Insurance is a fact of life, and Illinois business owners must factor into the cost of doing business the price of insurance to cover the various risks associated with their commercial entities. As part of the ordeal of getting the right insurance at the right price, many business owners use the services of an independent insurance broker. Generally, an insurance broker will question or interview the proposed business insured to determine what types and amounts of coverage the business is seeking. The brokers are given confidential, proprietary and financial information so the broker can use that information to weed through the various insurance companies, products and premiums to select a policy that will best suit the consumer’s needs. The expectation is that the broker will find the desired coverage at the lowest possible price. Once a policy is selected, the insured consumer often issues a single payment to the broker. This single payment includes both the insurance company’s premium and the broker’s commission. The broker deducts its commission and forwards the premium to the insurance company.
A new twist in this course of practice was brought to public light in 2004 when several large independent insurance brokerage firms were caught taking additional "commissions" from the insurance companies behind their clients’ backs. These contingent commissions, or secret kickback commissions, were amounts in addition to the commissions already paid by the consumers as part of their premiums. Under the contingent commissions scheme, insurance companies provide additional commissions to brokers based upon a variety of factors, including aggregate amount of business referred to the insurance company by the broker or renewed by the insured and the loss-ration performance of the policies placed (i.e., having few, little or no claims).
Contingent Commissions and Large Independent Brokers. Aon and Marsh and McLennan Companies, Inc. were two of the largest insurance brokers1 who were taking contingent commissions. Back in October, 2004, former New York governor and then Attorney General Eliot Spitzer filed suit against Marsh2 for participating in the contingent commissions scheme. A little over a week later, the chairman and CEO of Chicago-based Aon, Patrick G. Ryan, announced that the insurance broker would eliminate the practice of accepting contingent commissions from insurance companies.3 Aon described contingent commissions as "non-service-specific, volume- or profit-based compensation arrangements," a practice that "developed over several decades as a means of compensating insurance intermediaries for services provided on behalf of insurers."4 Thereafter, the next two largest Illinois brokers, Willis and Gallagher, also agreed to stop "accepting" contingent commission types of payments. Following pressure from Illinois Attorney General Lisa Madigan and Illinois Department of Financial and Professional Regulation, Division of Insurance Director Michael McRaith, insurance companies such as Hartford, Zurich, ACE, Chubb, AIG and St. Paul Travelers have also agreed to reform practices and have ceased the practice of paying out undisclosed contingent commissions to its independent brokers.5
Why Prohibit Contingent Commissions? Taking undisclosed commissions creates an inherent conflict for an independent insurance broker. The independent broker represents itself to the consumer as an entity which will procure the best insurance alternative for the customer’s needs at the best possible price. Brokers are compensated for this by the commission they receive for the placement of policies. When commissions are disclosed up front, the consumer is able to make an informed decision. When the commissions are not disclosed, the consumer is deprived of a material piece of information it may have needed in questioning the selection and price of the policy before deciding whether to purchase it. Independent brokers are expected to act in the best interests of their customers. However, with undisclosed contingent commissions, the broker has an incentive to put its own pecuniary interest above that of it customer. This is especially true when brokers are given incentives to discourage their clients from filing claims. The largest independent brokers and insurance companies who have ceased the practice of accepting and offering contingent commissions, respectively, are now at a disadvantage in the marketplace to those who still engage in the practice. Like conduct should be treated equally by the agencies that regulate and the legal system that governs the licensed industry. Without like treatment, an avoidable disparity occurs within the marketplace. This has an effect not only on the competitors, but on the end consumer who pays the artificially inflated premium prices.
