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New York State’s Insurance Broker Disclosure Regulation: A Solution in Search of a Problem

On January 1, 2011 the New York State Department of Insurance’s much-debated Regulation 194 will go into effect. The new regulation provides that “an insurance producer selling an insurance contract shall disclose the following information to the purchaser orally or in a prominent writing at or prior to the time of application for the insurance contract:

(1) a description of the role of the insurance producer in the sale;

(2) whether the insurance producer will receive compensation from the selling insurer or other third party based in whole or in part on the insurance contract the producer sells;

(3) that the compensation paid to the insurance producer may vary depending on a number of factors, including (if applicable) the insurance contract and the insurer that the purchaser selects, the volume of business the producer provides to the insurer or the profitability of the insurance contracts that the producer provides to the insurer; and

(4) that the purchaser may obtain information about the compensation expected to be received by the producer based in whole or in part on the sale, and the compensation expected to be received based in whole or in part on any alternative quotes presented by the producer, by requesting such information from the producer.”

Adding insult to injury, the new regulation requires the producer to provide additional information to the purchaser if the purchaser requests it, including some of the following, at or prior to the issuance of the insurance contract, except that when time is of the essence to issue the insurance contract, it has to be provided within five business days:

• A description of the nature, amount and source of any compensation to be received by the producer/broker or any parent subsidiary or affiliate based in whole or in part on the sale;
• A description of any alternative quotes presented by the producer or any parent, subsidiary or affiliate would have received based in whole or in part on the sale of any such alternative coverage;
• A description of any material ownership interest in the insurer issuing the policy or any parent, subsidiary or affiliate;
• A description of any material ownership interest the insurer or affiliate has in the producer, subsidiary or affiliate; and
• A statement whether the broker is prohibited by law from altering the amount of compensation received from the insurer based in whole or in part on the sale.

N.Y. Comp. Codes R. & Regs. tit. 11, §30.3 (2010). The regulation defines ‘compensation” extremely broadly, as

“anything of value, including money, credits, loans, interest on premium, forgiveness of principal or interest, trips, prizes, or gifts, whether paid as commission or otherwise. Compensation does not mean tangible goods with the insurer name, logo or other advertisement and having aggregate value of less than $100 per year per insurer.”

((§30.2(a)). Under the new regime, efforts to achieve greater transparency in insurance transactions potentially result in the Emperor having no clothes at all.

The adoption of the new regulation follows several years of controversy over the issue of contingent commissions, that is compensation received by producers over and above the standard per policy brokerage percentage. “Contingent Commissions” as the term is typically used, describes commissions paid by insurance companies to brokers who bring a certain amount of business to the company. Although payable on a per-risk basis, contingent commissions are commonly allocated on the performance of the entire portfolio of business placed with a particular insurer, by a specific broker. Contingent Commissions are also used as form of compensation between insurance companies and their agents, and are commonly based on the overall loss performance of customers.

Due to the efforts of former Attorney General and Governor of New York, Eliot Spitzer, contingent commissions came under criticism based on the fact that they seemingly create a conflict-of-interest. Supposedly, the conflict-of-interest stems from the fact that insurance companies compete, among brokers, for fees paid to the broker and not on the price of the policy to the buyer. Therefore, the argument goes, a broker is thus influenced to recommend a particular insurance company based on the amount of the total commissions received rather than on the best policy for the customer.

Currently, there are no provisions of the Insurance Law that prohibit the payment of contingent commissions, and arguably there is no statutory authority for the new regulation. The only statutory provision that comes close is the catch-all section 2110 of the Insurance Law, which permits the superintendent of insurance to “refuse to renew, revoke, or . . . suspend for a period the superintendent determines the license of any insurance producer,… if, after notice and hearing, the superintendent determines that the licensee …has:

(4)(A) used fraudulent, coercive or dishonest practices; (B) demonstrated incompetence; (C) demonstrated untrustworthiness.”

