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P R O D U C E R C O M P E N S A T I O N I S S U E U P D A T E
Industry Faces Increased Federal Investigations

Scrutiny of the insurance industry continues, with rumors swirling on several fronts. Last week, the FBI announced it has been investigating potentially fraudulent industry practices. Additionally, whispers about American International Group, Inc. and its former CEO, Maurice "Hank" Greenberg kept the company in the spotlight.

Last Wednesday, FBI officials said they have been examining the insurance industry for nearly a year. The bureau is investigating if "accounting problems and other corporate fraud schemes might present a pervasive problem for the insurance industry."

At a news briefing, Chris Swecker, assistant director of the FBI’s criminal division, said, "We’re taking a hard look at cases like AIG to see if there’s an indication of something more pervasive. I’m not going to say that [the insurance industry] is the next crisis, but I will say that we’re looking at it," the Washington Post reports.

The Post also reported that the FBI’s review focuses "on insurance-related corporate fraud, the diversion of policyholder premiums for the personal benefit of agents and brokers, and workers’ compensation frauds that target pools of small businesses." Reinsurance is also said to be a focus.

However, in an unexpected turn of events later in the day last Wednesday, the FBI backtracked on its prior statements regarding its investigations of the insurance industry. According to National Underwriter, Joe Paris, an FBI spokesman, said that Chris Swecker was "widely misquoted" and that the FBI is taking a "proactive look" at the industry, but that "We’re not investigating anyone."

Diane Koken, the National Association of Insurance Commissioners’ president and Pennsylvania insurance commissioner, issued a statement that the organization is working with the FBI. "State insurance regulators, working through the NAIC, have been tapped by the FBI to provide guidance in understanding the technical requirements for accounting and reporting of reinsurance transactions, including arrangements that limit a reinsurer’s risk of loss," she said. "We understand the FBI is seeking to determine whether the accounting practices recently identified represent an industry-wide concern. Several states are currently pursuing a number of investigations in this area, and have been reconsidering existing financial reporting standards since last December."

In another federal development, Manhattan prosecutors are investigating if Greenberg "orchestrated an effort to manipulate the company’s stock price in his final weeks as chief," according to The New York Times sources.

The NYT sources say that an executive of AIG’s trading group has a recording of Greenberg discussing AIG’s falling stock prices in February and telling the trader to purchase AIG shares.

While it is not inherently illegal or for a company to buy its own stock, as long as it follows certain rules, it can be problematic if the purchases are intended to artificially inflate the stock’s price. Prosecutors will now investigate if Greenberg’s actions to assess compliance with the law.

According to the Wall Street Journal, "some legal observers said it is highly unusual for a chief executive to call a trading desk directly to inquire about the stock price, and that action could raise questions as to intent."

"The development is a significant turning point in the investigation, as investigators branch out into examining possible market manipulation," according to the NYT. "It also gives federal prosecutors a more prominent role in the inquiry."

AIG was also the focus of reports that executives "regularly made changes to the company’s reserves to help meet earnings goals through much of the 1990s," according to a NYT source.

The article attributes that information to an AIG ex-employee, who is reported to have said that AIG "most commonly" adjusted reserves to boost the earnings of directors’ and officers’ liability insurance. "These policies—and the reserves assigned to them—are large enough that adjustments to them could make a substantial difference in the earnings of a company as big as American International," the NYT article says.

AIG was the subject of further reports that investigators believe that more than two of AIG’s executives—former or current—knew about and participated in the "top level" accounting adjustments, according to the WSJ.

"The more AIG executives who knew about any such practices, the more problematic the scenario for AIG becomes as it struggles to resolve the probes into accounting maneuvers over five or more years," the article says.

Marsh & McLennan Companies, the broker that was the attention of much media and regulatory attention during the beginning of the investigations into the industry, announced May 3 that its quarterly profits fell 70%. Its net income fell to $134 million, compared to $446 million a year ago.

The Securities and Exchange Commission took action against a third General Re executive in recent days. The NYT reports that John Houldsworth, the former head of General Re’s Dublin office, "faces a civil fraud complaint as part of an investigation of financial manipulation in the insurance industry." Last week, the SEC told Elizabeth Monrad, a former General Re executive, and Richard Napier, a current company executive, that civil fraud complaints were planned for their roles in a much-questioned 2000 General Re-AIG deal.

V I E W : P & C T R E N D S
Insurance Industry: “You Look Marvelous, Darling”

Insurance brings us 3% of the world’s billionaires and occupies 37 slots in the Fortune 500. And now we see p-c insurers are a top return provider for the average investor? Part of the data accumulated by Fortune magazine each year is total returns to stockholders. As the chart below shows, p-c insurance companies nicely outpace the typical Fortune 500 company. What’s going on here? Will the comedians stop with the actuary jokes already?

* As compiled by Fortune magazine staff for the insurers making the Fortune 500 in 2004, and the five and 10 years preceding that (includes price appreciation and dividend yield).