Illinois Law on the Fiduciary Duty of Independent Insurance Brokers. Illinois insurance brokers or insurance "producers" as defined by Illinois law, are persons "licensed under the laws of this State to sell, solicit, or negotiate insurance."6 As such, their conduct is regulated pursuant to the Illinois Insurance Code and Illinois Insurance Placement Liability Act.7 In 1996, the Illinois General Assembly acted to limit the exposure of insurance "producers" to common law claims of breach of fiduciary duty concerning the placement of insurance under certain circumstances. Under 735 ILCS 5/2-2201, the producer "shall exercise ordinary care and skill in renewing, procuring, binding or placing the coverage requested by the insured or proposed insured."8
Additionally, §2-2201 provides:
"(b) No cause of action brought by any person or entity against any insurance provider, registered firm, or limited insurance representative concerning the sale, placement, procurement, renewal, binding, cancellation of, or failure to procure any policy of insurance shall subject the insurance producer, registered firm, or limited insurance representative to civil liability under standards governing the conduct of a fiduciary or fiduciary relationship. . . "
Producers have argued that this language takes them entirely out of the realm of a fiduciary relationship with its consumer and therefore no longer subject to the standards of a fiduciary or a fiduciary relationship where ordinary care and skill in procuring the policy is exercised. What that broad stroke argument fails to recognize are the exceptions to that safety net. Specifically, it ignores the rest of paragraph (b):
". . . except when the conduct upon which the cause of action is based involves the wrongful retention or misappropriation by the insurance producer, registered firm, or limited insurance representative of any money that was received as premiums, as a premium deposit, or as payment of a claim."9
The Insurance Code also states:
"Any money that an insurance producer. . . receives for soliciting, negotiating, effecting, procuring, renewing, continuing or binding policies of insurance shall be held in a fiduciary capacity. . . 10
As contemplated by the General Assembly, the § 2-2201 legislation was intended to limit the exposure of independent insurance brokers, not completely eliminate it. In addressing his colleagues before the amended Senate Bill 1279 was passed, Senator Michael Madigan explained that the legislation would "limit the liability of insurance agents in non-fiduciary relationships with their customers. It would retain the language that would govern them when they are in a fiduciary relationship with their consumer."11
Illinois Courts on Contingent Commissions and Fiduciary Duty. In March, 2005 a class action lawsuit was filed against Mesirow Insurance Services, Inc. in the Chancery Division of the Circuit Court of Cook County, Illinois12 seeking damages from the contingent commissions that were accepted by Mesirow and other unknown brokers on behalf of business insurance customers who bought insurance policies through Mesirow. One of the bases for which relief was sought was for breach of fiduciary duty owed by the independent brokers to their business insurance customers. The Circuit court dismissed the claim and the case was appealed.13 The plaintiff made its assertion of fiduciary duty under the exception language of § 2-2201, in sum, arguing that the actions of the broker when placing the policies and accepting the payment of premiums for those policies under the contingent commission scheme amounted to the wrongful retention or misappropriation of those premiums.14
The Illinois Courts recognize that even with the passage of § 2-2201 the relationship between an insurance broker and its insured consumer continues to be a fiduciary one.15 In its opinion, the Appellate Court spent six of the 19 pages discussing and considering the law and the acts by which an independent insurance broker, like Mesirow, would subject the broker to civil liability for breach of fiduciary duty under the Illinois Insurance Code and Illinois Insurance Placement Liability Act.16
Illinois Courts and § 2-2201. When the Illinois Appellate Court considered Mesirow, it noted that neither party, nor the court itself, had found any cases explaining what constitutes "wrongful retention or misappropriation."17 It found that while some cases may be instructive as to how the Illinois courts have interpreted misappropriation, Mesirow’s case presented a whole different set of facts.18 The Appellate Court held that "a producer misappropriates premiums within the terms of § 2-2201 when it directs a premium to an insurer, the price or coverage is not in the customer’s best interest, and the placement earns the producer undisclosed contingent incentives."19 It also found that "§ 2-2201 of the Code does not preclude plaintiff’s claim for breach of fiduciary duty, because plaintiff comes within the exception in § 2-2201(b) by alleging in its complaint that defendant misappropriated certain premiums by placing them with an insurer when the placement was not in the best interest of the consumer."20
Based upon the Appellate Court’s decision it appears that business insurance consumers still retain a right of private action against independent insurance brokers under the theory of fiduciary duty under the exception language of § 2-2201(b) and that when the actions alleged amount to a wrongful retention or misappropriation of premiums paid, there is a breach of that fiduciary duty.
What is Disclosure? In order to be effective, and give any meaning at all to giving the consumer the information material to making an informed decision, a disclosure has to be more than small print on a website. It has to be more than just page 15 of a 20-page policy. It needs to be made in plain and conspicuous language. A definition of the contingent commission and an explanation of how the broker is compensated should be included, as well as a reference to the regulation of insurance producers/brokers by the Illinois Department of Financial and Professional Regulation. It must be specific to the transaction occurring between the broker and its customer. It needs to identify what specific insurance products are the subject of the contingent commission and under what circumstances and by what criteria and measure the brokers receive contingent commissions. It also needs to detail the amount the broker stands to earn with the placement of the policy or renewal in both the standard commission and any contingent commission. If the broker is to be given incentives to discourage claims, and will not be the insured’s agent in that capacity, that must also be disclosed. One of the most important things in a disclosure is to have the person to whom the disclosures are being made sign an acknowledgment of the disclosure.