NY CLS § 2110(a)(4) (2010). On August 25, 1998, the New York State Insurance Department released Circular Letter No. 22 in which the Department voiced its concern about an “alleged market development” that had recently come to its attention. The Circular Letter for the first time addressed the practice of brokers who receive undisclosed compensation from insurers, in addition to commissions, for placing business with an insurer, without disclosing this “additional compensation” to the insured. The Circular Letter required that:

• All compensation arrangements between an insurer and a broker should be reduced to writing;
• All such compensation arrangements should be disclosed to insureds prior to the purchase so as to enable insureds to understand the costs of coverage and the motivation of their broker in placing the business;
• All fees paid to brokers (and reasons for such fee payments) should be included in a broker file maintained by the insurer…

Beginning in 2004 the New York Attorney General’s office and the Insurance Department conducted a sweeping investigation of the brokerage industry in New York, focusing on the practice of contingent commissions. Ultimately law suits were filed against insurance giants Marsh & McLennan, Willis Group and Aon Corp and others in response to complaints of non-disclosure and reports of multiple compensation arrangements. The suits alleged that the defendant brokers steered clients to insurers with whom they had lucrative payoff agreements and that they solicited rigged bids for insurance contracts. Large insurance companies were also investigated and persuaded to change their compensation practices and disclosure policies. The lawsuits were ultimately settled with the defendants agreeing to pay large settlement amounts, and agreeing to adopt reforms banning contingent compensation, requiring them to accept only one payment for an insurance contract and to fully disclose such payments to customers.

Following the settlement agreements, the National Association of Insurance Commissioners (“NAIC”) amended its model law pertaining to brokers. The NAIC amended its Producer Licensing Model Act adding provisions requiring brokers to disclose the amount of compensation received from an insurer or third party. In 2005 the Connecticut legislature enacted Conn. Gen.Stat.§38a-707a, which closely mirrors the NAIC model law. At present fourteen states have adopted restrictions that are substantially similar to the Model Act, including California and Illinois.

In July and August 2008 the then Superintendent of Insurance Eric Dinallo and Attorney General Andrew Cuomo, conducted joint public hearings to obtain views of interested persons about proposed legislation addressing permissible forms of insurance producer compensation and disclosure in the insurance industry as a whole. No new legislation has been enacted in New York, and no legislative action appears likely to take place anytime soon.

To date, the Insurance Department’s Office of General Counsel (“OGC”) has issued at least three opinions concluding that neither the insurance law nor regulations promulgated thereunder require a broker to disclose to its clients the fixed commission it earns on the policies it places. (OGC opinions dated 8.30.05; 11.20.06; and 1.30.08, copies attached). Nevertheless, the new regulation was adopted in early 2010 and goes into effect on January 1, 2011. However, there have been efforts to challenge the propriety of the regulation.

On May 25, 2010 the Independent Insurance Agents and Brokers of New York representing 1,800 insurance agencies and their 18,000 employees and the Council of Insurance Brokers of Greater New York, representing independent insurance brokers in the New York City metropolitan area, filed an Article 78 proceeding in the Supreme Court of the State of New York, Albany County, New York seeking to overturn the regulation on the grounds that:

• The Department lacks statutory authority to issue the Regulation;
• The Regulation represents an impermissible attempt to rewrite the insurance law on a subject the Legislature has already specifically legislated and the Regulation ignores and contradicts the relevant statutory provisions enacted by the Legislature;
• Certain mandatory disclosure provisions impose great burdens and unwarranted costs of compliance so as to constitute an arbitrary exercise of regulatory power; and
• Certain mandatory provisions of the Regulation lack a rational basis so as to constitute a violation of the Due Process and Equal Protection Clauses of the Federal and State Constitutions.

The case is currently pending and it is unlikely that it will be decided before the new regulation takes effect next year. Nonetheless, it is clear that the new regulation will have one major impact, the introduction of greater bureaucracy into the system. The purported goal of the new regulation is to keep the insured fully informed about the different factors involved in the broker’s policy choice, but at what cost? Contingent compensations have been a constant and important part of the brokerage industry and it is unclear that they harm the interests of insureds. Requiring brokers to inform insureds of their potential commission fees if a policy is purchased, ultimately places the burden on the insured to determine whether the receipt of contingent fees affects the policies recommended by the brokers.

The new regulation will seemingly create additional layers of work for an insured, by forcing the insured to “broker shop” in an effort to compare contingent commissions and compensation arrangements. Though this may be lead to a more transparent regime, it also increases the “costs of doing business”. To that extent, the new regulation will merely frustrate a process that created little or no fuss prior to the Spitzer investigations.. In other words, simply because contingent commissions provide an important incentive for brokers, does not necessarily mean that they are bad for insureds. It appears that Spitzer’s efforts may have created smoke where there is no fire.