[Senate Hearing 108-736]
[From the U.S. Government Publishing Office]



                                                        S. Hrg. 108-736

OVERSIGHT HEARING ON INSURANCE BROKERAGE PRACTICES, INCLUDING POTENTIAL 
   CONFLICTS OF INTEREST AND THE ADEQUACY OF THE CURRENT REGULATORY 
                               FRAMEWORK

=======================================================================

                                HEARING

                               before the

     FINANCIAL MANAGEMENT, THE BUDGET, AND INTERNATIONAL SECURITY 
                              SUBCOMMITTEE

                                 of the

                              COMMITTEE ON
                          GOVERNMENTAL AFFAIRS
                          UNITED STATES SENATE


                      ONE HUNDRED EIGHTH CONGRESS

                             SECOND SESSION

                               __________

                           NOVEMBER 16, 2004

                               __________

      Printed for the use of the Committee on Governmental Affairs



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                   COMMITTEE ON GOVERNMENTAL AFFAIRS

                   SUSAN M. COLLINS, Maine, Chairman
TED STEVENS, Alaska                  JOSEPH I. LIEBERMAN, Connecticut
GEORGE V. VOINOVICH, Ohio            CARL LEVIN, Michigan
NORM COLEMAN, Minnesota              DANIEL K. AKAKA, Hawaii
ARLEN SPECTER, Pennsylvania          RICHARD J. DURBIN, Illinois
ROBERT F. BENNETT, Utah              THOMAS R. CARPER, Delaware
PETER G. FITZGERALD, Illinois        MARK DAYTON, Minnesota
JOHN E. SUNUNU, New Hampshire        FRANK LAUTENBERG, New Jersey
RICHARD C. SHELBY, Alabama           MARK PRYOR, Arkansas

           Michael D. Bopp, Staff Director and Chief Counsel
      Joyce A. Rechtschaffen, Minority Staff Director and Counsel
                      Amy B. Newhouse, Chief Clerk

                                 ------                                

     FINANCIAL MANAGEMENT, THE BUDGET, AND INTERNATIONAL SECURITY 
                              SUBCOMMITTEE

                PETER G. FITZGERALD, Illinois, Chairman
TED STEVENS, Alaska                  DANIEL K. AKAKA, Hawaii
GEORGE V. VOINOVICH, Ohio            CARL LEVIN, Michigan
ARLEN SPECTER, Pennsylvania          THOMAS R. CARPER, Delaware
ROBERT F. BENNETT, Utah              MARK DAYTON, Minnesota
JOHN E. SUNUNU, New Hampshire        FRANK LAUTENBERG, New Jersey
RICHARD C. SHELBY, Alabama           MARK PRYOR, Arkansas

                   Michael J. Russell, Staff Director
              Richard J. Kessler, Minority Staff Director
            Nanci E. Langley, Minority Deputy Staff Director
                       Tara E. Baird, Chief Clerk


                            C O N T E N T S

                                 ------                                
Opening statements:
                                                                   Page
    Senator Fitzgerald...........................................     1
    Senator Akaka................................................    24
    Senator Carper...............................................    25

                               WITNESSES
                       Tuesday, November 16, 2004

Hon. Eliot L. Spitzer, Attorney General, State of New York.......     5
Hon. Richard Blumenthal, Attorney General, State of Connecticut..     8
Hon. Gregory V. Serio, Superintendent of Insurance, State of New 
  York, on behalf of the National Association of Insurance 
  Commissioners..................................................     9
Hon. John Garamendi, Insurance Commissioner, State of California.    12
Albert R. Counselman, President and Chief Executive Officer, 
  Riggs, Counselman, Michaels and Downes, Inc., on behalf of the 
  Council of Insurance Agents and Brokers........................    30
Alex Soto, President, InSource, Inc., on behalf of the 
  Independent Insurance Agents and Brokers of America............    32
Ernst N. Csiszar, President and Chief Executive Officer, Property 
  Casualty Insurers Association of America.......................    34
Janice Ochenkowski, Senior Vice President, Risk Management, Jones 
  Lang LaSalle, and Vice President for External Affairs, Risk and 
  Insurance Management Society...................................    36
J. Robert Hunter, Director of Insurance, Consumer Federation of 
  America........................................................    38

                     Alphabetical List of Witnesses

Blumenthal, Hon. Richard:
    Testimony....................................................     8
    Prepared statement...........................................    72
Counselman, Albert R.:
    Testimony....................................................    30
    Prepared statement...........................................    96
Csiszar, Ernst N.:
    Testimony....................................................    34
    Prepared statement...........................................   115
Garamendi, Hon. John:
    Testimony....................................................    12
    Prepared statement...........................................    92
Hunter, J. Robert:
    Testimony....................................................    38
    Prepared statement...........................................   130
Ochenkowski, Janice:
    Testimony....................................................    36
    Prepared statement...........................................   123
Serio, Hon. Gregory V.:
    Testimony....................................................     9
    Prepared statement...........................................    77
Soto, Alex:
    Testimony....................................................    32
    Prepared statement...........................................   107
Spitzer, Hon. Eliot L.:
    Testimony....................................................     5
    Prepared statement...........................................    55

                                APPENDIX

American Insurance Association, prepared statement...............   148
The Insurance Marketplace Standards Association (IMSA), prepared 
  statement......................................................   150
The National Associaiton of Professional Insurance Agents, 
  prepared statement.............................................   153

 
                     OVERSIGHT HEARING ON INSURANCE
                     BROKERAGE PRACTICES, INCLUDING
                    POTENTIAL CONFLICTS OF INTEREST
                    AND THE ADEQUACY OF THE CURRENT
                          REGULATORY FRAMEWORK

                              ----------                              


                       TUESDAY, NOVEMBER 16, 2004

                                     U.S. Senate,  
                  Subcommittee on Financial Management,    
                  the Budget, and International Security,  
                  of the Committee on Governmental Affairs,
                                                    Washington, DC.
    The Subcommittee met, pursuant to notice, at 10:32 a.m., in 
room SD-342, Dirksen Senate Office Building, Hon. Peter G. 
Fitzgerald, Chairman of the Subcommittee, presiding.
    Present: Senators Fitzgerald, Akaka, and Carper.

            OPENING STATEMENT OF SENATOR FITZGERALD

    Senator Fitzgerald. This meeting will come to order. I 
would like to advise the panelists and the audience that the 
Democratic Senate Caucus has just called a meeting at 10:30 and 
so Senator Akaka will be somewhat delayed, but he intends to 
come here later.
    Today, I conduct my final oversight hearing as a U.S. 
Senator and the hearing is on the growing controversy 
surrounding insurance brokerage practices and the impact of 
these practices on the consumer. I would like to welcome the 
distinguished witnesses we have with us today and thank them 
for taking the time out of their busy schedules to share their 
perspectives.
    Today, we consider allegations that some insurance brokers 
hired and paid by their clients to represent them in procuring 
insurance suited to their needs have instead steered their 
clients to the insurers who are paying so-called contingent 
commissions, that is, commissions above and beyond their direct 
commissions that are based on volume or profitability of 
insurance business. In some cases, according to Attorney 
General Eliot Spitzer's lawsuit and the guilty pleas of certain 
broker executives, some broker employees have apparently even 
engaged in criminal bid rigging and price fixing. Everyone 
inside and outside the insurance industry condemns the criminal 
conduct and calls for its vigorous prosecution and punishment.
    This oversight hearing breaks no new or interesting ground 
with respect to criminal bid rigging or price fixing. We do, 
however, critically examine the compensation structure of 
insurance brokerage and we ask whether that structure poses 
unacceptable conflicts of interest and whether our current 
regulatory system is equipped to tackle that question with due 
regard for both free and fair markets.
    My study of this insurance brokerage controversy convinces 
me that there is a Federal role, the time-honored Federal role 
that guarantees competition and fights the mischief of undue 
market concentration.
    Contingent commission arrangements have been common and 
legal for decades. I believe it is no coincidence that the 
controversy of these compensation arrangements tracks the 
increasing consolidation of the brokerage market, especially 
the market for large corporate buyers. I believe it is no 
coincidence that Attorney General Spitzer first sued the 
largest market player in insurance brokerage, and I believe it 
is no coincidence that when Attorney General Spitzer first 
investigated contingent commissions pursuant to his powers 
under New York's Donnelly and Martin Acts, he appears to have 
discovered anti-competitive and even criminal abuses 
orchestrated not just by any random insurance broker, but by an 
insurance broker that controlled 40 percent of its target 
market.
    By itself, an ordinary contingent commission seems unlikely 
to harm consumers or competition. Indeed, a broker who favored 
an inferior insurer merely because that insurer paid contingent 
commissions would quickly find itself swamped by competitors 
eager to provide a superior service to the broker's ill-served 
clients.
    But that, of course, presupposes competition. What if 
insurance buyers with global insurance needs had little choice 
in selecting a broker? And what if insurers seeking global 
expansion of their business had little choice in accommodating 
a broker? In short, what if one or two global insurance brokers 
constituted a market bottleneck?
    On the face of it, contingent commissions raise the specter 
of a conflict of interest. In any given instance of advising a 
client to purchase insurance from a particular insurer, has the 
broker provided that advice because it is in the best interest 
of its client or because the broker will be better compensated 
by this particular insurer under a contingent commission 
arrangement?
    I believe it is mistaken, however, to look at contingent 
commission agreements in the abstract and draw sweeping 
conclusions from what first appears to be a misdirected 
incentive. Sales forces in many healthy, competitive industries 
enjoy incentive compensation or some form of profit sharing. 
The operative question should not be, could an unscrupulous 
broker theoretically steer business to an insurer despite the 
interest of its client and based on self-interest alone? The 
operative question should be, could a broker or a dominant 
group of brokers consistently get away with steering business 
to an insurer despite the interest of its client and based on 
self-interest alone?
    If we answer the former question yes, then we have a breach 
of contract or perhaps a tort claim. If we answer the latter 
question yes, then we have a failure of competition. For 
failures of competition, our soundest antidote is antitrust 
law.
    For nearly 60 years, since enactment of the McCarran-
Ferguson Act of 1945, regulation of the business of insurance 
has been delegated entirely to the States. The system of State 
regulation has worked well for many purposes, but State 
regulation purporting to govern global conduct may not always 
perfectly detect the abuses of daunting market power.
    I believe it is time for Congress to revisit the antitrust 
exemption of the McCarran-Ferguson Act with respect to 
insurance brokerage and to make clear that vigorous Federal 
antitrust enforcement can and will reach the kind of anti-
competitive conduct on the part of insurance brokers alleged in 
Attorney General Spitzer's lawsuit.
    Furthermore, I see no continuing reason to shackle the 
Federal Trade Commission with an antiquated prohibition on even 
the mere study of the insurance industry. Until 1980, the 
Federal Trade Commission was empowered to study the industry 
and make policy recommendations. That year, Congress took away 
even that modest authority. The FTC enforces antitrust laws, 
among other charges. Declaring the FTC categorically unsuited 
even to peer at the insurance industry ignores the reality of 
national, indeed global, insurance markets, increasing 
consolidation in some market segments, and surges of 
centralized coercion that may not readily appear on the 
regulatory radar of any single State.
    If we profess to favor free markets and robust competition, 
then we must equally favor their civilizing predicates, 
antitrust law and transparency. Healthy markets thrive on 
sunshine, and it has certainly been said of these contingent 
commission arrangements in insurance brokerage that disclosure 
is woefully inadequate.
    We hear numerous calls for better disclosure of these 
compensation arrangements. But I will be especially interested 
in hearing from the witnesses exactly what form they propose 
for this better disclosure, and more fundamentally, whether 
disclosure alone is adequate to counter market concentration. 
Put another way, for those witnesses who promote greater 
disclosure as an adequate fix for this brokerage controversy, 
would you likewise support vigorous enforcement of Federal 
antitrust law to counter the leveraging of market domination?
    I believe that transparency is an important and salutary 
measure. Depending on its form and content, it may be more than 
we need in markets that are competitive. But in markets that 
are not competitive, mere disclosure of a practice that a 
dominant company can demand may not be enough.
    This oversight hearing occurs at an interesting time, not 
only because certain insurance brokerage practices have come 
under fire, but because Congress is increasingly focused on 
insurance reform. I will be interested in hearing the views of 
the witnesses as to whether they believe that this brokerage 
controversy lends more or less support to the optional Federal 
charter proposal, which would put insurance companies on a 
footing similar to banks in the ability to choose either State 
or Federal regulation.
    And I will be interested in hearing the views of the 
witnesses as to whether this brokerage controversy lends more 
or less support to the proposal developed by the leadership of 
the House Financial Services Committee, the State Modernization 
and Regulatory Transparency Act, or SMART Act, a draft of which 
has been circulated by Chairman Oxley and Capital Markets 
Subcommittee Chairman Baker. The House Financial Services 
Committee has conducted 16 hearings on insurance reform since 
the Committee's organization in January 2001 and I applaud the 
hard work of Chairman Oxley and Congressman Baker in this area.
    At this point, I will save my introduction of Senator Akaka 
for later when he arrives and I would like to proceed directly 
to our first panel of witnesses.
    Our first witness is the Hon. Eliot L. Spitzer, the 63rd 
Attorney General for the State of New York. Mr. Spitzer 
testified previously before this Subcommittee on mutual fund 
reform and we welcome you back here today. By the way, after 
you testified here, some of the larger mutual fund complexes, 
as you may have noticed, lowered their fees, at least on 
indexed funds, sometimes by four to five times, so 
congratulations. I think you had a significant effect that went 
well beyond your complaints.
    On October 14, 2004, Attorney General Spitzer filed a civil 
suit against Marsh and McLennan Companies for alleged violation 
of State law regarding the companies' compensation 
arrangements. That same day, he also filed criminal actions 
against specific individuals in the insurance brokerage 
industry. Last Friday, November 12, Attorney General Spitzer 
filed a second civil suit against a California broker, 
Universal Life Resources, alleging that Universal accepted so-
called override fees from insurers to steer business to them.
    Our second witness is the Hon. Richard Blumenthal, Attorney 
General for the State of Connecticut. Attorney General 
Blumenthal has launched an investigation into insurance broker 
commissions and is seeking new State laws in this area. He was 
first elected to serve as Connecticut's 23rd Attorney General 
in 1990 and is currently serving an unprecedented fourth term. 
Prior to being elected Attorney General, Mr. Blumenthal served 
in both the Connecticut State Senate and the House of 
Representatives. Mr. Blumenthal also served as U.S. Attorney 
for Connecticut from 1977 to 1981.
    Our third witness is the Hon. Gregory Serio, Superintendent 
of Insurance for the State of New York. He is here today to 
represent the National Association of Insurance Commissioners, 
known as NAIC. As New York Superintendent of Insurance, Mr. 
Serio is responsible for the monitoring and regulation of more 
than 1,000 insurance companies, with total assets exceeding $2 
trillion. Mr. Serio previously served as First Deputy 
Superintendent and General Counsel of the New York Insurance 
Department and is Chief Counsel to the New York Senate Standing 
Committee on Insurance.
    Our fourth witness is the Hon. John Garamendi, Insurance 
Commissioner for the State of California. Mr. Garamendi was 
first elected as Insurance Commissioner in 1991. He 
successfully implemented Proposition 103, which put into place 
a major reform of the auto and homeowners' insurance industry 
in California. In 1995, President Clinton appointed Mr. 
Garamendi as Deputy Secretary at the U.S. Department of the 
Interior. He was elected to a second term--I guess you came 
back and were elected to a second term as California's 
Insurance Commissioner in 2003, and last month, he proposed 
regulations that would require disclosure of certain financial 
incentives received by insurance agents and brokers.
    Again, I would like to thank you for being here to testify. 
Mr. Garamendi traveled for 5 hours to get here, all the way 
from the Golden State, and we know it takes a lot of time to 
come to Washington to testify. We appreciate it.
    In the interest of time, we will include your full 
statements in the record and we would appreciate it if you 
could limit your opening remarks to 5 minutes. We will have a 
light that is at your table that will kind of keep track of the 
time.
    Attorney General Spitzer, welcome again to the 
Subcommittee. We really appreciate your help and I compliment 
you on the outstanding job you have been doing. You have been 
breaking new ground in many different areas and I admire your 
courage and tenacity. So thank you for coming before us.