Conclusion. All independent insurance producers should stop taking undisclosed contingent commissions. Not only can such conduct be deemed to be a breach of their fiduciary duties to their customers, but it has an adverse effect upon a fair competition in an open marketplace. To continue to allow any independent insurance broker to accept contingent commissions without a conspicuous, written disclosure, signed by the individual consumer who is paying for the policy, deprives that consumer of a material fact needed to make an informed purchasing decision. The "product" these business owner consumers are buying when they choose to write that check to the insurance broker is much more far-reaching than many other purchases they may make that day. Insurance policies are purchased in the hopes that they will protect commercial entities from all the risks of loss that could potential put them out of business. Any undisclosed contingent fee commissions put insurance brokers in adverse positions to their consumer insureds. The brokers are given access to confidential and proprietary information and assume a fiduciary relationship with the consumer. When contingent commissions are based on how many policies are being placed, renewals, and number and amounts of claims, it immediately puts their profitability at odds with their fiduciaries’. To know that the broker is placing the policies with all commissions disclosed upfront is material for the consumer to make an informed decision as to why one insurance policy product or insurance company was recommended over another. It leaves pricing up to the competition within a more open marketplace. Within the marketplace, the effect of treating like conduct differently is to create an arbitrary discrepancy in the marketplace. There is no logical reason to allow one broker to continue to accept undisclosed contingent commissions while forbidding its competitor to engage in the same conduct. It gives an unfair advantage over the brokers that no longer accept contingent commissions and the insurance companies that no longer offer them. If independent insurance brokers are to retain their clients’ trust (and business), they need to reexamine the risks they take in accepting contingent commissions and conducting "business as usual."
1 Adding Arthur J Gallagher & Co. and Willis Group Holdings Ltd. to the list, the top four largest insurance producers in the United States settled claims and agreed to stop the practice of accepting contingent commissions.
2Complaint, Spitzer v. Marsh & McLennan Cos. Inc. and Marsh Inc.(No. 04-403342)
3 Press Release, Aon Corporation, Aon Eliminates Contingent Commissions; CEO Calls for New Approach (Oct. 22 2004)(on file with author).
4 Press Release, Aon Corp.
5 Press Release, Illinois Attorney General, Settlement Reached with Illinois Insurance Company Zurich; Investigation Uncovered Unlawful Bid-Rigging Scheme (March 27, 2006); Press Release, Illinois Attorney General, Settlement Reached with Insurance Company Ace; Investigation Uncovered Unlawful Bid-Rigging Scheme, Illinois to Receive $8 Million Payment (April 26, 2006); Press Release, Illinois Attorney General, Settlement Agreement Calls for Certain Contingent Insurance Commissions to Cease January 1, 2007 (November 30, 2006). Press Releases refer to AIG’s settlement as a result of pressure from the State of New York and December 21, 2006.
6 Illinois Insurance Code, 215 ILCS 5/500-10(West 2004). In Illinois there remains a distinction between insurance agents (who are primarily employees of the insurance companies) and "brokers" (who are independent), but for regulatory purposes both are referred to as "producers").
7 Illinois Insurance Code, 215 ILCS 5/500 (West 2004).
8 Illinois Insurance Code, 735 ILCS 5/2-2201 (West 2004).
9 Illinois Insurance Code, 735 ILCS 5/2-2201 (West 2004).
10 Illinois Insurance Code, 215 ILCS 5/500-115(a) (West 2004).
11 S.B. 1279, 89th Gen. Assem., Reg. Sess. (Il. March 27, 1996) (statement of Illinois Senator Michael Madigan).
12 DOD Technologies, Inc. v. Mesirow Ins. Serv., Inc., No. 05 CH 04677 (2008) [case is not yet final]. This suit followed a lawsuit against Aon which was filed in the Circuit Court of Cook County in 1999 (Daniel v. Aon Corp., No. 99 CH 11893 ) and certified as a class action in July, 2004 by Judge Julia Nowicki.
13 DOD Technologies, No. 06-3300 WL 432444.
14 DOD Technologies, No. 06-3300 WL 432444 at *7.
15 DOD Technologies, No. 06-3300 WL 432444 at *6
16 DOD Technologies, No. 06-3300 WL 432444 at *4-10.
17 DOD Technologies, No. 06-3300 WL 432444 at *7.
18 DOD Technologies, No. 06-3300 WL 432444 at *8.
19 DOD Technologies, No. 06-3300 WL 432444 at *9-10.
20 DOD Technologies, No. 06-3300 WL 432444 at *10.
David S. Klevatt, Klevatt & Associates, LLC, Principal. University of Colorado, Boulder, Colorado, B.S. Finance, 1984 DePaul University School of Law, Chicago, Illinois, J.D. 1988
Laura Parry, Attorney/Manager, Klevatt & Associates, LLC; Indiana University, Bloomington, Indiana, B.A. 1985 Chicago-Kent College of Law, Chicago, Illinois, J.D. 1994
Klevatt & Associates, LLC provides professional, personal counsel to clients in business law, business transactions, insurance and reinsurance law and coverage, business formation and general counsel, commercial receivables, commercial contracts, commercial/residential real estate, employment law, trademark prosecution and enforcement and in civil litigation, arbitration, mediation, trial and appeal.