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Business: Insurance Scandal

Steven Pearlstein
Washington Post Columnist
Wednesday, October 20, 2004; 11:00 AM

Washington Post business columnist Steven Pearlstein will be online to talk about his latest column, in which he examines the unfolding insurance scandal. Pearlstein writes today that ethical blindness is hardly unique to the insurance industry.

A transcript follows.

About Pearlstein

Steven Pearlstein writes about business and the economy for The Washington Post. His columns on the economy appear every Wednesday and Friday.

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Dallas, Tex.: Great column today, but you mischaracterized the travel agency business. While traditional agents have indeed begun to (appropriately) charge for their services, online agents have a different model. They charge hotels 18-35% commission to be listed as a "special value" hotel, even if the rate charged is no better than one available elsewhere. If the hotel doesn't play the game, their listing is put at the bottom of the listing, 10 or 20 screens away. Meanwhile, the consumer is steered to hotels most beneficial to the agent, not the buyer. As a consumer, I don't like it.

Steven Pearlstein: That's very interesting. I didn't know that. But I hope it is not naive to say that in the Internet type competition, it won't be long before a site comes along that is really dedicated to getting the consumer the best deal (if one doesn't already exist) and the word will get around quickly and everyone will use it. Because it's all out there for everyone to see and compare. I think I'm right in saying Orbitz ranks offering by best price (if you request that). The hotels, I agree, are still more of a muddle.


Columbia, Md.: Thanks for another good read. Willful blindness? I think that is too kind. The correct term is 'theft'. Don't believe for a second these people don't know what they were doing is criminal, they are just feeding at the trough until they are 'caught', and not a minute sooner. Why do you think they find it so 'easy' to drop the whole practice in a second? Would insurance companies 'drop' risk assessment if Spitzer calls them on it? HELL NO! Why? Because it is a legitimate practice in the industry. The speed by which a 'practice' is dropped in any industry when the legal system kicks in is the tell-tale sign of an unethical or criminal behavior.

Steven Pearlstein: And thanks for your kind opening to this discussion. I think I agree with your last statement that the speed with which a practice is dropped is an indicator of how unethical the practice is. But I think you have oversimplified the way in which those practices develop. Its just not very probable that most of the people in the insurance industry are corrupt while most of the people in other industries are not. So then you have to get to the more difficult question of how people who are basically good people and know better can have their perceptions so clouded that they can look at a practice that, in the clear light of day is obviously unethical, and not say: "We better stop doing this because if it ever gets out, we'll be in deep doodoo." And that's what I was trying to get at in suggesting that these things develop slowly, over time, a bit like a frog that is killed as the water gets hotter and hotter until it finally boils.


Wheaton, Md.: This practice of kickbacks seems to be accepted as normal business all over the world, which is why the UN doesn't seem to think the Iraq Food for Oil program had any problems.

Steven Pearlstein: Good point. But its not just overseas. I didn't have space to get into it but even here in Washington, it goes on all the time in one of our biggest industries, computer integration. When an integrator has a choice between two vendors of relatively equal price and cost, it may well be swayed to the one that offers a bigger "volume discount" or commission, I am told. And the payment doesn't flow back to the customer necessarily, as it was explained to me by someone in the industry. Then of course there are the well-known practices by which makers of prepared foods pay grocers for "shelf space," which grocers can either pocket or use to lower their markup and thus pass on to consumers. Is that illegal or improper? Probably not, because in the end the consumer gets to compare the shelf price at grocer A to grocer B. But determining what is a suitable markup or commission or volume discount and what isn't -- well, it turns out that may not be so clear cut as people think.


Washington D.C.: As an insurance coverage, underwriting and claims lawyer with over 15 years' experience, I'm more than a little upset by the description of some of the arrangements involving J&H/M&M as "kickbacks." Unlike the securities industry or the mortgage banking industry, in insurance there is no single "primary market," so there isn't much of a proxy market-clearing price for insurance policies and products. I think the allegations here are genuinely untrue.

Brokers - not just J&H/M&M but also Aon, Frank Crystal, etc., shop policies to different Carriers and get quotes which aren't merely about price. Property/Casualty insurance is not a fungible commodity, and Brokers are compensated to assist Insureds in shopping.

Coverage terms, exclusions, deductibles, defense-enhancement clauses, and other features of liability insurance coverage are all in the mix. An insurance Broker is in fact a representative of the Insured, but is legally the agent of the Carrier for the purposes of collecting the first premium check - which is usually the Broker's fee.

So, given that Brokers are in fact legally permitted to be paid consideration - by Carriers - for serving Insureds, where is the violation of law?

Steven Pearlstein: I'm not sure what is to be gained by getting into a legal argument about what is or is not a criminal kickback. But I think most people assume that if you pay a broker in any industry to go out and shop you the best product (best in terms of price and quality), you have what is known in the common law as a duty of loyalty to do that, without leaving yourself open to being swayed by other, self-interested considerations. Certainly if you accept such commissions, they should be disclosed in advance as well as after the fact. But better, it seems to me, to rebate all such commissions to the customer, even if it means charging a higher flat fee to cover your expenses and a reasonable profit margin. You will note, by the way, that the word kickback did not appear in my column, for which we can all thank my most vigilant editors.


Rochester, N.Y.: With jayson blair and stephen glass, not quite sure if you might want to look closer to home for ethical transgressions. They operated for a long time, despite complaints.

