By DAN REYNOLDS, senior editor of Risk & Insurance®
Three of the world's five largest insurance brokerages turned in respectable net income and margins for the second quarter of 2009 in earnings released in late July.
But a decision by Illinois Attorney General Lisa Madigan and the Illinois Department of Insurance to allow home-state brokerage Arthur J. Gallagher & Co. to accept contingent commissions has again roiled the compensation waters.
Brokerage CEOs, suddenly on the defensive, spent their earnings calls responding, sometimes a tad heatedly, to analysts' questions on the topic.
FIRST TO THE NUMBERS
Itasca, Ill.-based Arthur J. Gallagher was first out of the box last week with earnings figures on July 28 that cast the brokerage as a model of consistency. For the second quarter of 2009, the company reported a pretax profit margin of 20 percent in its brokerage segment. That was just a tick off the 21 percent pretax brokerage margin that the company reported in the second quarter of 2008.
The company's total net earnings for the quarter were the same story. Gallagher reported $43.8 million in net earnings companywide in the second quarter, compared with $40.8 million in the second quarter of 2008.
The company's quarterly revenue was undented by the ongoing recession at $453 million, up 5.75 percent over the $428.90 million it recorded in the second quarter of 2008.
Investors seemed unimpressed by the company's consistency. Gallagher's stock began the week at $22.32 per share. The stock ended the week at $22.90 per share.
On July 29, Chicago-based Aon Corp. reported net income of $149 million for the second quarter. That's a far cry from the $1.1 billion net income it reported in the second quarter of 2008, but those figures included a $1 billion after-tax gain from the company's sale of the Combined Insurance Companies of America and Sterling Life Insurance.
Aon showed some improvement in its brokerage operating margin, recording a pretax margin of 19.6 percent in the second quarter of 2009 compared with 18.3 percent in the second quarter of 2008. The market treated Aon more kindly, sending the company's stock price up 7.21 percent for the week, from $36.85 per share to $39.51 per share by the market's close on July 31.
London-based Willis Group Holdings Ltd. also came across like a company being governed with a steady hand, reporting an adjusted operating margin of 21.2 percent in the second quarter compared with 21 percent in the year-ago period. With its assimilation of HRH well under way, the company recorded net income of $87 million in the quarter compared with $39 million in the year-ago period.
But Willis failed to maintain investor confidence throughout the week. At the close of business on the New York Stock Exchange on Friday, the company's shares were valued at $24.93, a 3.93 percent decline for the week.
It was the early week news on the part of Arthur J. Gallagher that it could again legally receive contingent commissions from carriers that pricked some analysts' ears: And not necessarily in a negative way. If brokers can accept contingent commissions, it's cost-free money that can drop straight to their bottom lines and boost their margins. Investors would want to know about that.
"I am very happy to be back on a more level playing field with the majority of our industry," Gallagher's CEO and Chairman J. Patrick Gallagher said after reporting his company's agreement with state regulators.
Ever since Eliot Spitzer as New York's former attorney general tagged commercial insurance brokers for unethical compensation arrangements back in 2005, some of the big houses have ceased taking contingent commissions (which are commissions from carriers based on profits or volume) in the wake of settlement agreements with various attorneys general.
Gallagher said he had lobbied Illinois' attorney general repeatedly on the topic with the moral premise that, if some brokerages are allowed to accept contingent commissions, his should be too--thus the "level playing field" language.
Joe Plumeri, chairman and CEO of Willis, however, was pointed last week in his criticism of contingent commissions.
"The issue is: Do you get paid 2 percent or 3 percent or 4 percent--whatever it is on an up-front basis--by negotiating a proper deal with an insurer, or do you take it based upon profits, or do you take it based upon volume? If we took it based upon profits, I think that's a conflict," Plumeri said.
When it bought HRH last year, Willis bought a brokerage that accepted contingent commissions. Willis is gradually weaning those HRH accounts away from contingent commissions toward up-front compensation, and Plumeri bristled when questioned by Citigroup analyst Keith Walsh about any remaining HRH contingent commission revenue.
"First of all, everybody keeps saying, 'You take contingents.' I took the contingents because we had to do a deal, Keith. I have said that on every call: It has nothing to do with how we feel ethically about contingents. We took them to be able to do a deal," said Plumeri.
Also on July 30, Walsh took up the topic of contingents with Aon CEO Greg Case.
"We applaud the steps of the Attorney General of Illinois as they continue the trend of leveling the playing field for competitors," Case said.
"I think for us the importance is not about contingent commissions. It's much more about transparency and a level playing field for all competitors, and I would observe even with these steps there is still a long, long way to go in the overall industry," Case said.
The New York-based Risk and Insurance Management Society Inc., which represents the insurance buyers of the world who end up paying for these commissions in one way or another, said last week it was not happy with the news coming out of Illinois.
"RIMS is concerned that Arthur J. Gallagher & Co., who signed the agreement in 2005, is now permitted to participate in this compensation practice," said Terry Fleming, RIMS vice president and director of the division of risk management at Montgomery County, Md., in an e-mailed statement.
August 3, 2009
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