Compensation of insurance agents and (particularly) insurance brokers has been in the news for months, largely thanks to the efforts of the ambitious Eliot Spitzer. Never one to be left out of a high profile policy fracas, California Insurance Commissioner John Garamendi has taken time away from his crusade against "use it and lose it" underwriting [see below] to propose new rules prescribing the sorts of information that agents and brokers should be required to disclose to insurance buyers, particularly concerning the way in which those agents or brokers are going to be paid for placing the coverage.
Unlike the "use it and lose it" proposal, the text of which is still seemingly unavailable online, the latest draft regulation on agent/broker disclosure is readily accessible via the link at the end of this press release or directly, here [PDF].
The National Association of Mutual Insurance Companies [NAMIC] suggests that the Commissioner is getting ahead of himself, offering a solution without first finding a problem.
'The logical construct is that one should establish the existence of a problem before demanding a solution, said NAMIC State Affairs Manager Christian J. Rataj. 'To date, no evidence has been offered by the commissioner to support his conclusion that insurance producers are placing their desire for financial gain above the needs of their clients.'
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The original version of the regulations was released in October of 2004. NAMIC and PIFC argued that the regulations were unworkable and that the California Department of Insurance (CDI) did not have the legal authority to change existing state law. While the revised proposed regulations are less onerous than the original, NAMIC asserts the fundamental position that the CDI should adopt only those regulations that are specifically tailored to address an 'actual documented' problem.
In the Commissioner's testimony before a U.S. Senate subcommittee [PDF] this past November, he acknowledged that it is not unlawful, in California or in most other jurisdictions, for an insurance broker to receive compensation both from the insurance buyer and from the insurer that issues the policy. Rather, the question in the Commissioner's mind is whether it should be permissible for a broker to arrange compensation in that way without disclosing the arrangement to the customer:
Let me be clear. I am not saying that the acceptance of a commission or a contingent commission from an insurer is, by itself, a violation of the law. . . . [But] if a broker stands to receive more money by placing a client with one particular insurer as opposed to another, that action creates a potential conflict of interest because it gives the broker an incentive to favor that insurer. Whether this should be made illegal is something that I am certain state legislatures will be considering as a result of this scandal.
But there should be no question that accepting such compensation in secret, or providing a disclosure that does not clearly tell the client what compensation the broker is receiving and from whom, is a violation of the broker’s duty to its client. And deciding to recommend that a client buy insurance from a particular insurer, not because that insurer offers the best product for the client but because the broker will receive additional compensation, is illegal.
"Illegal?" Not necessarily, but certainly not particularly ethical: an insurance broker acting on behalf of a prospective insurance buyer is that buyer's "agent" and as such owes fiduciary duties, including a general duty to disclose information relevant to the transaction and to place the interests of the client first.1 Those general duties militate in favor of the broker revealing to the customer any facts -- such as a commission from one of several possible insurers -- that might affect the broker's judgment in recommending one policy over another. In other words, the proposed regulations largely compel brokers to make disclosures they arguably ought to be making even without these regulations.
Absent the proposed regulations, a broker who receives undisclosed compensation from a third party only faces some consequence from that action if (1) the client discovers that it occurred and (2) the client can show that some actual damage to the client's interests resulted from the transaction. Damage would generally be found only if the buyer could have obtained identical insurance coverage more cheaply if a different insurer -- one that was not paying extra compensation to the broker -- had been selected. In a case of that sort, the measure of damages ought to be the difference between the premium the customer paid and the lower premium that "should have been" offered.2 This is likely to be a modest amount in most cases, though it could be more substantial in the case of a large commercial account.
The proposed regulations, in contrast, would declare this sort of non-disclosure to be per se unfair or unlawful, effectively "crimininalizing" the conduct and exposing the broker to disciplinary action -- fines, restrictions on or withdrawal of the broker's license -- whether or not any measurable damage was done to the customer in a given case.
The issue boils down to one of regulatory philosophy. Those who oppose regulation, such as NAMIC, would urge that this sort of conduct should be acted upon only in the particular cases in which it does harm. Those, such as the Commissioner, of a more crusading bent would counter that the conduct is an evil in itself and should be punishable in every instance, including those in which "no one was hurt" by it. Take your pick.
[Post title inspired by Lewis Carroll [C. L. Dodgson], Alice's Adventures in Wonderland: Chapter XII. Alice's Evidence.]
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UPDATE [1423 PDT]:
Business Insurance reports that proposed legislation on agent/broker disclosure requirements has failed in a state Senate committee:
The committee was originally scheduled to vote on a bill proposed by Sen. Joseph Dunn, D-Santa Ana, that would have imposed specified requirements on agents or brokers with respect to how they make inquiries of insurers, obtain coverage, disclose information to the client and charge fees to the client. California Insurance Commissioner John Garamendi supported the bill.
Instead, the committee voted on a more limited bill that would have added new disclosure requirements. It was defeated 5-2.
Information on the bill (SB 938), including the most recent version of the text, is available through the Legislative Counsel, here. As the Business Insurance story notes, the bill existed independently of the Commissioner's proposed regulations discussed above. Whether the regulations will be affected by the bill's failure remains to be seen.
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Notes:
1 The terminology gets slightly confusing here. An "insurance agent" is usually deemed to represent and to act for the insurer, while an "insurance broker" is usually deemed to represent and act for the prospective insurance buyer. (That distinction was a major issue in the case discussed here.) As a representative of the buyer, a "broker" is that buyer's agent in the generic, common law sense: one who acts for another and has the power to bind the client/principal or affect the client/principal's legal interests. It is from that principal-agent relationship that the duties of loyalty, disclosure, etc., naturally flow.
2 A more serious case can be imagined if the broker, acting under the influence of the promise of extra compensation, placed the coverage with an insurer that later proved to be insolvent or if the coverage provided by the selected policy proved not to cover a loss to which the alternative policy would have responded, but those cases strike me as much less likely to occur than the sort of "I paid too much" claim described in my example.
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