TESTIMONY OF HON. ELIOT L. SPITZER,\1\ ATTORNEY GENERAL, STATE 
                          OF NEW YORK

    Mr. Spitzer. Mr. Chairman, thank you very much for your 
kind words, and in particular, thank you for your leadership on 
these issues. They have not always been easy issues, but you 
have played a unique role in leading Senate inquiries into 
critically important areas in the financial services sector and 
I am tempted just to adopt your statement as my statement and 
then leave it at that. It was right on point, in particular 
your statements about McCarran-Ferguson, the FTC, and the need 
for Congressional inquiry. I will get there in a moment.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Spitzer appears in the Appendix 
on page 55.
---------------------------------------------------------------------------
    To quote but amend Yogi Berra, this is deja vu all over 
again one more time. This is the third time we have seen the 
same story. We saw it with analysts at the investment banks. We 
saw it with mutual funds. Now we see it with the insurance 
industry. There are common elements to each of these three 
stories and I will very quickly run through them.
    In each instance, we have seen the financial services 
sector incapable of resisting a conflict of interest. In every 
instance, it has capitalized on that to the detriment of those 
to whom it owed a duty of care. Indeed, at one point, we all 
know the famous comment from one Wall Street analyst who said 
what used to be viewed as a conflict of interest is now viewed 
as a synergy and they simply do not understand the difference.
    Second, in each instance, each of these three story lines, 
there has been an abject failure of self-regulation. Nobody 
came forward to say there is a problem, there is an issue with 
respect to steering, bid rigging, conflict of interest that run 
deep in the industry, just as nobody came forward with analysts 
or mutual fund scandals.
    Third, there has been a failure of the regulatory entities 
that are supposed to oversee the sector. They failed to ask 
even obvious questions that would have revealed deep-seated 
problems.
    Fourth, we have had continuing claims of purity and 
excessive regulation, and indeed claims of intense competition 
from industry leaders up until the point that the allegations 
were leveled.
    And finally, we had dramatic mea culpas only once they were 
caught.
    This is a story line which would be tiresome and grow 
wearisome over time. Indeed, we have seen it in other sectors, 
as well, most notably the pharmaceutical sector, but since we 
are here to discuss financial services, I will not verge into 
that.
    Let me describe very quickly the sequence of our--the 
progression of our inquiry, and it began with simply a letter 
which notified us that there were PSAs, MSAs, contingent fees 
which are, as you said, Mr. Chairman, not in and of themselves 
improper. But given the magnitude of these fees, we simply made 
an open-ended inquiry to Marsh and McLennan and asked them, how 
do you ensure that these fees do not taint the decisionmaking 
that you endeavor to make on behalf of your clients?
    We were told two things. First, there is adequate 
disclosure. And second, there is no information flow within the 
company such that the front-line brokers who were making the 
decisions about what products to recommend don't even know what 
the contingent fees are, and therefore, we were told, they 
cannot be influenced.
    We learned very quickly that the claim of adequate 
disclosure was simply false. The disclosures that are made are 
not only grossly inadequate, they are often misleading, and 
indeed the companies, and I say that plural, intentionally make 
it difficult for their clients to find out what MSAs, PSAs, or 
overrides are paid because they do not want that information to 
be made available.
    We went back to the company and said, give us more 
information. They said, well, nonetheless, even if the 
disclosure is not adequate, there is no information flow, and, 
of course, we found out very quickly not only was it impossible 
to cabin information relating to an $800 million revenue flow 
within the company, but there were specific instructions to the 
brokers to steer business based upon the magnitude and the 
relative value of the override payments and contingencies.
    We dug even further and we were told by the company in 
response, well, maybe there is steering, but there is no 
steering to detriment, a comment that seems blatantly 
contradictory on its face. If you are steering, it is 
necessarily steering to detriment. We then said to them, how 
can that be, and they said, well, only if there are identical 
proposals for an individual client would we choose based upon 
the MSA, and we said that is somewhat ridiculous, and indeed it 
is.
    We then dug further, asking the last logical question, 
because, of course, if I have a fiduciary duty to a client, I 
don't want that client to see different bids in the file and to 
have the client see that I am not picking the best bid. So 
necessarily, then, you begin to act in a way to ensure that 
only the bids you want end up in the file. And so we inquired 
of the carriers, do you have any information for us that would 
indicate bid rigging in the system? Forty-eight hours after we 
served that interrogatory on the carriers, lo and behold, our 
phone started ringing and we were the recipients of remarkable 
information about the bid rigging scandal that we have seen as 
a consequence.
    There is liability that extends to brokers. There is 
liability that extends to carriers, civil and criminal. As you 
said, there have been criminal pleas entered. There will be 
more criminal pleas entered very shortly, perhaps as early as 
today, from another carrier. That is ongoing as we speak. And 
we are finding undisclosed relationships that clients simply 
would be appalled to understand if they had ever been told.
    The impact on our markets is enormous. The insurance sector 
is vast. The numbers are laid out in my testimony. And it has 
indeed become part of our political discourse over the past few 
years that the impact of rising premiums has been a tremendous 
drain and disincentive for the creativity of our capital 
markets and businesses in general.
    Unfortunately, we have not heard that one of the reasons 
the premiums have been rising has been the collusive behavior, 
illegal behavior, of brokers and carriers, behavior that they 
understood that they simply refused to detail to the public.
    Let me say, Mr. Chairman, I think there are four discrete 
areas where Congressional inquiry would be terribly useful, 
inquiry that is necessary for Congress to undertake, because 
frankly, I think only Congress has the capacity to reach the 
subpoena power to really delve fully into the breadth and scope 
of the issues before us. With all due respect to my fellow 
regulators at the State level who have done, in many ways, a 
very good job, these are issues that Congress must begin to 
inquire into.
    The first area relates to the massive insurance capital 
flow to offshore vendors. Why is it that suddenly Bermuda is 
the home to so many insurance carriers, reinsurance carriers, 
brokers? Why have we seen such massive capital outflow from the 
United States, where there is regulatory authority for the 
States to exercise, to venues where the insurance carriers, the 
reinsurance carriers, and the brokers intentionally secrete 
themselves in ways and in areas that we cannot inquire into? 
There is, I would suspect, a Pandora's box that should be 
opened so we can understand what is going on in these offshore 
venues. It will not be a pretty picture.
    Second, we need to scrutinize the wide-ranging interlocking 
relationships that have been revealed just from our superficial 
inquiry among brokers, insurance carriers, reinsurance 
carriers, reinsurance brokers. There is a multi-layered stream 
of income that flows to these companies, often with common 
ownership, that is simply not understood, that is not revealed, 
that has every indication of being corrupt and anti-
competitive. It is an ugly picture.
    Third, how are premiums being set? We hear much that is 
said about their huge losses. We see premiums spike. But I 
don't think we really understand the true finances of these 
companies. Part of the reason is they have secreted assets 
overseas. They have hidden them offshore. It is about time that 
we get accountability. The only way is to delve into, in a much 
more serious way than has ever been done, the way they set 
their fees.
    Finally and fourth, I would suggest that there should be a 
fundamental inquiry into the ethics of an industry that needs 
to be fundamentally scrutinized. Just as has been the case with 
every other scandal that has come before us, the failure of 
this industry at any point to put up its hand and say, we have 
a problem, their willing, rapid descent to the lowest common 
denominator of behavior that is criminal, violates common 
decency, is appalling. This is an industry that has for years 
claimed purity. Once again, we are seeing that the more 
profound their claims of purity, the more profound the heinous 
behavior we find. Thank you very much.
    Senator Fitzgerald. Thank you, Mr. Spitzer. Mr. Blumenthal.

  TESTIMONY OF HON. RICHARD BLUMENTHAL,\1\ ATTORNEY GENERAL, 
                      STATE OF CONNECTICUT

    Mr. Blumenthal. Thank you, Mr. Chairman. I would like to 
join General Spitzer in thanking you for your leadership, your 
courage, and your tenacity as a leader of this Subcommittee and 
I am chagrined to hear that we are at your last hearing, but I 
hope it is a meaningful one and I know that your leadership 
will be much appreciated in this body.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Blumenthal appears in the 
Appendix on page 72.
---------------------------------------------------------------------------
    I would like to thank my fellow panelists, most 
particularly General Spitzer for his leadership in this area. 
Each of them has played a role and I am honored to be with them 
on this panel.
    In Connecticut, we have an investigation that is separate 
and distinct, has involved some 43 subpoenas beginning in 
October. Even earlier, we issued letters of inquiry. The scale 
and magnitude of corrupt practices and unethical conduct 
continue to mount. Increasing evidence of those practices 
certainly means that fundamental reform is necessary, more than 
simply disclosure, as you quite rightly suggest.
    The evidence of illegal and harmful conduct, harmful not 
just to individual consumers but to our entire economy, 
mandates that we act decisively and dramatically to restore the 
credibility and trust in this industry and in the regulators 
who have a responsibility to oversee and scrutinize it. What we 
have seen in our investigation is evidence of bid rigging, 
fraudulent concealed commissions, secret payoffs, and conflicts 
of interest, all stifling competition and inflating the cost to 
consumers as well as businesses.
    There will be a barrage of well-aimed, powerful State 
enforcement actions. They will involve more than one State. We 
are now seeing a multi-State response to this crisis, and even 
as we speak, there is communication and growing cooperation 
among those States to address this problem.
    Our aim is to pursue these actions promptly and 
aggressively, not to be diverted by any voluntary changes on 
the part of the industry, but uncover all the wrongdoing and 
recover ill-gotten gains for consumers. Restitution is a vital 
objective.
    But reform is also an important goal and I want to be very 
straightforward with this Subcommittee. I welcome the idea of 
changing Federal antitrust laws so as to enable and encourage 
Federal enforcers to play a greater role and I welcome the 
inquiry that the Congress may make in regard to the areas that 
have been concealed. But I would strongly resist, indeed, the 
States will fiercely fight, any effort to preempt them or 
supplant them or prevent them from protecting their consumers. 
Antitrust has been traditionally a strong and vital role for 
the States. Consumer protection in the insurance industry has 
been traditionally and historically a State responsibility. And 
so while we may fervently hope for cooperation, we would 
fiercely fight any preemption.
    On the other hand, while federalizing the problem is not a 
solution, States must reform their own houses and stronger 
State laws are necessary. I want to commend Insurance 
Commissioner Garamendi for his leadership in this area, and my 
testimony sets forth some very specific proposals that go 
beyond disclosure, although they focus also on disclosure, full 
and complete disclosure, when a broker, for example, is 
compensated by both the insured and the insurer.
    I believe there must be consumer choice to have a broker 
represent him exclusively. There must be a code of ethics that 
is binding. There must be other reforms that mandate better 
practices, forbid conflicts of interest and provide the 
policing and resource authority that is necessary.
    So I think that State insurance laws must be reinvigorated 
and reinvented so that they are real agents of reform and 
insurance commissioners cease to be captives of the industry as 
they have been all too often in the history of insurance 
regulation.
    Federalizing the problem may not be a solution, but the 
States must do a better job in protecting consumers. I welcome 
this opportunity and hope that it is the beginning of a 
constructive dialogue between the States and the Congress on 
this subject. Thank you very much.
    Senator Fitzgerald. Thank you, Mr. Blumenthal. Mr. Serio.

   TESTIMONY OF HON. GREGORY V. SERIO,\1\ SUPERINTENDENT OF 
    INSURANCE, STATE OF NEW YORK, ON BEHALF OF THE NATIONAL 
             ASSOCIATION OF INSURANCE COMMISSIONERS

    Mr. Serio. Mr. Chairman, thank you. The events of the past 
month have shone a bright and rather unflattering light upon 
the insurance industry. Compensation arrangements that smack of 
bid rigging, of steering, of favoritism are wrong and they have 
always been wrong. The industry has tried to split legal hairs 
to say that alternative compensation arrangements are lawful, 
but they seem to miss the point when they do that. There are 
serious endemic problems inside the industry that have only now 
been uncovered.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Serio appears in the Appendix on 
page 77.
---------------------------------------------------------------------------
    The use of PSAs, MSAs, and other contingency arrangements 
and how they have been used in insurance brokering for overtly 
or implicitly influencing basic insurance transactions for the 
benefits of the broker and/or the insurer and to the detriment 
of the insured is wrong and has always been wrong. Failing to 
disclose these arrangements to commercial buyers only makes 
that matter that much worse.
    For brokers and carriers, the test was and always is a 
straightforward one. Have they acted in the best interest of 
the consumer, or could their acts be seen to constitute a 
conflict of interest? Frankly, putting it more bluntly, we 
would ask, would the consumer of the insurance product object 
to the fees and the additional costs if they knew about them, 
and would they object if they knew that the compensation 
arrangement figured prominently into the recommendation to make 
a certain placement?
    This test, applicable to virtually every broker-driven 
insurance transaction, is particularly crucial to the integrity 
of the insurance transactions that take place at supposedly 
sophisticated levels where by law there has been minimal 
regulatory authority or legal standards defining the four 
corners of the transaction. Yet time and again, brokers and 
carriers both ignored the test, thereby ignoring the best 
interests of the insurance buyer.
    The insidious nature of the transgressions, together with 
an apparent ``go along to get along'' attitude on the part of 
the carriers and even some buyers has turned the legal actions 
taken so far into a rocket fuel for changing the course of 
public policy. Brokers and insurers are even racing to disavow 
PSAs. At this point in time, though, we are not satisfied with 
simply undoing the inappropriate behavior. We want to take the 
opportunity to effectuate real and meaningful change and 
improve the integrity of the market and better protect all 
consumers at all levels of sophistication.
    This industry has earned a sweeping reform, whether through 
legal and regulatory action taken so far or future legislative 
action. And frankly, the professional insurance buyers have 
also earned some of the reforms that will be coming down the 
road.
    The NAIC, which has spearheaded a multi-year effort to 
uniformize rules for the licensing and regulating of brokers, 
proposed a new rule for the disclosure of all compensation the 
producer receives from an insurer in the placing of business. 
Furthermore, to make certain that insurance buyers are indeed 
active participants in the insurance transaction, the NAIC 
proposed that buyers provide written consent for the producer 
to receive any contingent compensation. The NAIC is also 
coordinating a nationwide information network for people to 
provide online tips to the insurance commissioners around the 
country to register complaints regarding broker activities.
    The NAIC's member insurance departments discipline brokers 
and agents every day for violating the respective duties they 
owe to their clients. The regulatory actions are taken after 
investigations, are usually started with a complaint, are 
usually from insured or from information gained from tips or 
from information gained during other regulatory activities.
    The specific actions taken in New York over the past month 
by the Insurance Department relating specifically to broker 
compensation, the citing of 15 separate Marsh entities and the 
flagging of all licenses associated with Marsh, the citing of 
ULR and its principal, and the expected increase in regulatory 
activity over the coming weeks arose out of the collaborative 
efforts between the New York Insurance Department and the New 
York Attorney General. This matter originated with a single and 
specified complaint to the Department by a carrier and 
accelerated into the investigation it is today through the 
filing of very specific complaints by others with the Attorney 
General.
    In fact, I have to agree with the Attorney General that the 
industry has not been forthcoming on providing specific 
information about these problems. Indeed, we had to take what 
would be called the slow road to our examination, our early 
examination into the use of PSAs because the very complainant 
who brought an initial complaint to us, a competitor in the 
marketplace, failed to provide the Department with the kind of 
information that would have led us down this path.
    It has been because of the Attorney General's powers as the 
chief law enforcement officer of the State as the appropriate 
lead agency on this matter, given his broader legal powers, his 
greater investigative resources, and frankly, his tireless 
pursuit of cases of this nature, and the Department has been in 
every respect a full collaborator on this and on many other 
matters that we have undertaken jointly over the past several 
years.
    The State regulatory system, insurance regulators and law 
enforcement together, have worked to reveal these problems in 
the marketplace. Though people will still be tempted to declare 
this a crisis of regulation or to declare an acute need for 
wholesale Federal intervention in the regulation of insurance, 
these should be avoided as the only responses for these 
reasons.
    The insurance industry, as the preceding speakers have 
said, more than regulation itself, needs modernization. An 
industry that does not provide a written contract at the time 
risks are bound needs to be modernized. An industry whose 
executives are afraid to sign certifications stating that their 
regulatory filings comply with the law needs to be modernized. 
An industry that has sought Federal legislation as much to 
escape regulation as to improve its own efficiency and efficacy 
needs to be modernized. And certainly an industry that finds 
itself facing questions of fundamental fairness in its 
treatment of customers needs to be modernized, no matter how 
small or compartmentalized the problem may seem to be. I agree 
with Attorney General Spitzer that it is not a small or 
compartmentalized problem at all.
    The modernization will come from the legal and regulatory 
actions now being taken. It will come from the NAIC. It will 
come from Commissioner Garamendi and our colleagues at the 
NAIC. And the Congress' own deliberations on SMART, which has 
been moving, to provide uniformity of rules across State lines 
will also be an important component of this.
    The Congress' recent work in the area of military sales of 
life insurance could well provide a workable model of joint 
Federal-State regulation. Federal declarations of the authority 
of State insurance departments to regulate insurance sales, 
together with oversight, is a good way to go about this.
    Much of the modernization, though, will still have to come 
from the industry itself. I noted to the Senate Banking 
Committee back in September that Federal regulation has not 
been the missing link in the efforts to modernize insurance. 
Rather, the absence of an industry-wide self-regulating 
mechanism promoting the highest and best standards on corporate 
governance, market conduct, and financial safety and soundness 
represents a significant hole in the insurance regulatory 
construct.
    Creation of an industry compliance model is a priority. 
Taking the steps within property casualty that were taken by 
the life industry after the illustration scandals of the early 
1990's is an imperative. Joining in a property casualty 
industry-wide organization is overdue. Acceptance of a 21st 
Century regulatory structure allowing State regulators to peer 
beyond the four corners of regulated entities into the 21st 
Century corporate structures that own or control these 
regulated entities will be the first measure of good faith that 
the industry can exercise to let us know that they are serious 
about putting the current matter behind them and taking some 
personal responsibility for how they operate as corporate 
citizens in the months and years ahead.
    I look forward to your questions.
    Senator Fitzgerald. Thank you very much. Mr. Garamendi.

