NEW YORK PRODUCER
COMPENSATION REFORM
FROM THE STATES
David Giusti

David Giusti is a Director of Client Services, State Net Financial Services Division (Washington, DC)

INSURANCE COMPENSATION arrangements continue to be closely examined in New York as a result of the bid rigging investigation that was spearheaded by former Attorney General Elliot Spitzer five years ago. Last July, the Insurance Department and Office of the Attorney General conducted several hearings concerning broker compensation and disclosure. Information collected at these meetings was used to determine if the contingent fee system leads to an uneven playing field and subsequently prompts insurance brokers to steer clients to insurers paying the most compensation. The departments also explored if additional transparency should be mandated so that consumers would be provided with more complete information before committing to a policy.

After the hearings, a regulatory working draft on Producer Compensation Transparency was issued and circulated on Jan. 29 for discussion. The draft regulation imposes minimum written disclosure requirements for insurance producers who receive commissions. Information that must be provided in writing includes: a description of the nature and amount of compensation to be received by the producer in connection with the sale; a description of any material ownership interest the producer has in the insurer issuing the contract; a description of any material ownership interest the insurance insurer has in the insurance producer; and a notice written by the New York State Insurance Department.

Not prohibited in current draft

Although there is concern that an irreconcilable conflict of interest may exist if contingent commissions are paid to producers who recommend policies to insurance buyers, the informal draft does not prohibit this form of compensation. Furthermore, a New York appeals court recently ruled in a case involving Liberty Mutual that contingent commission agreements are not illegal.

Does the contingent fee system prompt insurance brokers to steer clients to insurers paying the most compensation?

This discussion draft would apply to producers who receive compensation from either the issuance or renewal of an insurance contract. The draft defines compensation as anything of value, including money, credits, loans, interest on premium, forgiveness of principal or interest, vacations, prizes, gifts, or the payment of employee salaries, benefits, or expenses. Reinsurance brokers, captive insurers, and wholesale brokers or managing general agents who have no contact with the purchaser would be exempted.

Although the industry would like greater transparency in compensation, most favor voluntary disclosure and prefer to only release certain information in conflict situations or when requested by the customers. In particular, the mandatory requirement to provide the amount of compensation could present problems for some insurers because the value of the compensation is not always known at the time of the sale. In these situations, the regulatory draft requires the producer to describe the method for calculating the compensation in writing. The written description must include a reasonable estimate and factors that determine the amount of compensation, including volume, profitability, and retention. Still, the method for calculating future compensation may not be straightforward if the commissions are based on profit-sharing.

Another point of contention is the department's notification language. Some believe it is unnecessary and too specific. For example, the template suggests that insurance producers may have an incentive to recommend a particular product based on the amount of compensation paid in connection with the policy. A provision is also included in the draft that requires the producer, upon request, to provide quotes for alternative insurance products that were considered along with the relative amount of compensation that would have been received for each policy.

Working group meetings will continue with the financial services industry and consumer advocates in the spring, and a revised proposal will be provided to the Governor's Office of Regulatory Reform after this informal discussion period. Once the proposal is published in the state registrar, the Insurance Department will solicit formal comments and conduct public hearings. The New York State insurance commissioner is hoping to adopt the Producer Compensation Transparency rule this fall.