Morris Manning & Martin, LLP

LETTER FROM WASHINGTON - Recent Cases Support Legality of Contingent Commissions

11.01.2007

By Robert H. Myers, Jr. and Cindy Chang After then-New York Attorney General Elliot Spitzer initiated industry-wide investigations into allegedly anti-competitive conduct in 2004, some regulators and industry commentators advocated the reform or abolition of the accepted practice of insurance producers receiving contingent commissions. New York’s Insurance Department announced on November 2, 2007, that it is drafting a regulation that will require all retail brokers who deal directly with the public to disclose the value of all compensation agreements with insurers.

However, recently decided and filed cases support the legality of contingent commissions. Some cases even suggest that insurance producers do not have a fiduciary duty to disclose contingent commissions to their clients. These cases directly support the conclusion that, absent a horizontal conspiracy to restrain trade, contingent commission agreements are lawful and do not violate the antitrust laws.

A.    Background and Spitzer Era Cases

Traditionally, insurance producers received contingent commissions from insurers on the back end based on profitability or volume of business. However, the Spitzer investigations indicated that some “mega-brokers” and insurers used contingent commissions and “placement service agreements” (which require insurers to pay upfront) to engage in business-steering, bid rigging, and other anti-competitive conduct.

On the heels of these investigations, then-Attorney General Spitzer and several other state attorneys general filed suit against brokers and insurers alleging antitrust, RICO, and other state business fraud claims. At least three cases in New York and Florida remain pending, and these cases reflect the erroneous assumption that undisclosed contingent commissions are per se illegal. The pending cases also conflate “contingent commission agreements,” which are traditionally calculated after expiration of the policy term, with “placement service agreements,” “market service agreements,” and other agreements that are calculated upon the initial sale. 

Nonetheless, in one of the pending cases, People of the State of N.Y. v. Liberty Mutual Insurance, No. 401726/2006 (N.Y. Sup. Ct. filed July 31, 2006), the defendants argued to the trial court both that contingent commissions were legal and that a fiduciary relationship does not arise between an insurance producer and the insured. When denying Liberty Mutual’s motion to dismiss, the court found that even if the defendants’ arguments regarding contingent commissions were true, they do not refute the allegations of bid rigging. The court maintained that “bid rigging schemes” are not “contractual agreements” and may violate duties owed to the insured. Thus, though somewhat circuitously, this ruling distinguishes legal contingent commissions from illegal bid rigging and manipulations of the market. 

The final disposition of Liberty Mutual and other pending cases will provide additional guidance on New York’s interpretation of “contingent commissions.” Nevertheless, this preliminary ruling in Liberty Mutual is consistent with recent cases, discussed below, that recognize the distinction between standard contingent commissions and illegal schemes to manipulate the market.

B.    Recent Cases

Most recently decided and filed cases depart from prior cases that conflated “contingent commissions” with overarching schemes to control the marketplace. These recent cases collectively support the argument that contingent commission agreements, in the absence of a horizontal conspiracy to restrain competition, are legal and do not violate antitrust laws. 

In Hersch v. DeWitt Stern Group, Inc., 841 N.Y.S.2d 516 (N.Y. App. Div. Sept. 7, 2007), the Appellate Division of the Supreme Court of New York ruled favorably for an insurance brokerage firm by dismissing a plaintiff insured’s claims against a the brokerage firm for failing to disclose its contingent commission agreement with the insurer who issued insured’s policy. The court held, “Contingent commission agreements between brokers and insurers are not illegal, and, in the absence of a special relationship between the parties, defendant had no duty to disclose the existence of the contingent commission agreement.” Id. at 517-18 (citations omitted). Moreover, Hersch further supported the proposition that undisclosed contingent commissions are legal by holding that the broker did not have any fiduciary duties to the insured even though the parties’ relationship extended over a considerable amount of time and the broker assured the insured that his insurance needs were being met. 

In In re Insurance Brokerage Antitrust Litigation, Civ. Nos. 04-5184, 05-1079 (D. N.J., Aug. 31, 2007), a federal court dismissed class action antitrust claims against defendant insurers and brokers. The court made findings that demonstrate that undisclosed broker and insurer contingent commission agreements are legal as long as the brokers and/or insurers do not conspire with each other to use contingent commissions, or any other business transaction, in a manner, such as bid rigging, to restrict competition.

The federal court’s findings are consistent with the allegations in a pending civil law suit the Ohio Attorney General filed against Marsh and an array of insurers on August 24, 2007. The petition focuses on schemes to allocate business using false bids and horizontal agreements between insurers through Marsh to orchestrate the division of industry business and restrain competition. Most notably, none of the allegations involve the use of standard contingent commissions, and, in fact, an alleged admission of an insurer in the complaint claims Marsh characterized the agreements as “beyond a contingent commission agreement.”

In conclusion, recent cases support the legality of contingent commissions per se while rebuking bid rigging and other concerted anticompetitive conduct. Although some of the largest brokerage firms have pledged to cease use of contingent commissions, these holdings support insurance producers who continue to use contingent commissions legally without restricting competition.

Robert “Skip” Myers is a partner in the firm’s insurance group and practices in the areas of insurance regulation, antitrust, and trade association law. Skip received his bachelor’s degree from Princeton University and his law degree from the University of Virginia.

Cindy Chang is an associate in the firm’s Washington, D.C. office and a member of the insurance and reinsurance and litigation groups. Prior to joining the firm, Ms. Chang completed a clerkship with the Honorable Kathianne Knaup Crane of the Missouri Court of Appeals. She can be reached at 202-842-1081 or [email protected]