 TESTIMONY OF HON. JOHN GARAMENDI,\1\ INSURANCE COMMISSIONER, 
                      STATE OF CALIFORNIA

    Mr. Garamendi. Thank you very much, Mr. Chairman, for the 
invitation to appear. This hearing is extremely important. You 
have my written testimony. I will summarize it and add a few 
additional comments.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Garamendi appears in the Appendix 
on page 92.
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    There has been much discussion in recent weeks, 
particularly since the election, about values, about morality. 
It is rather narrowly defined. Unfortunately, we are faced with 
a situation here of values. We are faced with a situation of 
ethics. And above all else, just flat out greed. It has to be 
addressed.
    This issue is not new, as Attorney General Spitzer pointed 
out in his opening remarks. It is found pervasively throughout 
corporate America. This country, this economy will not prosper 
and will not move forward if there is no trust in the basic 
systems that we must have. So we must go further.
    I don't know where this is going to end up. We are in the 
opening pages of a very long and sordid chapter in America's 
corporate life and we have to change it. We absolutely must. 
Otherwise, we are going to have a series of problems. We simply 
cannot have economic growth without a sound, viable, readily 
available, competitive and fair insurance system. It is one of 
the fundamental building blocks of economic systems and 
particularly the American system.
    We will, in California, continue our investigations, both 
with the Department of Insurance effort of investigating. We 
will be bringing lawsuits against numerous brokers as well as 
insurance companies. Those are underway. Those will be 
coordinated with other States. We are already coordinating with 
the New York Department as well as Attorney General Spitzer and 
we will see much more coordination among many departments of 
insurance across the Nation as well as Attorney Generals.
    You will have over 100 investigative agencies on this 
issue. All the various departments of insurance, 50 of them, 
plus a couple of districts--one district and some territories 
will be engaged, and Attorney Generals. That is a very 
formidable enforcement action that will take place, and I 
suppose that eventually the Federal agencies will wake up and 
get at it, also.
    In California, beyond the investigation, we have the 
lawsuits that we will be pursuing. We are also pursuing a very 
vigorous effort to rewrite our regulations. This is not going 
to require new law. The laws have been in place for a long 
time. They basically say that a broker owes its allegiance to 
the consumer, to the customer, whether that be mom and pop on 
the corner or in the home or a major corporation. It is that 
breach of fiduciary responsibility that is at the heart of this 
problem.
    To better illuminate and to provide a bright line, in 
California, we are writing new regulations to do just that, to 
illuminate and to clarify, and I will very briefly go through 
that for your use here at the Federal level. This particular 
regulation is becoming the starting point for the National 
Association of Insurance Commissioners to develop a draft model 
law or regulation as may be required by the various States, and 
that process is moving along very swiftly and I would expect it 
to be completed at the December meeting of the NAIC.
    So here is what we propose to do in the regulatory process. 
The intent of it, and the language follows along, is to require 
disclosure of all compensation a broker receives from any 
party, including an insurer, in connection with the placement 
of insurance on behalf of a client. Pretty simple, should have 
been done, hasn't been done.
    Second, to prohibit a broker from putting his own financial 
interests ahead of a client's by, for example, failing to 
obtain quotes for insurance from a reasonable number of 
insurers able to meet the client's needs because the broker has 
an agreement to receive compensation from other insurance or 
from a specific insurer.
    Third, failing to present an offer for an insurer to be 
able to meet the client's needs because the broker has an 
agreement, MSA or a contingency commission. And fourth, 
recommending that a client accept an offer from an insurer 
because a broker has an agreement to receive compensation from 
that insurer when another insurer has made a superior offer.
    It would seem to be that these would be uncontroversial and 
should not be imposed by anybody. It is simply a matter of 
fairness, competition, and open markets. As I have said, I 
believe that there has been a need to clarify. Yet, you are 
going to hear from the industry objections and I want to 
respond to those objections right here and tell them they are 
going to have a big fight.
    First, the objections are these. With respect to the 
disclosure of the amount of commissions, brokers and agents 
will ask, well, why should we have to disclose the amount of 
the commissions? Most salespeople in other industries, they 
don't say what their commissions are, and they don't say where 
they are getting their money. The answer is this. Buying 
insurance isn't like buying groceries. It is not like buying a 
car. Security brokers and real estate brokers are required to 
disclose the sources and insurance salespersons and brokers 
should, also.
    Second, you are going to hear, why do these only apply to 
brokers? Why not to agents? The answer is fairly simple. Agents 
have a specific--they work for the insurance company. They 
don't work for the customer.
    Third, you are going to hear that how could we disclose the 
amount when we really don't know what it is going to be, 
because, after all, these are contingencies. Well, make a good 
guess to fully disclose everything you know. Even though it may 
not be totally accurate, at least the customer will know where 
you are getting your money.
    And finally, and this is probably going to be the biggest 
fight that we are going to have, brokers and agents will 
complain, oh my, you are imposing an impossible obligation on 
us. You are asking us to tell the customer what is suitable or 
what is the best available option and there are too many 
factors for us to do that. These are supposed to be 
professionals. These are supposed to be people that know the 
market. And to simply be able to apply their judgment, their 
best judgment, is not an impossible task and they are not going 
to face any more lawsuits in this area than they would in 
some--and that they already might, and certainly by not 
disclosing and by steering, they are facing some very serious 
lawsuits.
    We are not holding the broker to an obligation to find the 
very best policy, but rather it is the broker's duty to take 
all reasonable steps to determine the client's needs, to use 
its expertise in the best manner possible, and to make a 
recommendation based upon their experience and knowledge, and 
to keep their finger off the scale. That is what this is all 
about. It is about ethics and it is about fiduciary 
responsibilities.
    Thank you, Mr. Chairman.
    Senator Fitzgerald. Well, thank you all very much. I want 
to begin by following up with Mr. Garamendi's discussion of 
fiduciary responsibilities. Isn't one of the problems here that 
under the laws in most States, insurance brokers aren't 
actually treated as fiduciaries? In fact, my understanding of 
New York law is that they are not fiduciaries typically and 
that the courts, New York courts, have held that insurance 
brokers are actually--they are not even professionals, they are 
mere order takers and it is only when they engage in certain 
types of conduct where they can rise to the level of 
fiduciaries and owe their clients fiduciary duties.
    I think Mr. Spitzer's complaint in the Marsh vs. McLennan 
case is careful to cite all the advertising that Marsh and 
McLennan had done in which they are advertising how they are 
going to serve the client and they are going to try and get the 
best deal for the client, and you find the duty arising out of 
some of their statements. I believe they probably did develop a 
fiduciary duty with those statements that they make.
    But shouldn't consumers around the country be on guard that 
their insurance agent is not like their lawyer, who owes them a 
fiduciary duty? It is not like the trustee or the trust 
department at the local bank, which has a duty to avoid 
conflicts and has a duty to avoid self-dealing and to treat 
their clients' money as they would their own, or with a higher 
degree of care than their own, even. Insurance agents typically 
aren't fiduciaries and you have to be very careful dealing with 
them.
    Mr. Garamendi. Mr. Chairman, if I might, in California, we 
do have a dual law that allows a person to be both a broker and 
an agent, but there is a very clear distinction. In our 
proposed regulations, we make it clear what that distinction 
is. It is not a new distinction. It is based in our law as well 
as in the various court decisions that have come down over the 
decades, and that is that a broker--a salesperson becomes a 
broker when they offer their services on behalf of the client. 
That is, they work for the client, the customer, the 
individual----
    Senator Fitzgerald. And you are proposing making them 
fiduciaries in that instance, is that correct?
    Mr. Garamendi. They already are fiduciaries----
    Senator Fitzgerald. They already are.
    Mr. Garamendi [continuing]. In that instance, both under 
California law and under the various numerous court cases in 
California. We are not changing it, we are simply clarifying, 
making it clear that that is the situation. So when they offer 
their services to the customer on behalf of the customer, on 
the other hand, an agent is working for the insurance company. 
There is a clear distinction, at least in the California 
situation.
    Mr. Blumenthal. You are correct, though, Senator, that in 
most States, including Connecticut, there really is no 
unequivocal explicit fiduciary duty and that is one of the 
problems in the State laws and the lack of definition as well 
as the blurring of lines between agents and brokers in many 
States' laws. Under the model act that the insurance 
commissioners themselves devised in past years, the Model 
Insurance Act, the Insurance Producers Act, in effect 
contributed to the blurring of lines between agents and brokers 
and to the evaporation or the lack of----
    Senator Fitzgerald. So that model act is a problem because 
it blurs the line. How many States have adopted the model act?
    Mr. Blumenthal. Exactly, and the kinds of reforms that are 
being suggested by Commissioner Garamendi will help, I think, 
lead us out of that morass.
    Senator Fitzgerald. But they need to be adopted not just in 
California and Connecticut. We need to see it changed around 
the country. Mr. Serio, do you care to comment?
    Mr. Serio. I think that it does need to be changed around 
the country, but I think that defining the fiduciary duty and 
making it binding has to be one central objective.
    Senator Fitzgerald. But making these brokers fiduciaries 
imposes a lot of new duties and there are a lot of brokers--
real estate agents, they are probably not fiduciary duties. I 
would imagine the average person out there, if you are going to 
get a real estate lease and say you are a small company and you 
go to some real estate brokerage firm, they could well be 
steering you to a building where the building owner is giving 
them a kickback for steering you into that building. You don't 
know who they represent.
    Mr. Serio. Let us back up a little bit. We don't want to 
get caught up in the idea of whether the threshold is to be a 
fiduciary duty or not. They are licensed entities, these 
brokers, and in New York, we do have a bifurcation between 
agents and brokers and they do hold separate licenses, so it is 
a little bit clearer in our jurisdiction as to what banner they 
are flying under. It doesn't dissolve the overall question of 
compensation, but it does at least make it a little bit 
clearer.
    But here is the thing. We take regulatory action against 
brokers every day. We suspend licenses, we revoke licenses, we 
fine them, not because they have violated any fiduciary duty 
but because they have violated the standard of 
trustworthiness----
    Senator Fitzgerald. What is the standard of trustworthiness 
for a broker?
    Mr. Serio. That they did not act in the best interest of 
their customer, that they have not operated in the body of law 
that we have and the fact patterns that are presented to us----
    Senator Fitzgerald. So if they are steering their customers 
to carriers who offer them, the brokers, a bigger commission, 
they are violating their duty to their----
    Mr. Serio. That would be accurate.
    Senator Fitzgerald. In all cases?
    Mr. Serio. And this is the concern that we have had with 
this entire situation, is that no customer complaints ever came 
in on this issue. The carriers did not come forward to tell us 
about this. And frankly, inside, I am told certain people went 
to the Attorney General's office. We did not even get an inside 
view from anybody as to how these were operating. But in your 
normal mom and pop operation, when somebody is not happy with 
the way that their broker treated them, they make a complaint 
to the Insurance Department----
    Senator Fitzgerald. Now, you said that on November 5, you 
made a statement that for some reason, the customers of 
insurance brokers were mute on this. Why do you think they are 
mute?
    Mr. Serio. Not only have they been mute, but they are still 
mute on this issue.
    Senator Fitzgerald. Are they terrified of Marsh and 
McLennan and AON?
    Mr. Serio. We have been given some off-the-record 
conversations with individuals who said some of the buyers are 
embarrassed that they didn't see this happening, that they 
didn't say something about it when they did see it happening. 
There are buyers who were told about contingency fees or were 
told they were not going to be provided information on 
contingency fees and they did not----
    Senator Fitzgerald. So they were embarrassed they were 
snookered.
    Mr. Serio. And that they didn't do anything about it.
    Senator Fitzgerald. OK. Mr. Spitzer.
    Mr. Spitzer. Mr. Chairman, you are correct. Additional 
clarity about the precise contours of fiduciary duty and when 
it is triggered would certainly be helpful. Obviously, as you 
pointed out, in our complaint we allege that a fiduciary duty 
existed based upon representations that were made by Marsh 
individuals to their clients, and therefore the client could 
suppose and legitimately rely upon the Marsh individuals to act 
in a fiduciary capacity.
    I would add this other point, however, and I think this is 
to a certain extent what Greg was hinting at. The nature of the 
violations that we are alleging and that have been plead to and 
have been confessed to by individuals in court do not depend 
upon there being a fiduciary relationship. In other words, this 
is common law fraud. This is a violation of more common law, 
traditional responsibilities that are incurred even if they do 
not rise to the level of fiduciary. That is why the issue of 
steering and bid rigging and the undisclosed payments are so 
surprising and appalling to all of us. Even in the absence of 
the fiduciary duty, those would constitute violations.
    One last point with respect to the mutinous of those who 
were allegedly the victims. I do think that we are now seeing 
behavior in the marketplace, and this, I think, proves the 
point that we all agree upon. Where this behavior is disclosed, 
where there is adequate opportunity and information flow for 
the purchasers of insurance to make informed judgments, they 
will do so. I have heard and have reliable information that 
there is now a very significant push back against the brokers 
by the major purchasers in various lines of insurance to ensure 
that they not only get full information, but that they 
eliminate the type of behavior that is injurious to the 
consumer.
    And so while we may not have seen and did not see--and Greg 
certainly is right about this--consumers running to regulators 
complaining, we are now seeing them act in their economic self-
interest, which is exactly what we want to permit them to do by 
mandating disclosure and prohibiting certain types of 
relationships.
    Senator Fitzgerald. Now, following up on the nature of the 
allegations in your complaint, some commentators have made 
light of your complaint and said, well, the only thing you 
found that was illegal is bid rigging and everybody agrees it 
is illegal. So what? But when I read your complaint, I found 
that you have six counts, I believe, and you found a whole lot 
more than bid rigging. Maybe you would want to elaborate on 
that.
    Mr. Spitzer. Absolutely. Bid rigging is perhaps the most 
egregious and the most immediately violative area where we 
found behavior because it is so clearly corrosive to the 
marketplace. Steering is in and of itself a violation of law, 
because when the companies steer, they are making a judgment 
that is not in the interest of their client and they are making 
it for the improper purpose that they are receiving undisclosed 
additional compensation.
    I have not heard, and maybe you will hear it today from 
witnesses for the industry, I have not heard a single industry 
voice say steering is OK. Steering is wrong. Steering should 
not be permitted. We have senior executives under oath. When 
they see the E-mails--E-mails relating only to steering, where 
they say they are appalled, it should not happen, it should not 
be permitted. Strip out the bid rigging component of that. That 
was really the third layer of the onion. Steering is the second 
layer of the onion, and it is sufficient to say these companies 
have violated their duty. This behavior cannot be permitted to 
continue.
    Senator Fitzgerald. Very analogous to the revenue sharing 
we saw with the mutual fund industry.
    Mr. Spitzer. Absolutely correct.
    Senator Fitzgerald. And you found instances in which Marsh 
and McLennan actually took existing clients who were already 
placed with a given insurer and you had Marsh and McLennan 
pressuring their clients to move their existing policies to 
some other company that was going to pay them a higher 
contingent commission, is that correct?
    Mr. Spitzer. Yes, sir. And, in fact, the most--that is 
correct. We saw oversteering predicated solely upon the 
overrides that were being paid, and we also saw Marsh 
indicating to certain carriers that they should increase their 
bids so as to eliminate the possibility that the coverage would 
go to a carrier which was not going to pay them as much. I 
mean, the E-mails where they say, please increase your bid 
because we want the business to stay here or move, there is 
appalling stuff, and yet that is what we were finding.
    Senator Fitzgerald. And you also state a count for 
securities law violations.
    Mr. Spitzer. Absolutely.
    Senator Fitzgerald. Do you want to go into that and explain 
how you arrived at that?
    Mr. Spitzer. Sure, because there are disclosure violations. 
There is a duty to disclose to investors what the basis of the 
revenue stream is. Here you had a company that was deriving 
$854--I think that is the right number--$854 million in revenue 
from contingent fees, the basis of which was not disclosed and 
the inherent illegality which was not disclosed.
    Senator Fitzgerald. And in fact, when they were asked about 
it by analysts on conference calls when explaining their 
quarterly earnings, they refused to go into it, isn't that 
correct?
    Mr. Spitzer. They not only refused to break out the revenue 
that they derived, but they claimed that it was too murky and 
impossible to break out the distinct revenues that flowed from 
the contingencies when, in fact, internal to the company they 
had a very careful accounting that defined precisely where the 
contingencies came from, how to maximize them, and were acting 
as one would expect, in a way to increase the revenue that was 
generated.
    Senator Fitzgerald. And this was very relevant information 
for investors and the analyst community because I think just a 
few months before, a J.P. Morgan--I believe it was a J.P. 
Morgan analyst--had written a whole thing about the dependency 
of the insurance brokerage market on contingent commissions and 
this analyst questioned whether contingent commissions would 
still be allowed after we were just uncovering similar 
conflicts in the mutual fund industry. And still, Marsh and 
McLennan was refusing to answer questions about----
    Mr. Spitzer. That is correct, and just to show that I can 
say favorable things about that analyst, that indeed was a very 
prescient report where the analyst not only focused on this 
issue, raised the regulatory risk that Marsh was facing, but 
also quite accurately predicted where the stock would move in 
the event that there was any regulatory effort to disallow the 
revenue streams that he was talking about.
    Senator Fitzgerald. Now, do you think that these sorts of 
abuses could have occurred if Marsh and McLennan only had, say, 
8 percent of the market as opposed to 40 percent of the market? 
You have an extremely concentrated insurance brokerage industry 
in America. There were a lot of acquisitions during the 1980's 
and 1990's whereby the bigger players got bigger and bigger, 
Marsh and McLennan and AON being the two largest. They bought 
up a lot of smaller brokerage firms. Today, those two have 
about 70 percent, I am told, an estimated 70 percent of the 
commercial insurance brokerage market for large companies. I 
guess that would be Fortune 1,000 companies they are referring 
to.
    For some reason, Fortune 1,000 companies, why don't they go 
to a smaller insurance brokerage agency? Why do they feel 
compelled to use the biggest?
    Mr. Spitzer. Let me make one observation, Mr. Chairman. I 
think you are exactly correct. Certainly, the market power that 
Marsh had in certain cities and in the market writ large 
contributed to its capacity to extract the overrides. Having 
said that, there are much smaller companies that receive a 
larger percentage of their revenue when you look at their total 
revenue and look at the overrides that they receive, a larger 
percentage of their revenue in the overrides.
    I do not agree with you, however, that Marsh would have 
been in a position to structure the illicit relationships that 
it had absent market power. The steering, and then the bid 
rigging, were dependent upon its capacity to foreclose clients 
from seeking other brokers who might have provided access to 
the insurance they needed. So I believe that it is market 
strength that was a necessary prerequisite to the structure 
that we have seen.
    Mr. Serio. And that market strength came, not just from the 
brokering of insurance business, but from the related services 
and the related organizations that the Marsh entity had 
acquired over the years to make it essentially a one-stop 
shopping opportunity for a lot of large companies.
    Senator Fitzgerald. And those other entities are Putnam 
mutual funds----
    Mr. Serio. Mercer, risk services, and all these other 
entities that don't fall underneath any one regulatory 
umbrella. You were speaking a moment ago about the financials 
of the large brokerage and whether this would have been 
revealed at some point earlier if the financials of Marsh or of 
other large brokerages are actually examined on a periodic 
basis the way company financials are examined on a regular 
basis.
    Brokers are not inside that regulatory paradigm, however, 
and they largely operate, save for their market conduct 
activities and their relationship to their clients, there 
really are no other regulatory nexes between the brokers and 
the insurance regulators around the country. Perhaps if they 
were on a regular schedule of financial examinations, those 
glaring deficiencies in explaining where so much of their 
revenue source was coming from may at least have been 
identified earlier, if not acted upon earlier, if the brokers 
were under the same regulatory regimen that the companies are 
under.
    Mr. Spitzer. Can I add one last thought----
    Senator Fitzgerald. Yes.
    Mr. Spitzer [continuing]. Because I think this interlocking 
set of relationships really is at the essence of it and it is 
not only across a horizontal line to Mercer and to perhaps 
mutual funds, but really even within the insurance sector you 
have brokerage, you have investments that are made by the 
companies themselves and underlying carriers. You have 
investments in reinsurance brokerage and you have investments 
in the reinsurers themselves.
    And so you have these four pieces that all fit together 
with common ownership that we just don't understand, and I 
think it is not only market strength in terms of the 40 percent 
you cited in terms of the brokerage business, but also what 
market strength do they garner by virtue of the vertical 
relationships to insurers, reinsurance brokerage, and then 
reinsurers themselves. I think that dynamic is one that needs 
to be----
    Senator Fitzgerald. Yes. Does anybody care to comment on 
the reinsurance business? Apparently, both Marsh and McLennan 
and AON set up reinsurers, offshore, I believe, in the case of 
AON, in Bermuda, and----
    Mr. Blumenthal. I would like to add a thought on this, what 
is fundamentally an antitrust issue, before we move on. I think 
it ties directly to the point you were raising and the reason 
that we are here today. The remedy here has to be stronger 
antitrust enforcement. If nothing else emerges, and a great 
deal will besides this point, the scrutiny has to be to the 
size, dominance, market power of these companies, and it has to 
be an ongoing----
    Senator Fitzgerald. Of the brokers? Or are you saying of 
the insurers, as well?
    Mr. Blumenthal. Both. And the interlocking relationships at 
various levels. That is why ongoing scrutiny is so important, 
and that may be where the Federal Government ought to have a 
role.
    Senator Fitzgerald. Well, let us talk about that for a 
second. The McCarran-Ferguson Act of 1945 exempts the business 
of insurance from antitrust regulation with a few distinct 
exceptions, such as boycotts and a couple other things. It is 
not clear to me whether the McCarran-Ferguson Act exempts 
insurance brokers from Federal antitrust regulation. The 
language is the business of insurance, and clearly it covers 
carriers.
    Would it make sense to amend the McCarran-Ferguson Act--it 
would be very hard to ever repeal the antitrust exemption with 
respect to insurance carriers. If you see all the insurance 
industry people in this room, you would understand why, and 
there are other good reasons, actually, to allow companies to 
share underwriting information with each other, losses, age 
groups with buying cars or driving cars. But let us just focus 
on insurance brokers.
    Is there a reason to have the insurance brokerage industry 
exempt from antitrust laws? Shouldn't McCarran-Ferguson be 
amended to make it clear that exemption from antitrust laws 
only applies to the carriers, not to the brokers?
    Mr. Blumenthal. If it is not clear now, it should be made 
clear so that there can be more robust and effective Federal 
antitrust enforcement in this area. But the States certainly 
should pursue strong and effective remedies, and perhaps as a 
result of these court actions, there will be.
    Senator Fitzgerald. Now, I want to add that in reading 
Attorney General Spitzer's complaint, I got the impression that 
only a company that had a strongly dominant market position 
could get away with the kind of rogue behavior that is outlined 
in that complaint. I have to believe that Marsh's humongous 
market share is what enables them, in part, to engage in that 
kind of rogue behavior.
    Mr. Spitzer. I agree with the following caveat. There is 
also, to use Mr. Grogan's word, a synergy that benefits both of 
the carriers and the broker when they pay the overrides. One 
can very well view the override payments as an access fee, 
access to the cartel. In other words, if, in fact, Marsh is 
playing the role of organizing a bid rigging scheme that drives 
premiums up for everybody and allocates business among the 
carriers, the fee that is being paid by the carriers to Marsh 
for entry into that system is the overriding set of payments.
    Therefore, even without enormous market power, this is 
really a negotiation between the two sides of the transaction, 
a divvying up of the gains that result from the cartel 
behavior, and I think that is a theory that we will be pursuing 
in terms of damages that arise, because obviously the bid 
rigging drove the entire supply curve to a point where premiums 
were going up and we were all paying that in the form of 
premiums and the division of that gain was reflected by the 
override payments. So even theoretically, without the enormous 
market power that Marsh had, that relationship could have 
emerged.
    Mr. Garamendi. I don't want to leave the impression that 
this is only a result of market concentration. It may very well 
be that the market concentration created the atmosphere where 
this kind of steering and these kinds of compensations became 
the norm within the industry. But it is clear from our 
investigations that you don't have to be real large to be 
engaged in practices that are every bit as illegal as what Mr. 
Spitzer has found with Marsh. We believe this goes way down 
into the smaller reaches of this industry.
    Now, with regard to changing the McCarran law, what we 
have, it seems to me, with Marsh is a synergy in which the 
company was able to use its various pieces, whether it was the 
reinsurance business or the access to capital and the movement 
of capital from one place to the other or the brokerage, to 
create opportunities for itself, to tie, if you will, one part 
of its business to another part of its business. Tying happens 
to be illegal in most States, and it may very well be as these 
investigations, as we move to the various pages ahead of us in 
our investigations, that we are going to find tying and other 
State antitrust activities, or State laws, antitrust laws, 
being breached. I would be surprised not to find that.
    Clearly, however, you are onto something very important, 
and that is concentration within the economic systems of this 
Nation, not only with insurance, but in many other economic 
sectors of the Nation. The concentration is an anathema to a 
competitive market.
    Senator Fitzgerald. Now, what do you all think about, in 
1980, Congress passed a law that forbade the Federal Trade 
Commission, which enforces our antitrust laws, from even doing 
studies of the insurance industry? Do you care to comment on 
that?
    Mr. Garamendi. Is that the only mistake Congress has made 
in the intervening 24 years?
    Senator Fitzgerald. It looks like it, yes, but what do you 
think of that?
    Mr. Serio. Whether it is the FTC or it is the GAO or any 
other arm of the Federal Government, the opportunity to study 
insurance and to make recommendations is not a bad thing, and 
the Congress has been doing this more and more. The Congress 
has become a regular partner in insurance, certainly in 
insurance policy making, given the discussions we have been 
having on SMART, the discussions we had on the Fair Credit 
Reporting Act, where the NAIC and the commissioners endorsed 
the preemption of the Fair Credit Reporting Act and the study 
of the FTC on the use of Fair Credit Reporting standards and 
creating a uniform standard across the spectrum.
    That would not necessarily--I obviously haven't spoken to 
my colleagues in the commissioner's rank on this, but I don't 
think that would necessarily be an invasive step into State 
regulation. In fact, if it can help to earmark and identify 
those areas where either stronger regulation is needed or that 
trade-off between McCarran antitrust protection versus greater 
regulation, because that really was the trade-off in McCarran, 
is that they were given certain antitrust exemptions because 
there was a body of State regulation, and that was, as you 
said, Mr. Chairman, really focused on the companies, not on the 
other players in the insurance marketplace.
    And now we need to reevaluate that trade-off and if they 
are subject to McCarran, make it so, or to antitrust rules, 
make it so. Or if you still, and you clarify the rule that they 
are exempt from antitrust through McCarran, then there has to 
be a coordinated or consequent improvement in the State 
regulatory tools that we have at our disposal to better 
regulate the broker community.
    The size, as Commissioner Garamendi said, is not really the 
important part of this. In New York, people have gone to 
prison, State and Federal prison, because of the inappropriate 
use of brokerages and the influencing, controlling, tying, 
whatever you may call it of the insurance business between the 
broker operation and the insurance or the underwriting 
operation that they controlled jointly.
    Frank B. Hall is a name that we all knew in the 1980's, 
where you had a broker control problem. The issue was addressed 
by the States in that case. There have been, perhaps, new ways 
found to coordinate, as Attorney General Spitzer said, to 
interlock the various parts of the insurance process. But the 
fact of the matter is that we really are dealing with a lot of 
the same issue here, and whether the size became a controlling 
issue or just the ownership became a control issue between the 
broker side and the insurance or the reinsurance operations.
    Senator Fitzgerald. In a moment here, I am going to allow 
Senator Akaka to give his opening statement. I do want to ask 
Attorney General Spitzer, you have said that you favor a 
greater Federal role here, but are you sure that is the best 
way when, after all, it was you, not the Federal Government, 
that uncovered the conflicts in the securities analyst world? 
It was you, not the Federal Government, that discovered and put 
a spotlight on the problems in the mutual fund industry. And 
now it is you, a State Attorney General, who has shaken the 
insurance brokerage world.
    Are you sure--what if the Federal Government came in--this 
is the Federal Government that has tied its hands with respect 
to even studying the insurance industry--what if they pass 
something that preempts people like you from identifying a real 
problem and acting vigorously?
    Mr. Spitzer. First, I would much prefer the Federal 
Government do it. It would make my life much easier. I would 
have an easier time getting out of this room. [Laughter.]
    Obviously, I do not support a preemption amendment that 
would preclude the capacity of State inquiry into these various 
areas. Having said that, I certainly think we need the 
additional scrutiny that can be provided by the FTC, by 
Congress in the areas that I laid out, because your 
investigative powers are enormous. The areas where we have seen 
interlocking relationships that are injurious to competition, 
to a certain extent have a nexus offshore precisely because it 
is very often harder for State entities to inquire with respect 
to those jurisdictions. Congress, on the other hand, has a 
greater capacity to do so. The FTC does.
    So we would welcome your joining us in this effort. I 
certainly am not guarding with such loyalty our exclusive 
jurisdiction. I would love to see other entities join this 
investigation, join in the legislative effort, because although 
the State entities have had some success recently, I would hope 
that dynamic would change and that we would see vigorous 
efforts at the Federal level, as well.
    Mr. Blumenthal. And I would just add, if I may, Senator, 
because I think that the sentiments that Attorney General 
Spitzer has just articulated are common to most attorneys 
general, that preemption is the anathema here. We have very 
cooperative relationships, particularly in antitrust 
enforcement, with the Federal Government already and a lot of 
what we are discussing here really constitutes per se 
violations of our antitrust laws. Collusion, tying, price 
fixing, bid rigging are simply against the law, end of 
sentence. To ask the questions that you asked really, in many 
ways, is to answer them, that we need a stronger Federal role 
in these areas where in other industries that role would be a 
given and we would be working together.
    All of that said, if there is a Federal role, it ought to 
be a constructive and helpful one, and in so many other areas, 
unfortunately, in recent years, we have seen a lack of Federal 
activism, a laxity, and even an attempt to inhibit State 
action. The environmental area is the best example, but there 
are others.
    Senator Fitzgerald. I am not sure all of that is going to 
change anytime soon.
    At this point, I will allow Mr. Garamendi, if you have 
something, to join in.
    Mr. Garamendi. My good friend, Senator Akaka, please take 
the floor. I will be happy to follow you.
    Senator Fitzgerald. Let me just say I would like to 
recognize the Subcommittee's Ranking Member, Senator Akaka. We 
have worked closely together the last few years. In fact, I am 
told that we held 13 hearings together in the 108th Congress. 
We have worked together on many financial issues, such as the 
mutual funds, insurance now, and also financial management 
bills that have installed better audits and chief financial 
officers in some of the Federal agencies, such as Homeland 
Security and the National Intelligence Director CFO.
    It may surprise you, but until about 15 years ago, none of 
the Federal agencies were ever audited. Then they started 
requiring audits of the largest departments, and when I came 
in, the Agriculture Department was missing $5 billion. It was 
just missing. They couldn't find it--in cash. They later worked 
that difference down to only $200 million, but that is a lot of 
money. If we complain about Enron having bad accounting, 
sometimes the Federal Government needs to look in the mirror.
    But we have worked very hard to extend audit requirements 
to all Federal agencies. We are now having audited any agency 
that spends more than $25 million a year, and it has been a 
pleasure working with Senator Akaka these years and I want to 
thank him for allowing me to have such a collegial and 
productive working relationship with him these years. And he 
kindly every once in a while sends me some macademia nuts from 
Hawaii, which are very good---- [Laughter.]
    So I want to thank you for that, too. Thank you, Senator 
Akaka.

