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Spitzer will demand Marsh pays back 'illegal' profits

Marsh, the world's largest insurance broker, is in major trouble. At time of going to press, New York's attorney-general Eliot Spitzer appears close to achieving one of his first objectives - an overhaul of the management of the broker’s parent MMC including the inevitable resignation of chief executive Jeffrey Greenberg.

But Spitzer is set to demand much more. The Insurance Insider understands that the attorney-general, who has led the investigation into alleged fee-fixing and bid-rigging which is scandalising the insurance world, will require that Marsh disgorges the profits which he says the broker obtained illegally through Placement Service Agreements (PSAs) made with insurance companies.

On 18 October MMC revealed that in 2003 Marsh received $845mn from these arrangements and $420mn in the first half of this year. According to sources, Spitzer is considering demanding Marsh goes back five years and disgorges all PSA-related income to its clients which has been obtained “illegally”. This suggests MMC may be forced to return anything up to $4bn to insurance buyers - sums it can scarcely afford following the decision to pay $1.9bn for the corporate investigators Kroll in July.

Indeed, MMC's financials look dire: the company's shares have collapsed by almost 50 percent in under a week to a current $24 - sparking the inevitable wave of shareholder class action suits - while its bankers are demanding the renegotiation of its credit lines. Its banks have capped the embattled firm's credit at $1.9bn and are demanding it uses some of its $375mn spare cash to reduce the debt down from a current $2.1bn.

There is already one precedent for repaying illegal commissions. When Sotheby’s/Christie’s was found guilty of price fixing, Sotheby’s was forced to return a proportion of commissions to its customers.

The problems all stem from Spitzer's incredible 14 October complaint against the broker - first predicted by The Insurance Insider's sister publication Insider Week on 4 October - which alleges the broker dupes its customers by rigging prices with favoured insurers who then pay kickbacks. "Marsh solicited - and obtained - fictitious high quotes from insurance companies in order to deceive its clients into believing that true competition had taken place. It promised to protect insurance companies from competition, and did so. And it threatened to hurt the business of those who thought of truly competing for particular pieces of business," accused Spitzer.

Indeed, according to sources, Spitzer may argue that it is the very existence of the incentive agreements which is wrong - even if there is no evidence of harm caused to Marsh's clients. "The conflicts of interest are almost impossible to overcome," one official remarked. If so, this will cause problems for other brokers beyond Marsh - although it is quite evident that no other firm engaged in incentive agreements anywhere near as ruthlessly as the world's largest insurance broker. But what is certain is that the investigations are being widened to the day to include many new firms - both on the broking and underwriting side.

Spitzer has already demanded a change of leadership at MMC - giving rise to suggestions that the firm has angered the US regulator over its separate investigations into Putnam and Mercer’s - and was rewarded with the demise of Marsh Inc’s chief executive Ray Groves. “We were misled at the very highest levels of the company,” complained the A-G.

Greenberg will surely follow soon. Whoever replaces him will have an incredible job.

Insider comment: Spitzer drives Marsh to the edge

The Insurance Insider has been warning about the problems Placement Service Agreements (PSAs) pose for some time.

Our stance has always been that it is not necessarily the agreements that are wrong, but their application. Of-course bid-rigging and protectionist cartels are abhorrent, but we think in properly regulated markets PSAs are just about legitimate if they are full disclosed. Clients can then make their own minds up whether to use, say, Marsh in the full knowledge that it has arrangements with certain insurers to provide them with business and this may influence their decision-making (as Spitzer points out in his complaint, the so-called “services” used to justify these firms are illusory at best).

Nonetheless, the practice has been effectively abolished by Spitzer's extraordinary actions and with Marsh's reaction to suspend the practice. This, however, may have been a mistake. By doing so, Marsh has effectively hung a guilty sign above itself. Equally, as damaging - the broker has deprived itself of an extraordinary proportion of its earnings. MMC admitted on 18 October that it received $845mn in PSA income in 2003 (incidentally close to the $800mn we were predicting over a year ago) while Marsh Global Broking's costs were only $340mn. In other words, around $500mn went on to MMC’s bottom line in 2003 from these agreements.

Do other brokers - and in particular Marsh's great rival Aon - face the prospect of a similar regulatory-driven destruction? We don’t think so. Certainly, Spitzer has made it clear that it is an industry wide problem and there is no question that further damaging revelations involving firms other than Marsh, AIG, ACE et al will occur. But as we reveal in this issue, Aon was never as ruthless in applying these agreements as Marsh. If Aon has a weakness, it might be on reinsurance leveraging - but that issue is not as clear-cut as PSA driven price-fixing anyway.

One Insider subscriber summed up the difference with a graphic, albeit over the top, analogy. Aon is the BMW in the middle lane, pulled over by Spitzer for driving a little too fast while perhaps a little bit tiddly. But as the New York attorney-general writes out his ticket, a red Porsche zooms past at 110mph driven by a careering drunk. All of a sudden the BMW appears a lot less interesting! This, of course, is not meant as a slur on Marsh. But it does seem to adequately reflect Spitzer’s priorities. After all, Aon were the first global broker to receive a subpoena - but Spitzer has clearly chosen Marsh as his prime target.

The shockwaves will be felt for years to come. In this issue, which is almost entirely devoted to the subject, we examine the fall-out from Spitzer’s accusations, the winners and losers, how the problem developed, together with possible outcomes.

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