The main target is Marsh & McLennan, not A.I.G. I don't think that the political orientation of A.I.G.'s management had anything to do with the suit. Spitzer is positioning himself to run for governor in 2006.
October 17, 2004
GRETCHEN MORGENSON
Is Spitzer Preparing Marsh, Act II?
nytimes.com
LIKE the universe itself, corporate chicanery just seems to keep on expanding. Unlike earlier versions, however, the latest scandals tend to implicate not just individual companies but entire industries.
In last week's revelations, courtesy of a civil suit filed last week by Eliot Spitzer, the New York attorney general, the insurance industry got its turn. Stocks of major players in the industry have been hammered and investors are rightly wondering where the next bombshell might fall.
Mr. Spitzer's suit, which detonated Thursday, was filed against Marsh Inc., whose parent, Marsh & McLennan, also owns Putnam Investments and Mercer Inc., the consulting unit. The suit was a shocker even to industry veterans because it disclosed Mr. Spitzer's findings of phony bids designed to direct business to certain insurers and to keep insurance rates high. The suit said A.I.G., Ace Ltd. and the Hartford, a unit of Hartford Financial Services, took part in the schemes with Marsh.
Shares in Marsh, the largest insurance broker in the world, have lost 37 percent of their value since Mr. Spitzer filed his suit, wiping out almost $9 billion in investor wealth. Interesting isn't it, how investors shrugged off Mr. Spitzer's investigation into improper insurance practices at Marsh and other companies when it came to light on April 23? Back then, Marsh's shares were at $45.01; they stood at $46.13 before the suit was filed last week.
Besides bid-rigging, Mr. Spitzer's suit detailed the kickbacks from insurers that brokers receive for sending them business as well as the hidden fees charged to the companies buying insurance. These arrangements, known as marketing service agreements or placement service agreements, were openly used by the industry. But Mr. Spitzer argued that because they were used to steer business, they represented a breach of duty to Marsh's customers.
Marsh generated $800 million in revenue from the service agreements in 2003, according to Mr. Spitzer's suit, and most if not all of that probably dropped down to the company's bottom line, industry experts said. If that is so, the fees accounted for more than half of Marsh's net income of $1.5 billion last year.
On Friday, Marsh said it would no longer seek these fees. "We are greatly disturbed by the allegations of wrongdoing," said Jeffrey W. Greenberg, chief executive of Marsh, in a statement. "We take them very seriously, and we are conducting a thorough investigation of these allegations. As the facts are being reviewed, we believe it is in the best interest of our clients to suspend M.S.A.'s immediately," he added, referring to the market service agreements.
A.I.G. also said it would no longer pay service agreement fees. It said that the company's senior managers were not aware of the bid-rigging detailed in Mr. Spitzer's suit.
BUT even as Marsh and A.I.G. responded to the suit by changing their practices, industry participants and analysts said that Mr. Spitzer's accusations and his continuing investigation would have many other repercussions for the business. In other words, the trouble for investors in insurance stocks has only just begun. Other companies will soon come under the microscope.
Marsh dominates the global insurance brokerage market, with a 40 percent share. Almost $7 billion, or roughly 60 percent of the company's $11.5 billion in revenues last year, was generated by brokering insurance to corporate clients. Any significant change to the way the business is done will have a big impact on Marsh. That is why Mr. Market has punished its stock the most.
"The upshot of the news and the investigation is that there will be a fundamental change to the economics of the insurance brokerage business," said Adam Klauber, director of research at Cochran, Caronia Securities L.L.C., a research firm in Chicago specializing in insurance. "You're talking about a pretty significant potential economic hit to Marsh. Its earnings will be impacted and its growth going forward will be impacted."
Ace Ltd., one of the companies identified as participating in phony bidding, said it was cooperating fully with Mr. Spitzer. The Hartford, the other company named, said its corporate policy does not condone bid-rigging or any other illegal activity.
Marsh will almost certainly lose customers as a result of the lawsuit, analysts said, as its sister company, Putnam Investments, did when the scandal involving its executives made news in 2003. (Investors have withdrawn $32.5 billion from Putnam stock funds since September 2003, according to AMG Data Services.)
But industry experts said that officials who buy insurance - known as risk managers - may be much quicker to abandon Marsh than were Putnam investors, many of whom were trapped in 401(k) plans offering few alternatives. Risk managers, after all, must justify their choices to superiors or their company's board; neither group is usually interested in doing business with a company mired in controversy.
Another potentially big problem for the industry as a result of the suit may be future legal actions by customers. Insurance brokers act as negotiators when companies file claims. So, as one analyst explained, some insurance customers who have settled claims in recent years may wonder if these settlements were fair or if the brokers in charge of negotiating them were acting in their own interests.
Many insurance claims are settled on the courthouse steps. For example, the majority of liability claims against corporate directors and officers never make it to court. "Now it makes economic sense for companies to go back and see if they've left money on the table in these settlements," the analyst said. As a result, lawsuits questioning the fairness of these settlements could mount.
Marsh could also be hurt by defections from an unhappy staff. Until the company's internal investigation is concluded, its brokers will be operating under a cloud. The stock's recent plunge means that almost half of the stock options that had been awarded to Marsh employees as of the end of last year are now under water.
Mr. Spitzer said the practices outlined in his lawsuit have resulted in higher costs for consumers of all kinds of insurance. "There are several billion dollars in P.S.A.'s every year; those theoretically should go back to the consumer," he said. "But much more important, when you corrupt the marketplace and eliminate competitive bidding, that is massive. It will take economists time to model this and figure it out, but the numbers are huge."
What's ahead for the investigation? Mr. Spitzer would not say. But an industry executive, who spoke on condition of anonymity, said that the next phase of the assault would probably involve another questionable insurance industry practice known as tying. That is when a broker threatens to stop sending primary insurance business to an insurer unless it agrees to let the broker provide all of that company's reinsurance needs in return.
The executive said that Mr. Spitzer's office was receiving "crates of evidence of tying" as a result of subpoenas submitted recently. Profits on reinsurance, by the way, are far richer than those on primary insurance.
Marsh did $775 million in reinsurance brokerage revenues last year, roughly 11 percent of total revenues generated in its insurance segment. If Marsh is found to have been tying through its reinsurance subsidiary, Guy Carpenter, some or all of these revenues may be vulnerable.
"This is the industry that for years has been blaming everyone else for premium increases," Mr. Spitzer said. Greedy trial lawyers were the usual excuse for premium increases. Now we know that greedy corporations also have a starring role. |