               OPENING STATEMENT OF SENATOR AKAKA

    Senator Akaka. Thank you very much, Mr. Chairman, for 
calling this hearing today. I want to take a moment to pay 
tribute to our Chairman.
    This is the Chairman's final hearing as Chairman of the 
Subcommittee on Financial Management, the Budget, and 
International Security. Mr. Chairman, I want you to know that I 
really appreciated working with you. You have done a great job 
here. Your leadership has been impeccable, and you have been 
very productive. We have done so many things together and I 
attribute that to your leadership and your focus on the 
concerns and issues of this whole industry. As you mentioned, 
some of this goes back years. With your leadership, we are 
changing some of that which will really help our country in its 
accountability.
    I want you to know, Mr. Chairman, that I have enjoyed 
working with you on a number of important issues relating to 
financial management and transparency, and I want you to know 
also that I will miss you and you will be missed by the full 
Committee, as well.
    Mr. Chairman, with that, I have a lengthy statement that I 
ask to submit for the record.
    Senator Fitzgerald. Thank you. We will make your statement 
a part of the record.
    [The prepared statement of Senator Akaka follows:]

                  PREPARED STATEMENT OF SENATOR AKAKA

    Thank you, Mr. Chairman, for calling today's hearing. This is your 
final hearing as chair of this Subcommittee and I want you to know how 
much I appreciate the work you have done as Chair of this Subcommittee. 
I have enjoyed working wit you on a number of important issues relating 
to financial management and transparency. You will be missed.
    Mr. Chairman, today, we focus our attention on another scandal--
this one involving alleged bid rigging and secret commissions in the 
insurance industry. This issue has been brought to light by the actions 
of a group of State attorneys general and insurance commissioners.
    I realize that investigations are still pending, but I am 
interested in learning how widespread the abuse is in the industry. I 
am also interested in learning more about how the insurance industry 
operates and, in particular, whether certain types of compensation 
agreements are a potential conflict of interest for brokers because if 
these agreements are a potential conflict of interest, we need to know 
if enough is being done to protect insurance buyers.
    Insurance buyers trust their brokers to search the market for the 
policy that best suits their needs. Brokers should be required to not 
only disclose the total cost of coverage, and also to disclose all 
compensation received from an insurance company. This disclosure must 
be in plain language so that buyers can make informed decisions. I am 
troubled that, in the New York lawsuit, it appears that even 
knowledgeable, corporate, buyers of insurance have been taken advantage 
of and presented with policies that best suited the needs of the 
broker. Today's heari8ng will explore options to make the process more 
transparent.
    I also want to know whether the deceptive and questionable 
practices found in commercial property and casualty insurance are also 
found in other lines of insurance, such as health insurance, where 
premiums continue to rise.
    Employer-sponsored health insurance premiums increased an average 
of 11.2 percent in 2004 according to the Kaiser Family Foundation and 
Health Research and Educational Trust. For many working families, these 
increase have made it more difficult for them to make ends meet and to 
retain their health insurance coverage. If a portion of the increase in 
premiums for health insurance may be attributed to deceptive and opaque 
practices among insurance brokers, steps must be taken to make sure 
that families are not overpaying for their current coverage due to the 
questionable activities of some insurance brokers.
    Mr. chairman, another area we will examine is the ability of the 
states to provide defective oversight for the insurance industry. We 
need to determine whether the Federal Government should be more 
involved in the regulation of insurance activities which are now 
regulated at the state level. I expect some of our witnesses will 
discuss various legislative proposals including the optional Federal 
insurance charter and the so-called SMART Act (State Modernization and 
Regulatory Transparency). There are also suggestions that the Federal 
Trade Commission be empowered to investigate unfair and deceptive 
practices within the insurance industry.
    I want to thank all our witnesses for coming today and I look 
forward to their testimony. Mr. Chairman, thank you again for holding 
this timely hearing. I have truly enjoyed working with you during the 
108th Congress.

    Senator Fitzgerald. We have been joined by Delaware Senator 
Tom Carper, and Senator Carper, we appreciate your being here.

