The litigation brought by New York Attorney General Eliot Spitzer, and his counterparts in other states, has had the beneficial effect of rooting out “bid rigging” among brokers and “steering” of business to favored insurers. As much as $1 billion in fines and compensatory payments have, or will be, paid to remedy this illegal behavior.
Unfortunately, the lack of restraint shown by some attorneys general will produce results that are detrimental to the insurance industry as a whole and some of its participants in particular. The power and expense of litigation brought by a state attorney general does not result in the compromise and nuance that is generally the product of the legislative process. The result can be that innocent parties are injured in the rush to punish the guilty. Moreover, the balance of power between the legislative, executive and judicial branches of the state governments can become unhinged.
The insurance brokerage antitrust litigation in the U.S. District Court in New Jersey (CA No. 04-5184) (FSH) is a good example. [Full disclosure: MMM represented the National Association of Professional Insurance Agents as amicus curiaein this litigation.] The litigation has resulted in several settlement arrangements by defendant Zurich Insurance Company (“Zurich”) and its affiliates.
On March 20, 2006, the Zurich insurers entered into an agreement with several states (“Multistate Agreement”). This Agreement required the Zurich insurers to agree to the entry of an Order and Stipulated Injunction in the state courts in each of the signatory states. This Order requires that the agents for Zurich to provide a stipulated mandatory disclosure statement to their policyholder customers.
On March 24, 2006, the Zurich insurers entered into an agreement with the states of New York, Connecticut and Illinois (“3-State Agreement”). Unlike the Multistate Agreement, the 3-State Agreement contains a direct attack on the payment of contingent commissions. This Agreement prohibits the payment of contingent commissions relating to the placement of any excess casualty insurance policy from 2006 to 2008. In addition, it requires that the Zurich insurers cease paying contingent commissions on additional insurance lines when and if other carriers enter into similar agreements such that those carriers, combined with the Zurich insurers, represent more than 65% of the national gross written premium in the given insurance line in any calendar year. Finally, the 3-State Agreement also has a provision requiring the Zurich insurers to “support legislation and regulations . . . to abolish contingent compensation for insurance products or lines.”
Mandatory Inaccurate Disclosure
The zealous investigation and prosecution of “bid rigging” and “steering” by some of the largest brokerages has resulted in proposed settlements which will do more than simply compensate policyholders who have been forced, as a result of these actions, to pay excessive premiums. The Mandatory Disclosure Statement (“MDS”) shows how this process has run amok. The language of the MDS, which was developed by the AGs is, in many cases, misleading, inaccurate and occasionally just plain wrong. This shows what can happen when the checks and balances provided by a state’s mandated administrative procedures are ignored.
The MDS has several critical flaws: First, it creates the inaccurate impression that the role of an independent agent is identical to that of a broker. Second, it misleads insureds regarding the nature of compensation received by independent agents. Third, it creates the incorrect impression that independent agents have the sort of market power vis a vis insurers that is wielded by large brokers, who not only have the ability to negotiate the compensation they receive, but also can negotiate the level and price of coverage on behalf of the insured. These inaccuracies in the MDS place independent agents in direct legal jeopardy on a number of fronts.
The MDS includes the following disclosure: “Your agent or broker is an independent businessperson or team of people not employed by Zurich or any other insurance company.” This statement looks innocuous on its face, but is dangerously misleading. The statement is correct, of course, in its representation that the independent agent is not employed by the insurer. Nowhere, however, does the MDS mention that the agent is appointed by the insurer, acts under contract with the insurer and directly represents the insurer. Instead, the MDS one-sidedly characterizes the independent agent as “your agent.”
The law draws an important distinction between an independent agent, who primarily represents the insurer, and a broker, who primarily represents the insured. This distinction is critical to determining the legal duties owed by the insurance producer to the insured. By creating the impression that an independent agent acts in the same capacity as a broker, the MDS upends the fundamental legal relationship of the independent agent to the insured, placing inappropriate legal risk on independent agents.
Because brokers primarily represent the insured, they are charged with certain heightened legal duties to the insured. Yet the MDS blurs the distinction between independent agent and broker, leaving insureds with the impression that the independent agent—“your agent”—acts in the same capacity as a broker. This is a dangerous development for independent agents, as it places them at risk of liability for having misrepresented the nature of their relationship with the insured. In addition, it places independent agents at risk of being deemed to have assumed the expanded duties of a broker towards the insured.
The situation is reminiscent of the time in the not-too-distant past when insurers sought to limit their liability for the actions of their independent agents by placing language in their policies asserting that the agent acted solely on behalf of the insured. Policy wording of this sort eventually was rendered invalid by state lawmakers, who enacted statutes voiding such provisions as against public policy and not representative of the actual role of the independent agent. Now, however, the actions of state AGs mandating the MDS seem to be cutting the opposite way.
The Damage to Independent Agents
The MDS further places independent agents in legal jeopardy by forcing them to present insureds with statements that mischaracterize the nature of the compensation received by independent agents and the bargaining power of independent agents with respect to insurers. For example, the MDS suggests that independent agents may receive contingent commissions under circumstances that have virtually no application to most “Main Street” independent agents. The MDS also suggests that an insured may choose to compensate an independent agent directly, rather than through the agent’s commission from the insurer. In fact, direct payment by an insured to an independent agent is prohibited by law in several states. The MDS further suggests that independent agents “choose” how they will be compensated by insurers, creating the impression that independent agents have the ability to negotiate their compensation and other aspects of their dealings with insurers in the same way as large brokers.
