For Insurance Industry,
Questions Are Mounting

(See Corrections & Amplifications item below.)

It is the insurance industry's $845 million question.

Yesterday, beleaguered insurance broker Marsh & McLennan Cos. laid out an ambitious plan to abandon the revenue it gets from insurance companies under so-called contingent-fee arrangements: some $845 million last year and $420 million in the first six months of this year. It also announced a raft of other changes in its business practices.

So now the question is how these changes will affect Marsh, its rivals, its clients and a large number of property-casualty insurance companies.

The quick answer: Policyholders could win in the long run, but it is far from certain.

Yesterday, the entire industry seemed to be the winner. The changes, including Marsh's decision this week to replace Chairman and Chief Executive Officer Jeffrey Greenberg, helped avert criminal charges against the company by New York Attorney General Eliot Spitzer. The company aggressively is pursuing settlement talks that likely will result in a large fine and could codify business changes they are putting into place. As of 4 p.m. in New York Stock Exchange composite trading yesterday, Marsh shares jumped $2.45, or 9.3%, to $28.87 as its investors breathed a sigh of relief.

WALL STREET JOURNAL VIDEO New CEO Michael Cherkasky says Marsh's new model involves complete rate transparency.

Marsh's biggest rival, Aon Corp., was up $1.90, or 9.7%, to $21.54, and property-casualty insurance shares also rallied. American International Group Inc. rose $4.23, or 7.5%, to $60.33, among other strong gainers. After Mr. Spitzer accused Marsh on Oct. 14 in a civil lawsuit of cheating corporate clients by rigging bids and collecting huge fees from major insurers for throwing business their way, the shares had dropped as much as 46%, leading steep declines throughout the insurance industry.

The contingent commissions in question reward brokers for hitting profit or volume targets, providing brokers a financial incentive to pick some insurers over those perhaps with the best prices or terms. Aon and No. 3 broker, Willis Group Holdings Ltd., abandoned the fees last week.

While contingent commissions represented just 7% of Marsh's $11.6 billion in revenue in 2003, they made up a substantially larger portion of the New York firm's $1.5 billion profit that year. Marsh has said it can't estimate how profitable the fees are, but Prudential Securities insurance analyst Jay Gelb estimates their absence will cut Marsh's 2005 earnings by about $1 a share, to $2.50 from $3.45.

Even after the reforms Marsh announced, Mr. Gelb wrote in a report to investors, "we view it as financially and operationally weakened" by Mr. Spitzer's lawsuit. Not the least of the issues facing the company is the size of any fine and restitution required in settling with Mr. Spitzer's office.

But many analysts and investors anticipate the brokers will try to raise prices for clients, if only by breaking out some bundled services and charging separately. Whether they succeed, or drive clients to smaller or more-specialized brokers, is another issue.

"They're going to have to go back to the clients and ask for that money," says insurance consultant Andrew Barile, in Rancho Sante Fe, Calif.

Some analysts also are questioning newly named CEO Michael Cherkasky's management qualifications. Though Mr. Cherkasky was an accomplished lawyer and prosecutor, the previous public company he ran was a fraction of Marsh's size: Kroll Inc., with revenue of $485 million last year, before it was acquired by Marsh.

Mr. Cherkasky -- who sees his appointment as permanent, "God and board willing" -- is confident he has the right skills.

"We think it's going to be a very, very positive response from the marketplace," he says of Marsh's changes. These include disclosing clearly to clients what they pay for and instituting rigorous auditing and compliance regimes. Marsh executives say they have seen no sign of clients or employees fleeing and don't expect to.

Unless Mr. Cherkasky and the reforms succeed in placating commercial-insurance buyers, Marsh's loss could benefit Aon of Chicago and Willis of New York. Mr. Spitzer has intimated that he found problems at other big brokers but hasn't filed any charges. Both Aon and Willis say they are cooperating.

Still, any loss of clients by Marsh may be slow in coming. In a survey of some 20 corporate risk managers, Mr. Gelb said about half are considering leaving Marsh but "want to see whether the NYAG can prove its allegations before making a decision."

Separately, several companies -- including Home Depot Inc. and Time Warner Inc. -- say they are reviewing their transactions with Marsh or other brokers. An official at American Standard Cos. says the company is "waiting to see what unfolds."

All this plays out against a backdrop of falling prices for most lines of commercial insurance, the yardstick by which brokers' fees typically are set: Yesterday, the Risk and Insurance Management Society's quarterly survey of corporate insurance buyers showed that prices declined broadly for the third quarter in a row.

That complicates the picture for corporate insurance buyers. Those declines could mask any savings from reforms in the brokering industry -- and may discourage revenue-hungry insurers and brokers from passing savings along.

Also hanging over Marsh are its borrowing woes. The company's commercial paper, or short-term borrowing, was downgraded last week, making it harder to raise the cash the firm relies on. (It has little long-term debt.) Its bank lenders last week agreed to extend temporary credit, even in the face of Mr. Spitzer's litigation, until Dec. 30. Kathy Shanley, an independent credit analyst at GimmeCredit says she is "concerned" about that deadline but adds that dodging a criminal charge better enables the firm to negotiate a longer-term, if more costly, pact with the banks.

At first glance, insurance companies seem to gain the most: After all, they won't have to pay as much in contingent commissions. But AIG's chairman and CEO, Maurice R. "Hank" Greenberg -- Jeffrey Greenberg's father -- discounted the chances of a long-term gain for insurers.

In a conference call Oct. 15, the elder Mr. Greenberg said the overall cost to AIG of acquiring business through a broker receiving contingent commissions is only slightly more expensive than using one that doesn't. Brokers eschewing contingent commissions typically earned more in regular commissions, he said. While the insurers set the regular commissions, clients typically pay them along with their insurance premiums.

Marsh still could have an incentive to steer business to insurers charging the highest commission, but that risk is blunted by its plan to disclose commissions in detail. "The more information people have, the better position they're in to negotiate," Ms. Shanley says. "That should help customers negotiate a better price."

Corrections & Amplifications

Jay Gelb is an insurance analyst for Prudential Equity Group LLC, a unit of Prudential Financial Inc. The column incorrectly said he works for Prudential Securities.

Write to Theo Francis at theo.francis@wsj.com and Gregory Zuckerman at gregory.zuckerman@wsj.com