              OPENING STATEMENT OF SENATOR CARPER

    Senator Carper. Thanks, Mr. Chairman. I apologize for not 
being here earlier. As Senator Akaka may have explained, the 
Democratic Senate Caucus has met this morning to elect our new 
leadership to begin the next Congress and to put the elections 
of 2004 behind us. So I apologize.
    Mr. Spitzer, I understand you have testified already, is 
that correct, and I apologize for having missed your testimony. 
We are delighted that you are here and we thank you for the 
input you have provided for us here today and, frankly, on a 
number of other occasions, as well.
    I want to thank our Chairman as he prepares to ride off--
sometimes when people leave here, they ride off into the 
sunset. I think when Peter Fitzgerald rides off, he will ride 
off into the sunrise because he is still among the youngest 
members of the U.S. Senate. It has been a privilege for me to 
have served with you for these last 4 years. As Senator Akaka 
has said, we wish you only good things in the years to follow. 
We will miss your intellect and we will miss your determination 
just to figure out what is the right thing to do and to do it. 
We will miss your fairness and your even-handedness in 
approaching the issues with a real open-mindedness.
    The investigations by, I think, two of the attorneys 
general that are here today have revealed some disturbing 
information about current practices, both legal and illegal 
practices, that have been occurring in the insurance industry. 
They have caught none less an observer than 14-year-old Ben 
Carper, my son, who is in a stock market course at his high 
school, the Charter High School of Wilmington in Wilmington, 
Delaware, and every morning, one morning every week, usually 
Monday mornings, they present from the previous week's news a 
story that has a real bearing or implication, a significance to 
the stock market. The issue that you have been testifying to 
today, the issue about which this Subcommittee is holding this 
hearing, has not just caught the eye of this Subcommittee and 
its Chairman and Ranking Member, but also our youngest son. We 
have had some interesting conversations. I don't know what 
everyone else has been talking about around their dining room 
table in recent weeks, but we have been talking a bit about 
these matters.
    I would just say these revelations raise questions about 
the roles of brokers and agents. They raise questions about the 
protections that exist for consumers, or don't exist for 
consumers, and the general regulatory framework for insurance 
itself. As we delve into these issues, they are going to lead 
to bigger questions and bigger issues for us to address in the 
next Congress.
    So, again, we welcome all of you today. To our Chairman, we 
wish you, as you say in the Navy--I am an old Navy guy--as you 
say in the Navy, fair winds and a following sea. God bless. 
Thanks.
    Senator Fitzgerald. Thank you very much.
    I have two final questions before we allow you to have a 
break and invite the second panel up here. I want to know 
whether there is any information that consumers of residential 
insurance policies or automobile policies, if they need to be 
concerned here. Have either of the attorneys general or the 
insurance commissioner from California found any problems with 
agents or brokers or personal lines of insurance, steering 
their clients to carriers who give them, I don't know, free 
trips to Hawaii?
    My own insurance agent came out here with his daughter from 
Elk Grove, Illinois, and he has assured me that he has never 
accepted those forms of compensation that are sometimes offered 
by the carriers, maybe free trips to Hawaii, for example, if 
you place a number of your policies with a specific carrier. 
Have any of you done any work in this regard?
    Mr. Garamendi. Mr. Chairman, indeed, it is probable that 
there will be and do exist problems in the personal line 
insurance sector. We see this in--the potential to be there. 
These additional compensations, whether they are called 
contingency commissions or the like, in all probability exist 
in the personal lines area. We are looking into this in 
California. We have concerns about it.
    The way we are going about it is two-fold. First, with the 
regulations that we want to put in place to provide clarity 
that all fees, whenever an individual is acting in a broker's 
capacity, as distinct from an agent capacity, but in a broker's 
capacity, that all fees be fully disclosed and then to draw a 
bright line about what the proper activity of a person acting 
as a broker could engage in.
    Senator Fitzgerald. Are there greater disclosure 
requirements for the individual lines of insurance, typically?
    Mr. Garamendi. When a producer, a licensed person, whether 
that person is an agent or a broker--as I said, in California, 
it is a dual license. You can be either, and you may be one in 
one circumstance, as an agent, and in a different circumstance, 
acting as a broker. But there is clarity in at least California 
when a person begins to act as a broker. That is, they offer 
themselves as representing the interest of the consumer as 
opposed to an agent who is offering themselves to represent the 
interest of an insurance company. So there is a very clear 
distinction.
    We want to further clarify that with the language of the 
regulations and also to make it clear what activities would 
fall within or without the appropriate fiduciary 
responsibilities of a person acting as a broker. So we want to 
do that. That is the reason for the regulations.
    As I said, we are now engaged with other insurance 
commissioners around the Nation through the National 
Association of Insurance Commissioners to propose a model, 
which could be a law in certain States that don't have that 
clarity in their law, or a regulation for those that have a 
legal foundation to write a regulation. So that is underway. 
Investigations are also underway and will undoubtedly play 
themselves out.
    Now, we are being assisted by private attorneys who are 
bringing suits on behalf of individuals, companies, 
corporations who have been wronged by this entire practice 
which is being discussed here. We will, in California, 
undoubtedly join with some of those private attorneys. We will 
also join with our Attorney General in looking into all of 
these matters and probably bringing suit in various areas. We 
consider it to be a very serious problem.
    I know you are on this question, but before I leave this 
panel, I would like to comment on the proposed SMART 
legislation if you intend to come to that.
    Senator Fitzgerald. Well, we will be interested--Senator 
Akaka has some questions and I would like to allow him and 
Senator Carper, if he has questions, too.
    Senator Akaka. Thank you very much, Mr. Chairman. I would 
like to ask two questions.
    One is to Attorney General Spitzer. My constituents are 
increasingly concerned about the rising costs of their health 
insurance, and it is not only Hawaii but across the country. My 
question is, are the deceptive and questionable practices found 
in property casualty insurance also found in other lines of 
insurance, such as health, and what impact have these practices 
had on the rising costs of health insurance?
    Mr. Spitzer. Senator, it is a little question. I would be a 
little cryptic, only because I don't like to state conclusions 
until we have completed an investigation and filed a 
litigation, but suffice it to say we are finding the types of 
practices that are laid out in both the Marsh and the ULR 
complaints and the various civil and criminal complaints, as 
well, in other lines of business, as well. The various form of 
the overrides, the forms of the incentives may differ, but the 
underlying economic impact is ordinarily the same. It is both 
to create misincentive, distortive incentive, and then to drive 
the cost of premiums up.
    I would just say in response to the Chairman's question 
about how does this manifest itself in other lines of the 
insurance sales marketplace, we have found not only trips as an 
incentive, but also loans and offers of stock that are made to 
individual brokers or agents and repayment for either the loan 
or the stock is contingent upon the magnitude of commissions 
that are generated for the company or sales or the volume----
    Senator Fitzgerald. Stock in the insurance company being 
offered back to the agency?
    Mr. Spitzer. That is correct, and often, whether or not 
there is required repayment----
    Senator Fitzgerald. Stock or stock options?
    Mr. Spitzer. It can be both. But as I say, we are just 
beginning to delve into some of these areas, and sometimes it 
is loans outright, loans of cash, capital, and again, repayment 
schedules and obligations are contingent upon how much business 
is generated in terms of the volume of product of the 
underlying carrier that is sold. So this manifests itself in 
many different ways. But as I said, we have only begun and we 
have limited personnel, so we are delving into this now and we 
will get into it in due course.
    Mr. Garamendi. Just very briefly, we have reason to believe 
that this issue spills over into employee benefits, and that 
would be health care plus other kinds of employee benefits, 
disability and the like.
    Mr. Blumenthal. And in answer to your question, Senator, 
these kinds of arrangements directly raise the cost of 
insurance to your constituents because they add a level of 
private gain that goes into somebody else's pockets. The 
corrosive, corrupting effect on the entire health care system 
cannot be underestimated. I would agree with both of my 
colleagues here that we will see evidence of the same kinds of 
practices in other lines, not just employee benefits, but 
health care and automobile insurance, as well.
    Mr. Serio. If I may, Mr. Chairman and Senator Akaka, one of 
the distinctions, though, for some States on health insurance 
as compared to property casualty, or even other forms of 
employee benefits, such as in New York, we have specific 
statutes with respect to how much commission can be paid on 
certain health insurance products. There are caps. It is 
generally about 4 percent.
    So that gives us at least a bright line standard that you 
don't have that has complicated some of these other issues 
about what is an appropriate compensation level, and that has 
created a statutory model. We put that model into place, first, 
because of the concern over the high price of health insurance, 
and second, because of the large number of not-for-profit 
health insurers in the marketplace. And so we have actually 
been regulating commission structures in the health insurance 
field for a very long time that we do not do in other areas.
    Senator Akaka. Thank you for those comments.
    Mr. Serio, I understand that NAIC is doing much to 
modernize State insurance regulations through efforts such as 
an Interstate Insurance Product Regulation Compact. I am 
pleased that Hawaii is one of nine States, I understand, that 
have enacted this compact legislation. What are the biggest 
challenges to reaching the goal of regulatory uniformity?
    Mr. Serio. I think one of the biggest challenges to 
achieving regulatory uniformity has been the push-back by a 
number of interests in the industry who have been looking for 
regulatory uniformity as a way to get to less regulation.
    We have had an interest. In fact, we have had good 
conversations, both here in the Senate and over in the House, 
on what the commissioners need in terms of creating a better 
and a more modern regulatory structure. In fact, we were very 
pleased that Chairman Oxley over in the House put many of the 
things that appeared in what we called the NAIC road map into 
the first SMART bill draft, including greater financial 
surveillance, including greater oversight in receiverships and 
things of that nature, because those are things that we have 
identified to the Congress, shortcomings in the current State 
legislative structure for powers to the regulators.
    This is actually very relevant to the conversation we are 
having here today because a lot of these problems that have 
come up in the past have usually found themselves in the forms 
of insolvencies, that people had been untowardly using the 
insurance process to drive a company into insolvency. In the 
1980's, it was broker control that led to insolvencies of 
insurance companies. In the early 1990's, we had the same 
problem.
    This situation is a little different, but as I said 
earlier, I think broadening out the financial surveillance 
powers of the insurance departments as is being proposed in the 
SMART bill will give us a great leg up from where we currently 
stand with respect to being able to modernize State regulation.
    Senator Akaka. Thank you very much, Mr. Chairman.
    Senator Fitzgerald. Thank you very much, and I want to 
thank this panel. I think you have been terrific. It strikes me 
as I listen to the testimony that there could possibly be no 
end to the amounts of conflicts that you might find, especially 
the attorneys general, in other industries, as well. I was 
thinking about the real estate brokerage area, areas where 
people aren't necessarily fiduciaries.
    I even thought of another one that you may not think of 
very often, but in the media. Last week, I was at the St. Louis 
Post Dispatch at an editorial board interview and they reminded 
me that in 1949, the St. Louis Post Dispatch, together with a 
now-defunct paper, the Chicago Daily News, won a Pulitzer prize 
for uncovering that 32 newspaper editors and publishers in 
Illinois were on the then-Governor Dwight Green's State 
payroll, typically for $10,000 a year, which in 1949, that is 
like $100,000 today, and they won a Pulitzer prize for that.
    So the possibilities of conflicts are almost endless here 
and you give us a lot of food for thought and I think that it 
has been very helpful hearing the testimony from you both for 
Congress and for consumers nationwide. So thank you all very 
much for being here.
    At this point, I would like to take about a 2-minute break 
and then we will reconvene with the second panel.
    [Recess.]
    Senator Fitzgerald. I would like to reconvene this hearing, 
if we could have order in the hearing room.
    I now call on our witnesses for panel two. Our first 
witness is Albert Counselman, President and CEO of Riggs, 
Counselman, Michaels and Downes in Baltimore, and I guess you 
go by Skip, is that right?
    Mr. Counselman. That is right, Mr. Chairman.
    Senator Fitzgerald. Mr. Counselman is appearing today on 
behalf of the Council of Insurance Agents and Brokers, which 
represents the largest of all commercial insurance agencies and 
brokerage firms. Mr. Counselman is a former Chairman of the 
Council. His other insurance industry affiliations include Vice 
President and Director of Professional Agencies Reinsurance, 
Limited, former Chairman and Director of Assurance Global, and 
Director of the American Institute for Chartered Property 
Casualty Underwriters.
    Our second witness is Alex Soto, President of InSource, 
Inc., of Miami, Florida. Mr. Soto is representing the 
Independent Insurance Agents and Brokers of America, known as 
the ``Big I,'' for which he currently serves as Vice President. 
Mr. Soto was elected to the organization's Executive Committee 
in 2001 and has served as Chairman of its Communications 
Committee and the Branding Task Force and Natural Disaster 
Committee. He also served as Chairman and State National 
Director of the Florida Association of Insurance Agents.
    Our third witness is Ernie Csiszar, the President and CEO 
of Property Casualty Insurers Association of America, which is 
headquartered in my home State, in Des Plaines, Illinois, not 
too far from my home. Mr. Csiszar previously served as 
President of the National Association of Insurance 
Commissioners and as South Carolina's Director of Insurance. 
Originally from Romania, Mr. Csiszar has an extensive 
background in business and investment banking.
    Our fourth witness is Janice Ochenkowski--I hope I 
pronounced that right?
    Ms. Ochenkowski. You did.
    Senator Fitzgerald [continuing]. Who serves as Vice 
President for External Affairs for the Risk and Insurance 
Management Society, known as RIMS. She currently is Senior Vice 
President and National Director of Risk Management at Jones 
Lang LaSalle, Incorporated, a global real estate services 
company that is headquartered in Chicago. Ms. Ochenkowski has 
been responsible for risk management at Jones Lang LaSalle and 
its predecessor companies since 1980.
    Our fifth and final witness on this panel is J. Robert 
Hunter, Director of Insurance at the Consumer Federation of 
America. Mr. Hunter has served as Texas Insurance Commissioner 
and as the Federal Insurance Administrator, which handles the 
flood insurance program, I believe?
    Mr. Hunter. It was then, but yes, it does now. It was at 
HUD when I was----
    Senator Fitzgerald. Oh, OK. You were in that position as 
Federal Insurance Administrator under Presidents Ford and 
Carter. Mr. Hunter is an actuary and he is well known as a 
long-time consumer advocate. They could use you to solve our 
pension problems, too. We need some actuarial help on Capitol 
Hill.
    Again, I would like to thank our distinguished witnesses 
for being here today to testify. In the interest of time, your 
full statements will be included in the record and we ask that 
you limit your opening remarks to 5 minutes. Please watch the 
light. Since we have such a large panel, we will adhere to the 
5-minute rule to ensure that there is sufficient time for 
questions.
    Mr. Counselman, you may begin.

   TESTIMONY OF ALBERT R. COUNSELMAN,\1\ PRESIDENT AND CHIEF 
  EXECUTIVE OFFICER, RIGGS, COUNSELMAN, MICHAELS AND DOWNES, 
 INC., ON BEHALF OF THE COUNCIL OF INSURANCE AGENTS AND BROKERS

    Mr. Counselman. Thank you, Mr. Chairman. As you stated, I 
am representing the Council of Insurance Agents and Brokers 
today. The CIAB member firms employ more than 120,000 people 
and annually place more than 80 percent of all of the U.S. 
commercial property casualty insurance products.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Counselman appears in the 
Appendix on page 96.
---------------------------------------------------------------------------
    Insurance brokerage is highly competitive and it is built 
and relies on trust, trust between the broker and the client, 
trust between the broker and the carrier, and ultimately 
through those two relationships, trust between the carrier and 
the client. The ultimate trust between carrier and the client 
is essential because the insurance business is one of promises, 
including the promise of the clients to detail the nature and 
the extent of its risk exposures and the promise of the carrier 
to cover those exposures in case of trouble, accident, or 
tragedy.
    At the outset, we are deeply troubled by the charges of bid 
rigging and fraud brought by Attorney General Spitzer. Such 
activity is not only outrageous, but it is illegal and it has 
no place in an industry that is based on trust. These 
individuals have not only severely damaged their own brokerage 
firm, but they also have cast an undeserved pall on an entire 
industry. They besmirch the reputations of honest brokers 
throughout the country and they have undermined the trust on 
which our industry was built.
    While bad actors created a corrupt scheme to limit real 
choices for some customers, the role of contingent commissions 
in this evil equation has been irresponsibly represented. 
Contingent commission payments were not central to the alleged 
fraud despite the connections that some have claimed. 
Contingent commissions are legal and proper methods of 
compensation that have been used throughout the industry for 
decades. Although they are not a significant source of income 
in most firms, they are nonetheless well understood and 
accepted by the commercial marketplace.
    It is lack of effective disclosure, in some cases combined 
with the intent to defraud, that is at issue, not a systematic 
industry-wide failure to disclose fees or a failure of the 
entire business model, as has been suggested.
    Even so, we realize that there is increased concern and 
confusion in the marketplace and we support clear disclosure of 
this income. The Council had such a policy in place since 
October 1998, recommending precisely such disclosure.
    It is most important that the solution to these examples of 
fraud and this chance to improve disclosure be developed in the 
legislative and in the regulatory cycle and not in the news 
cycle. Contrary to recent news stories, isolated examples of 
abuse should not be equated with an industry-wide system of 
``secret payoffs and conflicts of interest.'' While such 
overheated charges create good headlines and produce new class 
actions for lawyers, they do not represent grounds for a 
stampede to judgment on a wrong-headed solution. Solutions 
should be based on facts and on deliberation, not headlines.
    We don't believe that the fraud Attorney General Spitzer 
uncovered resulted from a failure of the State-based insurance 
regulatory system. The toughest of regulations or laws will not 
stop an individual intent on malfeasance. That said, we also 
believe that regulatory reform is essential for the industry's 
long-term viability because of the inherent inefficiency and 
the confusion stemming from a vast array of overlapping and 
sometimes conflicting regulatory requirements imposed from 
State to State.
    As public policy objectives are pursued, we believe 
lawmakers and regulators must be mindful that the development 
of a relationship between broker and carrier is essential to 
enable brokers to provide the best possible products and 
services to their clients. A strong relationship with the 
carrier gives the broker clout that benefits the customers for 
lower premiums, better coverages, specialized coverages, and 
quicker service and claims payment.
    This is why the characterization of the client-carrier 
relationship as adversarial is misguided. At the end of the 
day, the carrier partners with the client through the broker 
intermediary, not as opponents but in a cooperative way to 
ensure that the risks that a client presents are properly 
covered.
    All the compensation paid to a broker is funded by a 
client, either through direct payments or through the client's 
premium payments. Contingency arrangements established by 
insurers have been a feature of the compensation landscape for 
decades and generally have been well understood and accepted by 
the commercial client base. They replace a portion of the up-
front commissions previously paid to producers and on average 
contribute approximately 4 to 5 percent of a brokerage firm's 
income. On average, for most firms, this represents 1 percent 
of premium volume. Again, we support and encourage client 
disclosure of such commissions.
    To conclude, let me say I am deeply troubled by the 
evidence of egregious conduct uncovered by Attorney General 
Spitzer. Bad actors should be prosecuted to the fullest extent 
of the law and this pattern of behavior must never be repeated. 
But contingent commission arrangements, when properly 
constructed, disclosed, and utilized, fulfill a need in the 
industry to help foster a cooperative insurance environment 
that works to benefit all participants, the commercial client, 
the carriers, and the producers. We strongly support improved 
disclosure and heightened transparency in these arrangements in 
order to remove any potential specter of conflict.
    As I said at the outset, this industry is based on and 
committed to trust, trust between broker and client, broker and 
carrier, and ultimately carrier and client. We stand ready to 
work with the appropriate committee of jurisdiction in the 
Congress and the States to find solutions to the issues raised 
at this hearing to ensure that this trust is maintained and the 
important work of the insurance industry, which is protecting 
people and the economy, continues.
    Thank you, Mr. Chairman.
    Senator Fitzgerald. Thank you, Mr. Counselman. Mr. Soto.