By being forced to present inaccurate and misleading statements to insureds regarding the nature of their representation, compensation and bargaining power, independent agents run the risk of being found liable under state unfair trade practices laws and common law. It makes little difference that independent agents do not intend to mislead insureds by presenting the MDS. State unfair trade practices laws prohibiting misleading statements generally do not require any specific intent to deceive in order for an agent to be found liable.
Nor does it necessarily matter that independent agents are required to provide the MDS to insureds under the terms of a settlement agreement reached by state authorities. A fairly recent case in New Mexico is instructive on this point. The case, Palmer v. St. Joseph Healthcare P.S.O., Inc., 77 P.3d 560 (N.M. Ct. App. 2003), cert. dismissed 101 P.3d 808 (N.M. 2004), involved a Medicare+Choice provider service organization (“PSO”) that was required by federal regulators to send a misleading notice to subscribers as a condition of continuing to participate in the Medicare+Choice program. The court held that the PSO could be found liable to its subscribers for circulating the misleading notice under the New Mexico unfair trade practices statute and state common law principles, notwithstanding the fact that federal regulators had generated the misleading notice and had refused to allow the PSO to change the notice to correct its inaccuracy.
In reaching this decision, the court acknowledged that the PSO had found itself “between the proverbial ‘rock and a hard spot.’” Moreover, the court expressed discomfort with the possibility that the PSO might be found liable for the misleading notice when a federal regulator ultimately was to blame. Nevertheless, the court found itself compelled to permit the subscribers’ lawsuit to proceed. The decision in St. Joseph Healthcare is a cautionary tale for those who would subscribe uncritically to the settlement agreement encompassing the MDS, and it serves to highlight the legal jeopardy in which independent agents now find themselves.
Punishing Many for the Sins of the Few
The multi-state settlements work harm to the state insurance regulatory system in another way: The prohibition on the payment of contingent commissions is an ill-considered “remedy” which does not fit the underlying wrongdoing. Certainly, prohibiting the payment of contingent compensation to agents or brokers that engaged in “bid rigging” and “steering” is appropriate. However, requiring the entire industry to adhere to such a prohibition is excessive and even irrational. Compensation based upon efficiency and production is utilized in almost every industry – and certainly, in the financial services industry, e.g., banking and securities. In fact, economic experts recognize that contingent commissions can “help keep property-casualty and other markets efficient.” J. David Cummins & Neil Doherty, The Economics of Insurance Intermediaries, May 20, 2005.
Finally, probably the most obvious example of overreaching by the AGs is the mandatory injunction requiring the Zurich insurers to “support legislation and regulations in the United States to abolish contingent compensation for insurance products or lines.” Can a settlement require that a defendant in a lawsuit waive its First Amendment rights regarding legislation and, in addition, to support a position mandated by a state attorney general? It could be argued that, as part of its punishment, Zurich could be required not to oppose any regulatory or legislative effort that was consistent with the terms of the settlement, i.e., no contingent commissions by Zurich. However, that hardly supports the conclusion that it should have to allocate its corporate energy and funds to support legislation affecting and entire industry. Moreover, if denial of the ability to provide contingent compensation is a reaction to Zurich’s improper behavior, why should Zurich be required to lobby for a similar punishment for those who have not engaged in such improper conduct?
The serious shortcomings of the multi-state settlements could have been avoided, and could still be mitigated, through the proper operation of two aspects of the state insurance regulatory system--regulatory rulemaking and, if necessary, the legislative process. The state regulatory rulemaking process embraces the important procedural safeguards of notice, public comment and reasoned deliberation of public authorities in light of the interests of all stakeholders. These safeguards are required for a rulemaking because it is recognized that a rulemaking is a quasi-legislative function with broad effect on the regulated community. Similarly, the state legislative process naturally engenders open public debate and consideration of the interests of all major stakeholders before new law is made.
The multi-state settlements illustrate only too well what happens when state AGs attempt to legislate through litigation. The settlements have a broad impact on a variety of stakeholders beyond the immediate parties to the lawsuits brought by the AGs. The AGs clearly recognized this fact when they turned to a task force of the NAIC for advice in formulating the settlements. Yet major stakeholders who are directly affected by the settlements were locked out of the process leading up to their implementation.
The result is a new, ill-crafted regulatory regime that unfairly penalizes those who are guilty of no wrongdoing and reformulates the relationship between insured and agent in ways that could put independent agents in legal jeopardy. State insurance regulators should take control of this situation now by working with the affected parties to develop reasonable standards. State insurance regulation will not survive if it allows itself to be overwhelmed by ambitious attorneys general. A challenge in state court may be necessary to turn the tide.
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.
Joe Holahan is Of Counsel in Morris, Manning & Martin’s Washington, D.C. office and is Director of the firm’s Terrorism Insurance Group. His areas of experience include privacy and data security, compliance with the Health Insurance Portability and Accountability Act of 1996 (HIPAA), state and federal insurance regulation, and managed care. He received his bachelor’s degree from University of Virginia and his law degree from Catholic University of America, J.D., 1990.