proposes New Compensation Disclosure Rules

09.01.2009

Two recent developments have thrust broker compensation back into the national spotlight. The most recent news on this issue was on July 28, when broker Arthur J. Gallagher & Co. (“Gallagher”) announced that it reached a nationwide agreement with the Illinois Attorney General and Illinois Department of Insurance permitting it to once again accept contingent commissions. Gallagher’s agreement with the Illinois regulators does not encompass Marsh, Aon or Willis, the remaining brokers who also agreed to end taking commissions in the aftermath of the 2004 investigation led by then New York Attorney General Elliot Spitzer.

While the net effect to Gallagher’s balance sheet from accepting contingent commissions is expected to be modest (estimated at $10 million to the firm’s earnings in 2011), the broader implication is more striking – that the results of the 2004 investigation, which turned up evidence at some of the larger brokers that contingent commissions were negotiated as a reward for steering business to certain insurers and bid rigging, may have run its course.

Marsh and Aon were quoted as reacting positively to the Gallagher news primarily because it vindicates their argument that there are dual systems of regulation for commissions in effect. Only the four largest public brokers agreed to give up contingent commissions and take on greater disclosure obligations while smaller brokers were free to continue their business practices generally unmodified. Willis continues to assert that contingent commissions create an inherent conflict that cannot be corrected by more transparency and disclosure. It is unclear whether Gallagher will voluntarily continue the disclosure obligations it was previously required to make in its previous settlement with the Illinois regulators.

While Gallagher will be relieved of its disclosure obligations under the former agreement with the Illinois regulators, the New York Insurance Department is moving in the opposite direction and has proposed a new producer compensation disclosure regulation. The proposed regulation, which is still in draft form and subject to additional revision, would require all insurance producers (including brokers) to disclose, before binding any insurance contract: (1) whether the insurance producer represents the purchaser or the insurer for purposes of the sale, (2) that the insurance producer will receive compensation from the selling insurer based on the insurance contract the producer sells (if applicable), (3) that the compensation insurers pay to insurance producers varies from company to company and from insurance contract to insurance contract, and (4) that at any time during the relationship, the purchaser may obtain detailed information about the source and the amount of compensation expected to be received by the producer for the sale and, in the alternative, quotes obtained or considered by the producer by requesting such information from the producer.

If the purchaser requests more information about the producer’s compensation or alternative quotes, the producer must disclose in writing before the issuance of the insurance contract: (1) a detailed description of the nature, amount and source of any compensation to be received by the producer or its affiliates based in whole or in part on the sale, (2) a detailed description of any alternative quotes obtained or considered by the producer including the coverage, the premium and the compensation that the insurance producer would have received in connection with those alternative quotes, (3) a description of any material ownership interest the insurance producer or its affiliates have in the insurer issuing the insurance contract, (4) a description of any material ownership interest the insurer issuing the insurance contract or its affiliates have in the insurance producer, and (5) an explanation that the insurance producer is prohibited by law from accepting a commission rate that is less than the filed commission rate.

The additional disclosures must be made if the amount of compensation to be received by the producer is not known at the time that the initial disclosure is required to be made. In such an instance, the producer has to disclose a description of the circumstances that will determine the receipt and amount in value of such compensation and a reasonable estimate of the amount or value. The draft regulations, which are expected to be finalized by the end of the year, exempt out wholesale brokers and managing general agents from its scope, and any violation or contravention of the proposed rule would be deemed to be a violation of the New York Insurance Unfair Trade Practices Act.

The dichotomy between the Illinois and New York actions is clear. One state is moving to relax restrictions on broker compensation while the other is imposing additional disclosure requirements. What is unclear is which initiative will pick up momentum and be followed by other states.

Anthony C. Roehl is an Associate in the firm’s Insurance and Reinsurance and Corporate Practices. Mr. Roehl’s principle areas of concentration are insurance regulation and corporate matters involving entities within the insurance industry. Mr. Roehl received his bachelor’s degree from the University of Florida and his law degree from the University of Michigan.