TESTIMONY OF ALEX SOTO,\1\ PRESIDENT, INSOURCE, INC., ON BEHALF 
   OF THE INDEPENDENT INSURANCE AGENTS AND BROKERS OF AMERICA

    Mr. Soto. Chairman Fitzgerald, I am delighted to be here. 
As you already stated, I am Alex Soto. I represent the 
Independent Insurance Agents and Brokers of America. I am a 
volunteer leader within that organization. We have more than 
300,000 independent agents and employees that work and are 
located in practically every town throughout America.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Soto appears in the Appendix on 
page 107.
---------------------------------------------------------------------------
    The way I make my living is as an independent agent in 
Miami, Florida. As you stated earlier, I am president of an 
agency called InSource, Inc. We are primarily a property 
casualty agency, where we sell commercial insurance products as 
well as personal insurance products to customers in our general 
area.
    I echo the comments made by Mr. Counselman in that our 
organization obviously deplores the activities that you have 
uncovered and that Mr. Spitzer has uncovered, issues such as 
bid rigging and market manipulation. Unfortunately, not only 
are they illegal, but they have given all of us, brokers and 
agents and everyone in the industry, a black eye.
    I also concur with the fact that those who are proven 
guilty should be punished swiftly, and again to the full extent 
of the law. And quite frankly, we applaud the efforts of the 
regulators and the attorneys general.
    Senator my world is completely different from that which 
you were describing earlier today of the mega-brokers that have 
the ability and the power to influence and manipulate the 
marketplace. My world, and I want to take a moment to share it 
with you, is one of extreme and high competition.
    You know, in the State of Florida, there are more than 
50,000 licensed agents and solicitors. In my county, Miami-
Dade, we have 5,000 licensed agents and solicitors who I 
compete with every day. On top of that, I am in competition 
with the direct sellers of insurance, those mechanisms that do 
not use an agent. I am in competition with the Internet, 
everyone that is putting wares on the Internet. I am in 
competition with affinity groups, such as the AARP. I am even 
in competition with credit unions that have tie-ins with 
insurance companies.
    And on top of that, one of my major insurance companies 
informs me that more than half of all the business that they 
write in my State, in the State of Florida, is written by 
brokers and agents outside of the State of Florida. So I am not 
only competing with the people in my State, but elsewhere.
    Every day, I must prove myself and the people in my office, 
not only with our prospects, but we must prove ourselves with 
our current customers. When a client invites us to bid on their 
insurance, that is precisely what we are doing. We get no up-
front fee. We get no payment from that client. We simply are 
given an opportunity to do a great deal of work to prove 
ourselves, that there is more value in doing business with me 
and with InSource than their current relationship.
    They define value in being the best price, the coverage 
that they are looking for, the best coverage, the quality of 
the insurance company that is being offered, and the services 
that I provide, my agency will provide to them. If I do not 
prove myself to be a better value in those terms to that 
prospect, I will not be selected. If I am not selected, I do 
not get paid by the client or anyone else and my expense is one 
that I have to eat.
    If I do get paid, obviously, I get paid a commission by the 
insurance company that we place the business with. The 
competitive marketplace keeps agencies responsive and 
accountable, and I think you hit it on the head. More 
competition is better for the consumer. It is the best. What I 
have found over my years in the business are the checks and 
balances.
    We do support, where the brokers are concerned, we do 
support transparency. It goes without saying that those people 
that are paid by the clients and also paid by the insurance 
companies need to make sure that all parties clearly understand 
where the money is, what the money is, and where it is coming 
from, and clearly, those must be agreements that must be 
reduced to writing and approved by both the client and the 
broker. The client obviously can dispute them and simply decide 
to do business with somebody else.
    We do support and we use them, independent agents 
throughout America, contingencies. Contingency is agreement. I 
cannot comment on PSAs or MSAs because I do not receive those, 
and candidly, I am almost embarrassed to admit to you that 
until this all emerged, I really had practically no familiarity 
with even those terms.
    But contingency agreements are legal. They reward 
excellence, as they do in every other transaction, promotional 
transaction in the United States. They are good business 
practices and they do serve a legitimate purpose. It creates an 
incentive for the agent to be a good front-line underwriter in 
the selections of risk and it also incents the agent to be a 
good risk manager in helping the client to put in place 
measures that will help them reduce their losses. When that 
occurs, everybody wins. The client wins, because on an ongoing 
basis, fewer losses will translate into less expensive premiums 
in the future. The insurance company pays less claims and they 
share a little bit of that profit if, indeed, the lower losses 
are there.
    Finally, we believe in State regulation. It has been my 
experience that regulation closer to home is the best 
regulation. Insurance commissioners in my State have taken 
numerous steps to protect the citizens of the State of Florida 
after the four hurricanes that we had, and I saw it firsthand 
after Hurricane Andrew. However, the system needs modernization 
and uniformity, and thus we support the SMART Act. In concept, 
it is a good venue because it will leave regulation at the 
State level, but there will be a certain amount of uniformity 
and modernization. Now, I underscore that this is a draft 
proposal so it needs to be worked on. This will provide 
targeted Federal tools with uniform standards to keep State 
regulations. Thank you, Mr. Chairman.
    Senator Fitzgerald. Thank you very much, Mr. Soto. Mr. 
Csiszar.

TESTIMONY OF ERNST N. CSISZAR,\1\ PRESIDENT AND CHIEF EXECUTIVE 
   OFFICER, PROPERTY CASUALTY INSURERS ASSOCIATION OF AMERICA

    Mr. Csiszar. Mr. Chairman, thank you for the invitation to 
appear today. I am so sorry that this is your last session. I 
would have been delighted to serve as one of your constituents. 
I am a new resident of Chicago, the proud owner of a new 
mortgage in Chicago, so----
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Csiszar appears in the Appendix 
on page 115.
---------------------------------------------------------------------------
    Senator Fitzgerald. Are you registered to vote?
    Mr. Csiszar. Yes, absolutely. [Laughter.]
    Absolutely, so I am so very sorry to see you go because I 
think your leadership role on this Subcommittee in terms of the 
investigation that you have carried on, whether it be with 
respect to Enron, whether it be with respect to the bond 
market, with respect to the investment banking industry in 
which I had a few years' experience a few years ago, I think 
they have been very valuable and have been of extreme 
usefulness, I believe, in bringing abuses to light that 
otherwise might not have been done so.
    I will tell you that, speaking on behalf of over 1,100 
members of the PCI, we welcome your oversight. In fact, we 
encourage your oversight because I, like all the panelists that 
I have heard this morning, I, too, am here to condemn in the 
strongest of terms any criminal--and I will go beyond 
criminal--any criminal, any deceptive, any anti-competitive 
conduct on the part of any member of a market.
    We truly have a large market in the insurance industry and 
it is a market that is based on trust, public trust in 
particular. Any activity that impedes on that public trust is 
activity that must be condemned and it must be stopped.
    In addition to that, any activity such as criminal, 
deceptive, anti-competitive activity also impedes on that free 
flow of information, that free flow of accurate information 
that is the very foundation of an efficient market, if you 
will.
    So we really think that these allegations, and I think they 
certainly look like they are going to be proven, are 
allegations that point to conduct that is absolutely 
deplorable. As I said, my 1,100 members welcome this.
    Having said that, I also want to make a few comments about 
the industry itself, because I have heard you and others this 
morning speak about this cartel arrangement and so on. To some 
extent, I think there is a good deal of truth in that. But what 
I would like to draw the Subcommittee's attention, and Mr. 
Chairman, you in particular, your attention to is the fact that 
there are over 2,700 companies that compete in this business. 
There are over 1.9 million people who are involved directly in 
the distribution of insurance products. It is a highly 
fragmented industry when you look at it overall.
    Now, in this particular segment of the market, of course, 
the brokerage market, it is very true that three players, from 
what I understand, controlled 80 percent-plus of the market. So 
it is very highly concentrated. But overall, the market is very 
fragmented and the returns in that market prove it. If you look 
at insurance returns over the long term, they tend to be in 
single digits. In fact, some would argue that there is an 
inverse risk relationship at work when it comes to the 
insurance market, too much risk for too little return, if you 
will.
    So it is a market that is very competitive, not just from a 
distribution standpoint but from a carrier standpoint as well 
as a reinsurer carrier. There are any number of reinsurers in 
the United States. There are a number of reinsurers in Bermuda. 
The Lloyd's market is also very active in this. The London 
market, in general, is active. So overall, it is a very broad 
industry. It tends to be a highly competitive industry and our 
point very simply is that what we are seeing here emanates in a 
very specific and a very narrow segment, albeit a very 
profitable segment of the insurance industry.
    As regards contingency fees, our view is, first of all, one 
of the problems with these agreements is I swear they shouldn't 
even be called contingency fees because they are taking the 
contingency out of it. In fact, if anything, there was a good 
deal of certainty attached to some of these agreements that the 
commissions would be payable. There was very little about them 
to be contingent.
    A true contingency agreement, however, such as the one 
described by Mr. Soto here, truly addresses a maybe, a perhaps. 
It is not tied to a specific policy. It is not tied to the 
placement of a specific policy. It is tied to overall volume, 
and quite often it is also tied to overall profitability, and 
oftentimes that profitability doesn't emerge until years later. 
Workers' compensation, for instance, it is a long tail line. So 
whether it is profitable or not sometimes takes years to 
determine.
    So it is not as simple as Mr. Spitzer would like it to be, 
perhaps, and quite frankly, we see contingent commissions as 
nothing more than mutual instruments. They can be used and they 
can be abused, as they were in this case, I believe. There is 
no reason to ban contingent commissions. What we suggest, of 
course, is that we take a true transparency, a true disclosure 
route to this, and that, in fact, we take one that is 
relatively uniform.
    One of the problems with State regulation, and I believe, 
having been a regulator, I wholeheartedly agree with the need 
to modernize State regulation. The fact of the matter is, a 
uniform approach in terms of good, solid transparency and 
disclosure, we believe would solve the problem.
    My time has run out and I will leave it at that. Thank you.
    Senator Fitzgerald. Thank you very much. Ms. Ochenkowski, 
thank you for being here.

TESTIMONY OF JANICE OCHENKOWSKI,\1\ SENIOR VICE PRESIDENT, RISK 
MANAGEMENT, JONES LANG LASALLE, AND VICE PRESIDENT FOR EXTERNAL 
         AFFAIRS, RISK AND INSURANCE MANAGEMENT SOCIETY

    Ms. Ochenkowski. Good afternoon, Mr. Chairman. As a 
lifelong Illinoisan, I, too, would like to thank you for your 
efforts on this Subcommittee and the work that you have done to 
restore integrity into the governmental process. We all 
appreciate it.
---------------------------------------------------------------------------
    \1\ The prepared statement of Ms. Ochenkowski with an attachment 
appears in the Appendix on page 123.
---------------------------------------------------------------------------
    I am here representing the Risk and Insurance Management 
Society, which is the largest professional organization for the 
risk management community. We appreciate the opportunity to be 
heard on this issue.
    Our member companies, which number over 4,000, are 
commercial insurance consumers and we are directly affected by 
the issue of broker compensation and placement practices. Our 
membership spans the country and consists of entities in all 
different industries and sizes, including 84 percent of the 
Fortune 500 companies as well as approximately 950 small 
businesses, which we define as those with fewer than 500 
employees. Many of our member companies have full-time risk 
management departments, while some rely solely on brokers for 
services.
    RIMS has always believed that the relationship between 
brokers and insurance consumers should be governed by the 
principle of complete transparency. We emphasized this position 
initially in 1999 and again in a statement issued in August of 
this year that provides that broker compensation and placement 
agreements should be transparent, with all sources of 
compensation, direct and indirect, disclosed without client 
request prior to the placement of business and annually by line 
of coverage. A complete copy of that statement is attached to 
my testimony.
    RIMS is shocked by the recent allegations of illegal 
activities by certain brokers and insurance companies in the 
placement of insurance contracts. We have been particularly 
distressed by the findings and allegations of New York Attorney 
General Spitzer that insurance brokers have violated their 
position as trusted advisor to their clients by steering 
clients to favor the insurance company and engaging in bid 
rigging schemes. Such activities undermine the trust and 
confidence that are at the heart of the customer-broker 
relationship. Our President, Nancy Chambers, issued a statement 
addressing this issue on October 22, a copy of which is 
attached to my testimony.\1\
---------------------------------------------------------------------------
    \1\ Exhibit A and B appears in the Appendix on page 128.
---------------------------------------------------------------------------
    Insurance brokers are an integral part of the insurance 
placement system. Brokers serve as intermediaries between 
commercial customers and insurers. Traditionally, brokers 
represent their customers while insurance agents represent 
insurance companies. Commercial insurance transactions are 
often very complex and brokers are essential to finding 
available insurance coverage to meet their customers' needs.
    RIMS, itself, is not a standard setting body for the 
insurance industry. RIMS does, however, place great emphasis on 
educating and advising its members about current issues and 
providing them with useful tools to deal with these issues, and 
this is the approach taken by RIMS with respect to contingent 
fees.
    As the use of placement service agreements and contingency 
arrangements became popular with some insurance brokers and 
insurance companies in the 1990's, RIMS advised its members of 
these practices. In 1999, RIMS issued a disclosure statement 
whereby brokers would disclose insurers with which they had 
contingency fee agreements upon the clients' request. Brokers 
and insurance companies declared at that time that contingent 
fees represented only a small part of total fees, and as such, 
our approach seemed appropriate.
    RIMS followed up on that 1999 statement through institution 
of a quality improvement process in 2000, which is a 
comprehensive program designed to guide and facilitate quality 
improvement for risk managers. We use these guidelines to 
improve communication, develop performance expectation 
agreements, and to evaluate broker performance under these 
agreements. This agreement states that all remuneration for 
services should be disclosed to the client while complying with 
local insurance laws.
    Further, in representing the interest of risk managers, 
RIMS provides workshops, discussion groups, and other 
educational programs that address the most pressing issues of 
the day. In fact, for the past 3 years, at its annual 
conference, RIMS has explored the many facets of the client-
broker relationship through a series of sessions. We believe 
that by educating our members, they will be fully equipped to 
evaluate potential conflicts of interest in the placement of 
insurance policies.
    As the facts are becoming known and the investigation into 
placement service agreements continues, in an effort to address 
the potential conflict of interest issue, RIMS would support a 
prohibition on the use of placement service agreements by 
insurers and brokers. Three of the largest brokers have 
publicly stated they will no longer enter into placement 
service agreement or accept contingent fees. Such actions, 
coupled with compensation disclosure, should bring greater 
transparency to the broker-client relationship and help to 
restore trust and confidence.
    Whatever actions legislators and regulators decide are 
appropriate to address the issues of placement service 
agreements and contingency compensation, the interests of 
insurance consumers must be considered. Consumers should not 
have to pay higher costs for insurance because of abusive 
actions that may have been taken by some brokers and some 
insurers. And hopefully, any remedial action will result in 
lower costs for insurance for consumers by eliminating improper 
actions that might have increased these costs. The recent 
allegations against several insurance brokers in New York have 
been very troubling. These allegations have not only undermined 
the broker-client relationship, but they have wider 
implications for the industry as a whole. And any penalties 
that may ultimately be levied against these companies involved 
should be used to offset consumer losses that have resulted 
from these deceptive practices.
    We understand that the NAIC is preparing to address the 
broker compensation issue and that one approach in their agenda 
is the adoption of a model law on disclosure of broker 
compensation arrangements. RIMS believes that a national 
uniform approach should be taken to address this issue. 
Regulatory clarity and uniformity are needed, not 51 different 
approaches.
    Thank you for this opportunity to testify on this important 
issue. RIMS looks forward to working with you and your 
Subcommittee and with Congress to address this issue and we 
appreciate your time and interest and leadership. Thank you.
    Senator Fitzgerald. Thank you very much. Mr. Hunter.

