Winds of Change…

Not unlike the admitted defeat of Britain’s imperialistic ambitions as witnessed by the “winds of change” speech made by that country’s prime minister Harold Macmillan in 1960, the property and casualty insurance industry appears to be facing its own epic change as a result of tumultuous events. However, where social rebellion spelled the end of Britain’s colonial empire, the future course of the global insurance industry is not being driven by revolt but rather heightened government regulation.

Like a simple revolt that fans out to become an uncontrollable political brushfire, current events influencing insurers were sparked by a single flame: New York’s attorney general, Eliot Spitzer. What began as an investigation into presumably one or two “isolated cases” in the U.S. of alleged bid rigging of insurance contracts by certain insurers and global brokerage houses involving the payment of contingent commission fees has spread uncontrollably in scope and depth to become almost akin to a global “witch hunt”. And, Spitzer’s investigations did not stop at broker remuneration arrangements, but expanded to company finite reinsurance contracts. The negative publicity that resulted from both these broad onslaughts has slewed the attitude of insurance regulators from a position of policy moderation to outright belligerence in their dealings with the insurance industry – not just in the U.S. but other major countries such as Canada and the U.K.

The outcome of the Spitzer investigations has seen over 60 state regulatory agencies in the U.S. issue subpoenas against insurers and brokerages over the past two months, observes Adam Klauber, chief of equity research at investment banker Cochran, Caronia. “I’ve never seen something like this [in the insurance industry’s history],” he says. Klauber, who spoke at the recently held Canadian Insurance Congress, notes that October 14 of last year was “a day of infamy” when Spitzer first revealed that criminal indictments had been made against people in the insurance industry. “Pure panic resulted, and stock prices [of companies] plummeted.”

The Property Casualty Insurers Association of America (PCI) recently urged state regulators to adopt a consistent approach (based on the directive of the National Association of Insurance Commissioners) in their investigations into the insurance industry. That cry for sensibility seems to have fallen on deaf ears, and as Klauber notes, “these investigations are far from over”. Furthermore, he points out that the cost of investigations initiated by state regulators is ultimately carried by insurers.

On the Canadian front, much of the regulatory mania associated with the Spitzer investigations appeared to have been averted when both insurers and brokers took action in bringing about voluntary disclosure of intermediary compensation arrangements – this initiative primarily evolved in the Ontario marketplace. However, not all of the regulative investigations over the past eight months in Canada into broker compensation and the issue of “conflict of interest” produced positive results – at least for the insurance industry. Quebec’s regulator, the Autorite des Marches Financiers (AMF) concluded from an investigation it made into intermediary remuneration and market conduct that there does exist a conflict of interest in the relationship between insurers and independent brokers.

The Quebec experience is highlighted in a consultation paper released in June of this year by the Canadian Council of Insurance Regulators (CCIR) and the Canadian Insurance Services Regulatory Onrganizations (CISRO), the outcome of which could significantly change the regulative landscape of the insurance industry with regard to broker remuneration and disclosure of relationship between insurers and intermediaries – with the cost to be presumably absorbed by the regulated parties. The bottom-line is that, despite the positive interaction between insurers, brokers and regulators in Ontario, the final recommendations made by CCIR and CISRO (after having gained feedback from all stakeholders) could well result in draconian legislation being inacted across the provinces in the name of “regulative harmonization”.

Notably, the CCIR/CISRO consultation paper draws attention to the perceived (rather than necessarily actual) view that a conflict of interest exists in the current system of broker remuneration, and in this respect the outcome could undermine consumer confidence. The report notes that more than two-thirds of insurers in Canada offer contingent commissions to agents/brokers with more than half of all companies having some form of financial relationship with intermediaries in terms of loans and ownership stakes. Among its findings, the CCIR/CISRO paper suggests legislative measures to either abolish performance-based intermediary remuneration or to restrict the benefits thereof. The paper also emphasizes the need for greater transparency in the relationship between intermediaries and insurers, and proposes that brokers should provide both verbal and written disclosure at the point-of-sale of their earnings arrangements with various carriers as well as the number of markets that they represent. The suggestion is also made that insurers should be held responsible for disclosing the relationship that they have with various brokers by publishing this information on their Internet websites. How exactly this will be regulated is unclear.

What is very clear is that a new era of increased regulation has dawned on the insurance industry. The cost of doing business, whether as a broker or insurer, will rise at the loss of competitive market forces. Wanted or not, the “winds of change” are sweeping through the insurance industry.