Steven Pearlstein: No denying that. Not sure what your point is, though. I was very clear that I don't think people in insurance or financial services or real estate are any less ethical than people in other industries. But I do think the level of transparency and competition in an industry, and the culture of an industry, helps to determine the ethical climate in those industries as they relate to widespread and common industry practices. Do you want to disagree with that, or simply make the point that the media isn't perfect.


Chicago: You said in your article, "This lack of price transparency brought with it a lack of price competition, allowing brokers to earn incomes that bear too little relation to the skill, time and risk involved."

I think you are incorrect in that statement. About 10 years ago, large brokers made the push to be compensated on a fee basis, and not commissions. This show complete transparency, and allows client to pay for skill, time and expertise involved. As regards MSA's/PSA's, these were disclosed to RIMS (a national group of risk managers) back in 1999, so they have long known about these arrangements.

Thanks for the forum.

Steven Pearlstein: Not sure the rest of us understand the acronyms you are talking about. What I do know is what I read in the newspaper and in the filings made by Spitzer. They tell of Fortune Brands buying insurance from Marsh and being unaware of the precise contingent commissions. Now they want the money. That's doesn't sound like informed consent. As to whether everyone knew that commissions were paid, you may be right about that, which only makes this all more curious.


Northern Virginia: I briefly worked for a prominent title company that operates in the Washington, DC metro area. After working with them, I was surprised to learn that they have business arrangements with the regional real estate agencies. These arrangements result in the agency getting a portion of the owner's title insurance policy when it is purchased at closing. In fact the mark-up on those policies is in the area of several hundred percent. The result for the homebuyer is that the agent, along with the title company, both push the buyer to buy an owner's title policy when in fact the value of the policy is questionable. This arrangement sure felt like a kick-back to me.

Steven Pearlstein: It is a kickback and, under NAR rules and regulations in many states, it is illegal. But there are ways around these prohibitions sometimes, which may be what you are talking about. But your other point is important: because title insurance is not purchased competitively on an open market by consumers who can and do shop around (rather than being presented with a fait accompli at closing), the price is way, way too high, creating monopoly-like profits that are used to pay off everyone involved in the process so they don't upset the apple cart.


Washington, D.C.: Kickbacks and conflicts of interest are everywhere. When your real estate broker has you sign an "affiliated party disclosure" it is a vague document with no specifics. Now tell your agent that you want a different settlement company, home inspector, land surveyor than the one he or she recommended and see how quickly they are able to "match" your price or raise issues about the quality of the other vendors. What they don't say is that they get a piece of every transaction they bring through the door of these businesses. Are these businesses acceptable? Maybe. Is YOUR best interest the primary driver in the selection? NO.

Steven Pearlstein: All well said.


Leesburg, Va.: Mr. Pearlstein,

Good read. I have to say whether or not I agree with what you write, I always enjoy your work.

OK, so we've identified another set of industries in which consumers' costs are obfuscated by additional fees, commissions and fine print. What, in your opinion has to happen to solve a bigger problem; the seemingly cavalier approach these industries take with respect to their customers? Knowing that its way of life is protected by million-dollar lobbying efforts aimed at stifling anti-competitive measures to either level the playing field of provide full disclosure to customers, these companies can perpetuate their stranglehold on the consumer, who is obligated by law in some cases, to buy their services.


Steven Pearlstein: It IS amazing the number of instances that state regulations are used by entrenched interests to prevent competition, in the name of consumer protection. The liquor distributors probably take the cake for this, followed closely by auto dealers. The problem is that these industries have so much at stake, and such fat profits from these uncompetitive arrangements, that they can spend freely to protect them. Meanwhile, consumers are many but have lots of things they can worry about, so they don't united to protect their own interests.


Washington, DC: Spitzer completely ignores the fact that in all "Distribution" businesses like Insurance Brokers, the business model and success of vendors/providers is also determined by their incentive payments to the "Distributors". Car dealers get 3% holdbacks, Wal-mart/SafeWay/Food Lion gets holdbacks from selling Proctor & Gamble products and Unilever alike, Sears receives incentive payments for selling GE vs. Maytag.

Insurance companies also pay different front-end commission levels for the same type of policy - i.e. - Workers Compensation from different insurance companies...this fact of the 'distribution' business is the same across all industries - not unique to Insurance!

Spitzer is off base and unfair - he may as well be suing Capitalism, because this is how Capitalism works. Spitzer has likely taken e-mails out of context and in complete disregard to the unique circumstances of the deal. But wow, is it ever popular in the Media!

Steven Pearlstein: That is certainly a widespread view in the industry, and, as I've said here today, there is some truth to that. But I think there is a difference between a retailer not disclosing his markup on a can of peas, which can be shopped and compared very easily, and a broker who is paid specifically to do the shopping for you and winds up putting your interests behind his own. And I don't think you're trying very hard to wrestle with that difference.


Arlington, Va.: I've always wondered whether title search companies actually research the title back to the dawn of time, or just locate the previous title search. I presume that the home seller or building seller would have appropriate proof in order to occupy and sell the place in the first place.

Steven Pearlstein: It is strange that, if a title has been searched within the last five years, you are not allowed to switch to the insurance company of the previous owner at a nominal fee, rather than having to write a wholely new policy. And why do you think that is? It is because that is how the title insurance industry makes its outsized profits.


Steven Pearlstein: Thanks, folks. See you next week.


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