   TESTIMONY OF J. ROBERT HUNTER,\1\ DIRECTOR OF INSURANCE, 
                 CONSUMER FEDERATION OF AMERICA

    Mr. Hunter. Mr. Chairman, on behalf of CFA's 50,000 
Americans, we would like to thank you for what you have done in 
your tenure. It has been terrific. You are one of our heroes 
and we would like to publicly say that.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Hunter appears in the Appendix on 
page 130.
---------------------------------------------------------------------------
    Senator Fitzgerald. Thank you.
    Mr. Hunter. There are four major issues that we see from 
the Spitzer investigations.
    First, and of greatest importance, the investigation 
reveals how easily sophisticated buyers of insurance can be 
duped by brokers, agents, and insurers. Imagine the potential 
for abuse with small businesses and individuals as they try to 
manipulate the insurance marketplace. It is a highly complex 
marketplace. They are buying legal documents they don't 
understand. They need help, so they go to people and say, take 
me. Help me. They are vulnerable.
    They have to not only find out whether they are comparing 
like policies, they have to look at the solidity of the 
insurer, they have to look at the service record because they 
can't kick the tires. They may not have a claim for years. They 
have to go through the underwriting process. And then they have 
the complex pricing systems, credit scoring, where you live, 
all these things, many determining price.
    This complexity causes weak competition at all levels of 
this business, not just for large businesses. CFA review of 
rates charged, for example, show that it is easy for the exact 
same insured to pay two to three times within the market. A 
competitive market should have a narrow range, not a range like 
that. In Hawaii, for example--I wanted to use Illinois, but 
they don't produce this information--in Hawaii, a clean auto 
risk, buying liability coverage, can pay $397 from USAA or $993 
from Geico Casualty--same exact risk. Figure that out.
    In 2003, the property casualty insurance industry paid 
contingency commission kickbacks of $4.2 billion.
    Second, the findings of bid rigging are a reflection of the 
deeply rooted anti-competitive culture that exists in the 
insurance industry. The culture derives from what you pointed 
out, the antitrust exemption in McCarran. We still see cartel 
rating organizations setting large parts of insurance rates for 
many companies, determining what future costs will be, and the 
FTC is handcuffed.
    Thus, in November 2003, industry executives could freely 
meet to discuss pricing. ``Let us not get pulled into a soft 
market. We are not ready for a soft market. We can't afford 
one. We need several more years of profitability,'' said James 
Schiro, CEO of Zurich Financial. Responding, Maurice Greenberg, 
Chairman and CEO of AIG, said, ``As an industry, we saw much 
further to go to even get to a marginally acceptable return. We 
absolutely need to hold the line on pricing and not give in to 
competition.'' That is the industry.
    Third, the Spitzer complaint shows that insurance 
regulators have utterly failed to protect consumers and to 
properly regulate insurers and brokers in a number of key 
aspects. To make matters worse, many of these regulators 
recently collaborated with insurance interests to deregulate 
particularly commercial insurance and especially the so-called 
sophisticated lines that we are now seeing were abused.
    Finally, the Spitzer investigation makes clear that 
consumer protection standards must be raised, not lowered as 
the industry is pushing for.
    There are five steps we would ask you to consider, three of 
which you mentioned, so I am going to go short on those.
    One, you should do no harm. Congress should do no harm. You 
should stop consideration of bills that would weaken consumer 
protections. We urge Congress not to enact optional Federal 
charters that would result in concentration, as it did in 
banking, or create a rush to the bottom as regulators compete 
to get share.
    We also urge that Congress stop consideration of the so-
called SMART Act. The SMART Act actually goes so far as to 
completely deregulate the cartel rating organizations but leave 
the Federal antitrust exemption intact. That is crazy, but that 
is what is in it.
    Senator Fitzgerald. If I can interject, what are the rating 
organizations----
    Mr. Hunter. The rating organizations are like the Insurance 
Services Office and the National Council on Compensation 
Insurance. They establish loss costs, the major part of the 
rate. They do it jointly. They project the future for what are 
the costs going to be next year. They get together and do this. 
It would be like building contractors getting together and 
agreeing on the price of bricks for next year and labor. It is 
clearly, if you look at the House Judiciary Committee hearings, 
it clearly would violate antitrust law if the antitrust law 
were applied, but it is not.
    The insurers do need to have some joint historic data, but 
all the testimony was that you don't need the antitrust 
exemption for that. As long as you truly use historic data and 
don't manipulate it, you can have that. But the manipulation of 
data is where the problem lies.
    Second, we suggest considering a Federal minimum standards 
bill for States to enforce. States have been gutting consumer 
protections in recent years in an attempt to hold off the 
Federal interest. They have been trying to keep the insurers on 
their side by saying, look, we can go even lower than those 
guys are willing to go, and they have been gutting regulations. 
It has been interesting since Spitzer's investigation to see 
them sort of get almost a stiff neck as they try to turn around 
to go back and say, we are trying to regulate.
    They have market conduct studies. They should have caught 
this. They go in with these market conduct and financial 
investigation studies and they catch nothing. The same thing 
happened with life insurance abuses a few years ago, when 
Prudential and all ended up having to pay billions because of 
lawsuits. They don't catch anything.
    If there is to be a Federal standards approach, the 
standards need to be high. I list some in my testimony. I 
hasten to say, even with high standards, a Federal approach is 
fraught with risk since the Federal regulatory expertise and--
there is a strong possibility that any Federal regulator would 
be subject to regulatory capture just as the States have been. 
Therefore, there needs to be well-funded approaches so that 
there can be a consumer advocate representing consumer 
interests.
    Third, unleash the FTC. I am not going to say any more 
about that. You have already talked about that.
    Fourth, repeal the antitrust exemption. I am not going to 
talk any more about that. I just think it is obvious that this 
industry has an anti-competitive history and it still functions 
that way.
    Fifth, require transparency. For over 20 years, consumer 
advocates have called for disclosure similar to an energy 
efficiency ranking you see when you shop for a refrigerator. We 
suggest that Congress would require a point-of-sale disclosure 
of the insurance policy value. The disclosure would show the 
expected payout per dollar of premium--how much you are going 
to pay out in claims, commissions, contingency commissions, 
overhead, profit, etc., and the actuaries know the figures 
because that is the way they set the rates.
    Right next to it, you would display the same information 
for this product for the overall industry. Consumers could 
focus on, for example, the part of the premium expected to be 
paid out in losses. If the consumer was considering a policy 
that would pay out 50 cents per dollar but the industry average 
was 70 cents, the consumer would know this is a bad deal and 
ought to drop it.
    I am way over my time. Sorry.
    Senator Fitzgerald. Thank you very much.
    All of you have had great testimony, all a little bit 
different angles, and all of you represent different 
constituencies. Just for the sake of our audience and people 
who may be watching this on C-SPAN at home, Mr. Counselman, you 
represent the Council of Insurance Agents and Brokers. 
Essentially, you represent the larger brokers----
    Mr. Counselman. We include in our membership the larger 
brokers, but our members include small brokers, as well. But 
our distinctive character is commercial insurance.
    Senator Fitzgerald. But Marsh and McLennan and AON----
    Mr. Counselman. They are also members.
    Senator Fitzgerald. Mr. Soto, you represent the Independent 
Insurance Agents and Brokers of America, the smaller agents, is 
that correct?
    Mr. Soto. That is correct. The average size of our 
membership is probably 10 to 12 employees.
    Senator Fitzgerald. Are Marsh and McLennan and AON, are 
they also members of your association?
    Mr. Soto. Some of their branch offices have joined our 
State organizations. On a national basis, they are not a 
member, the parent companies. Neither are those large brokers.
    Senator Fitzgerald. OK. Mr. Csiszar, you represent the 
Property Casualty Insurers Association of America. You 
represent the carriers as distinct from the brokers, correct?
    Mr. Csiszar. Yes.
    Senator Fitzgerald. Now, Ms. Ochenkowski, you represent the 
Risk and Insurance Management Society, which is, you said, 80 
percent of Fortune 500 companies. These are the purchasers of 
large corporate insurance policies, and so you are representing 
clients of insurance brokerage firms and underlying carriers.
    Mr. Hunter, you represent the Consumer Federation of 
America, which represents the little guy, the ordinary 
consumer. So I just wanted to have that straight for all our 
audience members.
    Mr. Counselman, you defended the contingent commissions.
    Ms. Ochenkowski, you said you would be happy to see the 
elimination of the placement service agreement, which is the 
form of contingent commission agreement or arrangement that 
Marsh and McLennan specifically had. You weren't as clear about 
whether you support--you didn't say, if I listened carefully, 
that you support prohibiting contingent commissions. You said 
you support prohibiting placement services agreements. Do you 
still think contingent commissions should be allowed?
    Ms. Ochenkowski. To be clear, we would support the 
prohibition of all of those forms of the contingent commission 
as well as the placement agreements. We have found through the 
information that has been provided in recent weeks that all 
forms of this compensation seem to put people in the position 
of behaving differently than they would if these agreements 
didn't exist. And as has been pointed out, the existence of 
contingent agreements in theory has not been illegal and we 
have not supported their abolition. But when we look at this 
entire issue, we think that--our position has evolved over time 
and we are in support of abolishing all of----
    Senator Fitzgerald. And you would like your members, these 
big companies that are trying to get insurance now, you think 
you want the brokers to clearly be working on their behalf, not 
be also accepting compensation from the insurers, is that 
accurate?
    Ms. Ochenkowski. Yes.
    Senator Fitzgerald. Now, Mr. Counselman, what do you say to 
your customers? They don't want you getting payments from the 
insurance carriers as well as from the buyers of the policies.
    Mr. Counselman. Mr. Chairman, you raise a good point. My 
concern is that there is an understanding of what a contingent 
commission is versus a placement service agreement which could 
be called a form of contingent compensation. But the contingent 
compensation that I am focusing on in particular in my 
testimony is loss ratio driven. It is provided by the insurer 
as part of the commission compensation package.
    Senator Fitzgerald. OK. Let me stop you right there. There 
are different types of contingencies. Typically, you can get 
paid for bringing in business to the insurance carrier that has 
a low loss ratio. In other words, the carrier is trying to 
incentivize you to go out and bring them good customers who 
aren't going to run up the losses.
    Mr. Counselman. Correct.
    Senator Fitzgerald. There are other types of contingent 
agreements that just pay you for bringing more policies from 
wherever it comes, revenue.
    Mr. Counselman. Correct.
    Senator Fitzgerald. Now, you run an insurance brokerage, 
correct? What is the name of it?
    Mr. Counselman. Riggs, Counselman, Michaels, and Downes in 
Baltimore.
    Senator Fitzgerald. OK. Do you accept contingent 
commissions?
    Mr. Counselman. Yes, we do.
    Senator Fitzgerald. And how are they based?
    Mr. Counselman. They are based--there are many, because the 
companies present them to us, so we have many from many 
different companies. The majority, more than 50 percent, are 
loss ratio based. They are not all loss ratio based----
    Senator Fitzgerald. Do you deal with any carriers who don't 
pay you a contingent commission?
    Mr. Counselman. Some carriers do not. The majority of the 
major carriers do----
    Senator Fitzgerald. And do you steer many of your clients 
to those? Do you put many of your clients into the carriers who 
don't pay you a contingent commission?
    Mr. Counselman. Absolutely, because the primary concern, 
and this would be true for all agents and brokers, the primary 
concern is to place the proper client in the proper insurer for 
their situation. The secondary concern for all agents and 
brokers is what is the compensation. But as has been pointed 
out, disclosure and transparency are what allow that to happen.
    Senator Fitzgerald. Do you disclose your arrangements to 
your customers?
    Mr. Counselman. Yes, Mr. Chairman, we do, and we----
    Senator Fitzgerald. You are not required to, though, unless 
they ask, is that correct?
    Mr. Counselman. That is correct, but we think it is a good 
practice to do so.
    Senator Fitzgerald. Do you even if they don't ask?
    Mr. Counselman. If they don't ask, we still think it is a 
good practice to do so.
    Senator Fitzgerald. But do you?
    Mr. Counselman. We do on the majority--many of our 
commercial presentations. We do not typically on small 
commercial, meaning very small clients who don't seem to have 
interest in that. But if they did, we would be pleased to 
provide that information, and we don't on personal lines.
    Senator Fitzgerald. But you always put your clients in the 
policies with the carriers that are best for them. You don't 
let the extra payments from the carriers influence or cloud 
your judgment?
    Mr. Counselman. If we didn't do the latter, if we didn't 
always put clients in the best insurer for their circumstance, 
we would not be in business for very long because our 
environment is--it is a competitive environment and it is the 
right thing to do. I mean, if I were a client, I want to be 
treated that way.
    Senator Fitzgerald. I tend to agree with it with respect to 
the smaller commercial clients. Now, do you have any Fortune 
500 clients?
    Mr. Counselman. We do have a handful, but not very many.
    Senator Fitzgerald. OK.
    Mr. Counselman. We do have some, however.
    Senator Fitzgerald. OK. But below the Fortune 500 or the 
Fortune 1,000 companies, there is a lot of competition amongst 
insurance brokers and I would have to say that my conclusion 
would probably be that contingent commissions, if there is a 
firm consistently steering their clients to poor policies in 
consideration of the contingent fees that they are receiving, 
they are not going to do very well for very long as an 
insurance brokerage, and----
    Mr. Counselman. There is also the distinction of 
contingents are different in different lines of business. In 
some lines of business, they are paid. In other lines of 
business, they are not paid.
    Senator Fitzgerald. Where are they paid and where are they 
not paid?
    Mr. Counselman. They are, for example, typically paid for 
property insurance, automobile, general liability. They are 
typically not paid for what are considered the higher risk, 
less predictable lines of coverage, like umbrella excess 
liability, the high limits of excess exposure or umbrella 
liability exposure. They are not paid typically in professional 
liability lines of business, directors and officers----
    Senator Fitzgerald. How about health insurance?
    Mr. Counselman. Health insurance, they are quite often paid 
and they are quite often--they are more often in health 
insurance related to premium volume and not to loss ratio.
    Senator Fitzgerald. OK.
    Mr. Counselman. So that is why I say that more than 50 
percent in the business are loss rated, but there are many that 
are not.
    Senator Fitzgerald. OK. Continuing my thought, I think 
there is, for the smaller companies and for individuals, there 
is plenty of competition, but with respect to the largest 
companies, the Fortune 500 companies, it appears two insurance 
brokerage firms, Marsh and McLennan and AON, have 70 percent of 
the business. So companies in RIMS, Ms. Ochenkowski's 
association, you are typically going to have a choice of just a 
handful of insurance brokers and they have an awful lot of 
leverage with you. Why is it that your members don't go to 
other smaller firms? Or why is it that they stick with Marsh 
and McLennan or AON?
    Ms. Ochenkowski. Well, Mr. Chairman, we have not done a 
study of this, but my own observations would be that most of 
the larger companies have much more complex insurance 
placements and so they have more sophisticated advisory needs. 
It has been perceived, rightly or wrongly, that the larger 
insurance brokers are capable of delivering that more 
sophisticated analysis. They have additional ancillary services 
such as loss control services, actuarial services, etc., that 
are available to commercial insurance buyers and those have 
been helpful in assessing the underlying risks.
    Senator Fitzgerald. So your biggest members of your 
association feel they have to go to one of these really big, 
behemoth insurance brokerage firms like Marsh, AON, or Willis 
in order to get the services they need? That doesn't give you 
many options, does it?
    Ms. Ochenkowski. It does not.
    Senator Fitzgerald. Are you worried about the concentration 
amongst the large insurance brokers?
    Ms. Ochenkowski. We certainly are becoming more concerned 
about it. However, as we have seen competition and we have felt 
that in terms of risk management and the quality process that 
we have, in terms of the way in which risk managers have 
evaluated the bids that have been placed with them, the 
procedures that we have used internally, until the recent 
Spitzer allegations, we felt that those practices were 
sufficient to steer us in the proper direction.
    Quite frankly, I think that is still truly the case except 
for those extraordinary incidences of fraud, where there is 
price steering and bid rigging. We are very closely watching 
the investigations that are going on so that we can better 
understand what the implications are for us as a whole.
    Senator Fitzgerald. Now, Mr. Csiszar, you represent the 
insurance carriers themselves. Aren't you worried about the 
concentration at the insurance brokerage level for large-dollar 
corporate policies? Isn't there a danger for some of your 
association members who refuse to play ball with a Marsh and 
McLennan or an AON, that they could simply move the whole swath 
of customers away from you and put them with another insurer 
who pays them a higher commission?
    Mr. Csiszar. Let me make it clear, Mr. Chairman, that in 
the case of our members, and I think this applies to the 
industry in general, we deal with agents as well as brokers and 
the brokers are but one small part of that business. I don't 
have the numbers, but my estimate would be that, by far, the 
largest amount of business comes in either through your 
employees as agents or captive agents. By far, the largest 
volume of business would come from either a Geico-style 
operation, where your own employees are agents, or you have 
captive agents, or you have independent agents. The brokerage 
business is but one part, a separate part, of what the carriers 
do.
    To the extent that you would have anti-competitive behavior 
of whatever kind going on in that segment of the market, yes, 
indeed, we would be very concerned about that.
    Senator Fitzgerald. How many of you have read the Spitzer 
complaint against Marsh and McLennan? Have you all read it?
    Mr. Soto. Parts of it.
    Senator Fitzgerald. Parts of it. There is a section in 
there in which the New York Attorney General's Office describes 
how Marsh and McLennan ordered their people to yank policies 
from carriers who weren't giving them much in the way of 
contingent commissions and move it over to carriers who were 
paying them more of a commission. That is pretty incredible, 
isn't it?
    Mr. Csiszar. Very much so. Very arrogant behavior, I would 
say--beyond arrogance.
    Senator Fitzgerald. Now, it seems to me that this kind of 
rogue behavior would not succeed for very long in a very 
competitive market, but where you have two big brokerage firms 
with 70 percent of the market and the top three maybe 80 
percent of the market, they can behave in this kind of abusive 
way. Do you agree with----
    Mr. Counselman. Mr. Chairman, I don't agree that is a 
prevalent practice, what has been described. I don't disagree 
that it occurred and I don't disagree that it is a problem. But 
Marsh and AON have a large percentage of the market--I have 
heard 80 percent said several times today--of a certain segment 
of the business. That may be 80 percent of the Fortune 1,000 
business. It may be 80 percent of the Fortune 500 business. I 
don't know which it is.
    But in many markets, our members, the Council of Insurance 
Agents and Brokers members, are the dominant or the largest in 
their market. There are some cities where Marsh or AON are the 
largest. There are many cities where they are the largest. But 
there are many other cities where they are not dominant. That 
may mean there is different behavior that we observe in 
different cities.
    Senator Fitzgerald. How about where you are in Baltimore?
    Mr. Counselman. They are not the dominant----
    Senator Fitzgerald. Are you dominant?
    Mr. Counselman. We are dominant in our market.
    Senator Fitzgerald. What market share do you have in 
Baltimore?
    Mr. Counselman. I don't even know, but it would be probably 
well less than 10 percent. It is probably less than 5 percent, 
if even--it is probably less than 1 percent. I don't know the 
numbers, because it is the kind of market that Mr. Soto 
described, where there are thousands of agents who are 
competing every day.
    The Washington, DC market, which is not very far from where 
I live, is a different market and that market tends to be more 
dominated by a few small brokers. So the market is different.
    My point is that in the whole commercial marketplace, Marsh 
and AON are significant because they are so large, but so are 
all of the others collectively. And so whatever rules or laws 
may need to be amended, we also need to understand what is the 
impact on the rest of that market, which may be as large as 50 
percent. It is not that Marsh and AON have 80 percent of the 
total market. They may have 80 percent of their target market.
    Senator Fitzgerald. Now, you defend the contingent 
commissions and you don't believe that it led to the bid 
rigging, but in the Spitzer complaint, he talks about the added 
fees as being a big incentive, and it is clear if you read the 
complaint that the added fees they could get from contingent 
commissions were one of the reasons they tried to rig bids in 
certain circumstances so that they could place the insurance 
with a carrier who would give them more of a kickback.
    Let me just read one paragraph from the Spitzer complaint. 
This is paragraph 35 on page 12. ``Marsh executives have issued 
directions about specific companies, as well. For example, in 
April 2001, a global brokering managing director in the excess 
casualty group in New York wrote to the heads of regional 
offices. She asked for, 1,920 accounts that you can move from 
an incumbent insurance company to a company that had just 
extended its contingent commission agreement.' She warned, 
however, `You must make sure that you are not moving business 
from key contingent commission companies.'' So she is saying, 
just move it from the companies that aren't paying us big 
contingent commissions. Highlighting the incentive represented 
by her directive, she concluded, ``This could mean a fantastic 
increase in our revenue.''
    Mr. Counselman, you don't believe this is a conflict of 
interest when the broker is accepting payments from the 
carriers to steer business to them?
    Mr. Counselman. What you just described to me is a conflict 
of interest. But Marsh and AON--I presume AON. I don't know if 
AON has global brokering like Marsh did as described in 
Attorney General Spitzer's suit. But what is described in 
Attorney General Spitzer's suit is the centralization of the 
marketing or placement of the business in conjunction with 
these placement service agreements. What goes on in the 
majority of our members' offices is placements in different 
companies, insurance companies, are done in those individual 
offices throughout the country where the client is located.
    Senator Fitzgerald. Each office may have their own 
contingent commission agreement. And Marsh used to be that way 
and then they centralized it in New York and then they sent out 
directives from New York to all the branch offices that are 
here, are the ones who are paying us the most nationwide and 
you need to steer your customers to buy their insurance from 
these carriers.
    Mr. Counselman. That is what I have read and that is what 
is quite different from what we experience day to day in the 
marketplace, which is why I am urging caution, because we are 
in numbers more firms and more individuals and a very 
significant part of the insurance marketplace and how insurance 
is placed in individual offices close to the client with 
individual agreements.
    Senator Fitzgerald. Mr. Soto, in the small insurance 
market--you represent the smaller agents--does your office in 
Miami, do you accept contingent payments from insurers?
    Mr. Soto. Yes, we do, Senator.
    Senator Fitzgerald. Would you accept them on, say, an 
individual coming in to place automobile insurance with you?
    Mr. Soto. We have insurance companies that pay us 
contingency commissions in commercial lines as well as in 
personal lines.
    Senator Fitzgerald. So should consumers of personal 
insurance around the country be worried that their small broker 
is getting a contingent fee from the insurance carrier?
    Mr. Soto. Excellent question. In theory, yes. In actual 
practice, that marketplace dictates that I have got to come up 
with the very best or I will lose it. If you look at the 
history----
    Senator Fitzgerald. Because you have lots of competition.
    Mr. Soto. Yes, and if you look at the history of what has 
happened in personal lines in the United States, about 30 years 
ago, the independent agency system actually dominated personal 
lines, and then a number of direct writers and captive agents 
created a model which was very competitive. They drove down the 
cost not only in terms of the overhead, but loss control, and 
over time, because of competition, because insureds over the 
years found that that model was very attractive, books of 
business shifted over to the point that we now control about 30 
percent of the marketplace. The companies that we do business 
with have reacted to that and become more competitive, more 
aggressive, and I can give you a couple of examples.
    For example, there is one company that sells directly to 
the clients and pays no commission and has no contingency 
arrangement, but we can beat and love to compete against that 
particular company because those expenses have not disappeared. 
They have internalized them and they spend a substantial amount 
of the premium dollar in advertising, which is not an arena 
that we are talking about here.
    The companies that I do business with, the model that they 
have created is one where I go out and get the client. I do 
some individual advertising in my community, in the churches, 
in the Kiwanis and all of that and I attract business and I can 
compete very well with those individuals. But at the end of the 
day, if I don't bring more value, they will not change their 
insurance to me so it is hari kari, economic hari kari for my 
office to not look at the bottom value.
    Senator Fitzgerald. Mr. Hunter, what about that? If we 
eliminated or prohibited contingent commissions, do you think 
consumers would really wind up saving money, and are you sure 
they wouldn't suffer by not having as good of services on the 
part of their agent or on the part of their broker?
    Mr. Hunter. There is no doubt they save money because, 
first of all, the individual and small business market is not a 
sophisticated market and it frequently doesn't do much 
shopping. It goes to an agent and the agent says, I represent 
ten companies. They think the agent will shop. There are no 
suitability requirements. If they have a captive person, they 
can put them in the higher-price company. That is why you have 
rates so incredibly wide apart.
    I had a dean of a law school call me. He was furious 
because he was in AllState and he thought he had a good rate 
but he was in the AllState. He was not in insurance, he was in 
indemnity and he had been in there for 10 years, but he always 
qualified for the low rate. He was paying twice as much. He 
only found out by chance. He brought a lawsuit and he got his 
money back. But that is a sophisticated consumer who thinks 
they are doing well. This is a complex thing, a lot of same-
name companies and all that.
    But even more concerning than the sales incentives are the 
profitability contingent commissions, and I think we are going 
to see something about that. Lots of people have been told not 
to file small claims lately by insurance agents and brokers, 
particularly in the last few years. So you can easily devise a 
hypothetical where someone coming in late in the year might be 
the--that $1,000 fender bender might lose the contingency for 
that loss ratio profitability. It is a danger. It is a 
temptation. I don't know of anybody doing it, but I didn't know 
what was going on with Marsh and McLennan, either.
    Senator Fitzgerald. Perhaps we should be more concerned 
about the contingent fees being charged of ordinary consumers 
than we are concerned about contingent fees being charged of 
the large Fortune 500 or 1,000 companies. Should Congress 
really care if Marsh and McLennan or AON skin IBM or 
Caterpillar? Should we care about that?
    Mr. Hunter. Absolutely, from a consumer point of view, 
because they are going to pass through the cost to us.
    Senator Fitzgerald. They are going to pass it on to us, OK. 
But certainly we should be concerned about it in the case of 
ordinary consumers getting their homeowners' or automobile 
policies. Mr. Csiszar.
    Mr. Csiszar. Mr. Chairman, I think--I keep coming back to 
the fact that let us not mix apples and oranges here. Mr. 
Hunter talks very broadly about contingent commissions. I think 
it is important to distinguish between agents and brokers and 
make it very clear that the agent represents a company and 
there is a contract between the company and the agent and the 
best cure for the consumer--do you know when I was a regulator 
what I would tell my consumer? When I had 225 companies writing 
automobile insurance in little old South Carolina? I told them 
to go shopping around because by shopping around, they got the 
best rate, and there were plenty of places to go for shopping. 
So if the law dean has a problem, the answer is go shop around 
and you will find out that you will have more than one choice.
    Senator Fitzgerald. Isn't that right, Mr. Hunter? If you 
are going to a State Farm agent, you know they are selling 
State Farm policies and probably everybody recognizes that is 
the only thing you can get there and they are trying to get 
more business for State Farm. They work for State Farm.
    Mr. Hunter. There is no State that doesn't have an Unfair 
Claims Practices Act. If an agent or a broker--it doesn't 
matter in this example--if an agent or broker delays my claim 
to get it past the reporting period so that they can keep their 
override contingent commission on profitability, or tells me 
not to submit it because it is not covered when it is, or tells 
me not to submit it because my rate will go up when you 
shouldn't tell me that, that is illegal in every State for 
agents as well as brokers.
    Senator Fitzgerald. Mr. Soto.
    Mr. Soto. May I comment on the issue of the claims 
reporting? First of all, it is, and I almost hate to use the 
term, ludicrous, and if you notice, Mr. Hunter indicated that 
he has not heard of any single incidence, but in theory, 
something could happen at the very end of a year. Somebody 
might not report a claim if you are on December 31. And yes, in 
theory, that can happen.
    In actual practice, the reality is that part of my process 
of proving myself every day is one where the moment that a 
claim occurs, that client is looking to me to be prompt about 
reporting, to explain the process, to be an ombudsman if the 
claims adjustor is not calling them, and it is difficult to 
envision that if you have a kitchen fire, I am going to delay 2 
weeks in reporting it and either win brownie points with you or 
get away with it. It is almost impossible to imagine on a 
Workers' Compensation claim that every State has a 
responsibility and a law under penalty that it must be reported 
within 24 hours. And you can go on and on with every line of 
insurance. It just really in actual practice doesn't happen.
    Could you find one or two examples of somebody who may have 
done that? I suppose you could, but I think that you set the 
standard early on when you said, are some of these problems 
individualized or are they systemic and do we need to make 
radical changes in the system because we have uncovered a few 
malfeasances? I think that is an excellent standard to look at 
this. Could that happen? Yes, it could happen. Does it happen 
in real life? I would suggest to you that practically never 
happens.
    Mr. Hunter. I would suggest to you I would expect that 
practically it was impossible for Marsh to bid rig, but there 
was an incentive and they did. If the agent or a broker has an 
incentive not to file a claim, they might do it.
    Senator Fitzgerald. Now, on the bid rigging--I have found 
in these Senate hearings that for every villain, there tends to 
be a hero. There were some insurance carriers that refused to 
go along and I believe one of them was CNA, is that correct?
    Mr. Csiszar. Yes.
    Senator Fitzgerald. CNA wouldn't touch that. Were there 
others, Mr. Csiszar? Who were they?
    Mr. Csiszar. There were others who are members of our 
association.
    Senator Fitzgerald. Would you like to name them, because it 
is in a positive light.
    Mr. Csiszar. I would rather not because there have been 
subpoenas issued----
    Senator Fitzgerald. OK, but CNA Insurance, I recall, was 
one that refused to go along with the charade.
    Now, wouldn't the insurance carriers like to get rid of the 
whole contingent commission arrangement? Isn't it kind of a 
shakedown of the insurance carriers when Marsh and McLennan 
comes to you and says, hey, if you don't play ball with us and 
give me part of your revenue, kick it back to us, we are going 
to move insurance business?
    Mr. Csiszar. Again, I would like to distinguish between 
agents and brokers. For a company to pay contingency fees to an 
agent is a way to incentivize the agent. That is something--
that is what you see with the car salesmen. That is what you 
see with a food broker, for instance. That is what you see in 
other industries, where you are incentivizing your own agent, 
independent or otherwise.
    On the brokerage side, I will give you an example. I just 
bought that famous house in Chicago and it so turns out that 
after looking at 50 homes, I kept coming back to the same house 
and it had only been listed the day before or 2 days before. 
Well, as we are looking at that house, my agent informs me that 
she is also the listing agent on that house. Did I object to 
that? No. She had done a tremendous job taking us through 50 or 
100 different homes. She was very clear in disclosing it to me. 
And, in fact, I appreciated the fact that she disclosed it and 
I don't mind her double-dipping on the commission because she 
has actually done a good job.
    I keep coming back to that on the brokerage side, it is the 
disclosure issue that is the real problem, true enforced 
disclosure. And, in fact, we have enough laws on the books to 
force that disclosure now. If the SMART Act were to pass, for 
instance, we would have even more tools in our hands. We would 
homogenize and make it uniform, make it the same disclosure 
everywhere.
    So I think we have got the tools to do this work and what 
happened is the enforcement process fell apart and you had a 
few arrogant players in the market who took advantage of it and 
had the market power to do it.
    Senator Fitzgerald. OK. So we have greater disclosure, but 
you still have two large brokerage firms with 70 percent of the 
large corporate market. That is enough leverage to exact other 
types of payment probably out of the insurance carriers. Are 
you worried about the concentration in the insurance brokerage 
industry?
    Mr. Csiszar. I think that even the large clients will 
discover that there are other brokers out there who could do as 
good a job as the large brokers. Do I know the tie-ins? 
Oftentimes, they stem from the fact that an AON or a Marsh can 
do catastrophe modeling for you. They can do financial modeling 
for you. They have other value-added services.
    I think that if General Motors wants to shop around, they 
can actually shop around and find another broker to deal with, 
because while there is concentration, I think that competition 
will break that concentration.
    Senator Fitzgerald. What do you think about that, Ms. 
Ochenkowski? He is saying that General Motors, IBM, or 
Microsoft, they can probably go ahead and use a smaller 
insurance broker who can provide the same services. Is there 
maybe an attitude in the largest corporations in America, the 
Fortune 500 companies, for example, whoever is the risk 
manager, just in order to cover himself or herself, feels safer 
going to a larger insurance brokerage firm? I had better use 
Marsh and McLennan so nobody else questions me when I am in 
the--is there that kind of mentality, do you think, going on?
    Ms. Ochenkowski. There may be some of that, and I think 
there are also true services. If you are global or 
multinational or even a national company, it is helpful to deal 
with a national or multinational broker so that there are 
service offices in the various cities in which a client also 
has operations. And that is one area in which----
    Senator Fitzgerald. Does anybody besides Marsh and McLennan 
and Willis have international reach, or global----
    Mr. Counselman. Mr. Chairman, yes----
    Ms. Ochenkowski. Some do, yes.
    Senator Fitzgerald. You do?
    Mr. Counselman. Yes, many of our members do go through 
other members who are members of networks that operate in other 
countries.
    Senator Fitzgerald. So you could help somebody in London?
    Mr. Counselman. Absolutely.
    Mr. Soto. And you can contract for the service. You know, I 
am dying to slide one of my business cards to her---- 
[Laughter.]
    Senator Fitzgerald. There you go.
    Mr. Soto. The reality is that as I have read this material, 
I have been flabbergasted by the fact that you have that kind 
of power to control large segments of business, and I am trying 
to raise my hand--I am talking about the mega-brokers--and I am 
trying to raise my hand and say, the reality is that we can 
either directly through alliance or through contracting, you 
can contract services such as loss control analysis and all of 
that. It doesn't really have to all be housed in-house.
    Senator Fitzgerald. Well, it is----
    Ms. Ochenkowski. Perhaps there ought to be better 
marketing, too, from the smaller regional agencies to larger 
insurance consumers. They don't think that sophisticated 
insurance buyers would choose to close the door on any viable 
options, although part of what you suggested in your question 
may be true, and that is that the senior management of our 
firms as well as shareholders sometimes respect the placement 
of coverage with other well-known names because there is a 
feeling of competence that comes from a household name.
    Senator Fitzgerald. Ms. Ochenkowski, your members are not 
exempt from Federal antitrust laws.
    Ms. Ochenkowski. That is correct.
    Senator Fitzgerald. Do you think insurance brokerage firms 
should be exempt from Federal antitrust laws?
    Ms. Ochenkowski. Well, that is something you raised earlier 
and it is not something that RIMS as an organization has 
considered. It is a very interesting question and I think we 
would like to think about it a little bit and come back to you 
with our response.
    Senator Fitzgerald. I am not suggesting the repeal of 
McCarran-Ferguson with respect to insurance carriers. That is a 
totally different thing, but specifically with respect to 
brokers. It is not clear to me whether the McCarran-Ferguson 
Act, which provides an immunity from antitrust for the business 
of insurance, meant to apply to insurance brokerage services.
    Mr. Counselman. We believe that brokers are subject to 
antitrust laws----
    Senator Fitzgerald. You do?
    Mr. Counselman. Yes, and that the insurance--the McCarran-
Ferguson Act protects or provides, has provisions for certain 
activities of insurance which allows rate making, for example, 
collecting data.
    Senator Fitzgerald. So you think the Justice Department 
could bring an antitrust lawsuit against Marsh and McLennan or 
AON just as the State of New York has brought an antitrust 
lawsuit against Marsh and McLennan?
    Mr. Counselman. I think that is conceivable.
    Senator Fitzgerald. You do? Mr. Csiszar, would you care to 
comment on that? It wasn't clear to me by reading the McCarran-
Ferguson Act.
    Mr. Csiszar. It is not clear, though certainly--and there 
has been no court case that I know decides it, either. But I 
think the thrust of McCarran-Ferguson had to do with the risk 
taking side of the business, not the insurance side.
    Senator Fitzgerald. By the carriers, not the brokers, 
correct?
    Mr. Csiszar. Right.
    Senator Fitzgerald. And so we are sitting here where there 
are two companies with 70 percent of the large corporate market 
and some of the panelists are suggesting that the McCarran-
Ferguson Act was not meant to provide immunity from antitrust 
to insurance brokers. Maybe this is something the Justice 
Department should take a look at, because I don't believe these 
kind of abuses could have gone on successfully or had much of 
an effect in driving up prices if there were more competition 
at the very large level.
    I don't think the contingent commissions that smaller 
brokerages, like Mr. Soto's firm, may be accepting at the end 
of the day, because there is so much competition in the 
marketplace, people can just move to any other brokerage firm, 
are going to drive up prices all that much. But where you have 
two players with 70 percent of the market, it definitely could.
    Mr. Counselman. Mr. Chairman, I think that contingent 
commissions also drive down prices when they are applied 
properly because they incent lower loss ratios. They incent my 
firm and individuals at member firms of the council to go out 
and find those insureds, those clients, prospective clients, 
who are interested in controlling their losses and will take 
the steps, the known steps that a client can take to reduce 
their losses. So when used properly, they incent positive 
behavior. Now, obviously, what has been described earlier today 
was not incenting positive behavior.
    Senator Fitzgerald. Mr. Hunter, do you believe they incent 
positive behavior, the contingent commissions?
    Mr. Hunter. It is possible that they could incent going out 
and finding some better business, but it is also possible it 
could incent holding down claims when they hand it in, so it 
has both incentives.
    Senator Fitzgerald. Should politicians be raising the issue 
of conflict of interest with anyone when, after all, 
politicians who run for office are taking campaign 
contributions from the very same people that they are 
regulating and passing laws on, correct? [Laughter.]
    Mr. Counselman. We are speechless. [Laughter.]
    Mr. Hunter. You need to have a hearing on that next. 
[Laughter.]
    Senator Fitzgerald. We have covered lots of ground. I would 
finally--we raised the antitrust issue. What about allowing, 
Mr. Csiszar, and I know this is sensitive, what about just 
allowing the FTC to study the insurance industry?
    Mr. Csiszar. In fact, they are doing a study now, I 
believe. They are doing a study on credit scoring. So they have 
got their foot in the door. I am not sure how they got it in, 
but----
    Senator Fitzgerald. Now, there was a prohibition from 1980. 
Do you think they should be allowed--we should repeal the 
prohibition enacted in 1980 that forbade the FTC not just from 
enforcement actions with respect to the insurance industry, but 
from even studying the insurance industry?
    Mr. Csiszar. I think anybody ought to be able to study it. 
I know that as a regulator, I dealt constantly with GAO on 
studies. So from my standpoint, studying the industry is 
something that is of value.
    Senator Fitzgerald. Does anybody else care to jump in on 
the FTC?
    Mr. Hunter. The credit scoring study was specifically 
authorized under FCRA. That is why it is an exception to the 
rule. They can't do anything else. In fact, I sat at a table 
with the chairman of the FTC testifying like this and the 
chairman was asked about insurance and he said, Mr. Chairman, 
if I knew the answer to that, I would have broken the law, and 
that is the problem.
    Senator Fitzgerald. Well, listen, you all have been 
terrific witnesses. I appreciate your candor and your 
willingness to speak your positions very forcefully.
    The record will stay open for 1 week, until the close of 
business next Tuesday, November 23, in case any of my 
colleagues have any written questions they may want to give to 
you or you have any further information that you would like to 
provide the Subcommittee.
    Thank you all again for being here. I appreciate your 
patience for this long hearing. The hearing is adjourned.
    [Whereupon, at 1:32 p.m., the Subcommittee was adjourned.]


                            A P P E N D I X

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