As noted last week in "Measuring Up Among the Elite," many of us in the p-c industry do not walk around thinking p-c insurers are a marvelous investment. Conventional wisdom is quite the opposite. There is no shortage of data and evidence that returns from p-c insurers historically have been both volatile and below average. The Dec. 16, 2004 issue of IN&V contained industry figures from 1980 to 2003 that showed the p-c industry being outpaced in return on equity by both its l-h brethren as well as commercial banks. More recently, our industry underwriting record so far this decade shows the same sort of thing.

What is going on here? How did the Fortune 500 p-c insurers suddenly show up looking so good? Well, as discussed in last week’s IN&V, the insurers in the Fortune 500 are a Tiffany class and perhaps not surprisingly their returns to stockholders on average outpace the industry average each year. While it’s not true across the board, many of the Fortune 500 p-c insurers have combined ratios (that is, losses plus expenses divided by premiums) much better than average. A quick check with the current A.M. Best "Aggregates and Averages" finds examples like AIG at 94.9%, Berkshire Hathaway at 84.9% and even standard line writer Allstate at 95.2% for 2003. This is at a time when the industry ran a combined of 100.1%. There will always be top performers and the list of stock p-c insurers in the Fortune 500 is a pretty impressive group.

The bigger part of the story, however, is that a rising tide raises all boats. That is, good times rolled for the p-c insurers in 2004. There is no better place to see this documented than in "2004 Year End Results" by the Insurance Information Institute Chief Economist Bob Hartwig. Before 2004, industry-combined ratios averaged 108.4% so far this decade. With 2004 coming along at 98.1%, it is easy to see that 2004 was a very good year. In fact, you have to go back to the year before I graduated from high school to find a second example of combined ratio below 100% (1978).

	$
Earned Premiums	$412.6
Incurred Losses (Including loss adjustment expenses)	299.5
Expenses	106.4
Policyholder Dividends	1.6
Net Underwriting Gain (Loss)	5.0
Investment Income	39.6
Other Items	-0.5
Operating Gain	44.1
Realized Capital Gains/Losses	9.3
Pre-tax Income	53.4
Taxes	-14.7
Net After-Tax Income	$38.7
Surplus (End of Period)	$393.5
Combined Ratio	98.1
*Figures may not add to totals due to rounding. Calculations in text based on unrounded figures. Sources: Insurance Services Office, Property Casualty Insurers Association of America and the Insurance Information Institute.

So, as the "Saturday Night Live" catchphrase goes, the P-C insurers did look marvelous, simply marvelous in 2004. Now that p-c insurers have had a year of respectable returns, the question on the minds of stockholders, insurers, regulators and agents is…will it last?

Paul Buse (paul.buse@iiaba.net) is a licensed agent and president of Big "I" Advantage, IIABA’s for-profit subsidiary. T O P

In order to maintain their standards of living when they retire, many executives and business owners need to supplement what they can save through their companies’ retirement plans. The limitations placed on qualified plans, such as 401(k)s and defined benefit plans, gives rise to the use of "nonqualified" plans to enhance executives’ incomes.

Nonqualified plans’ primary disadvantages are twofold: Employers do not receive a current deduction for monies set aside in them, and executives cannot have a non-forfeitable interest in them without triggering "constructive receipt" and thus being taxed on the contributions that go into the plan on the executives’ behalves.

A very common funding vehicle for nonqualified deferred compensation arrangements is a whole-life policy utilizing what is referred to as a "split-dollar" arrangement. Deferred compensation arrangements’ sometimes-vague mechanics and administrative requirements make servicing them cumbersome.

However, the environment for these deferred compensation arrangements recently has changed. New legislation produced a new Internal Revenue Code Section—IRC Section 409A. Deferred compensation arrangements will have to comply with a number of set requirements in order to keep such plans from running afoul of taxation.

Independent agents who sell insurance to fund these arrangements will have to talk to insurance companies and clients to ensure that administrative duties will be completed in a timely manner.

Another important aspect of the new rules is that the design of deferred compensation plans needs to be reviewed, particularly the payout triggers in the contract. The +34 has tightened the flexibility of accelerating payments prior to retirement or a change in control of the company.

As much as the new rules present some issues to deal with, they also create new opportunities to discuss deferred compensation plans with customers. Most of the new requirements, as set forth in IRC Notice 2005-1 on 409A, need to be resolved during 2005. Agents should reach out to customers as soon possible so that they don’t learn about the changes from someone else.

Dave Evans (dave.evans@iiaba.net) is a certified financial planner and life-health contributing editor for IA magazine. T O P

Last week, AMS Services announced Euan Menzies, president and CEO of Vertafore, Inc., will assume the role of president of AMS Services. Insurance News & Views talked to Menzies about what the transition means for agents using AMS systems.

EM: There are two sets of events embedded in this single the internal communications clearly reinforce, it was a personal decision for family reasons. Dave, as you may know, was a long time Connecticut resident and moved out to the Seattle area last year. After curiously growing to like the Seattle area, he decided that he wanted to be back in Connecticut for family reasons. Often times in these situations the words "family reasons" are a euphemism for something else, but in this case, it genuinely was a personal decision.

We wanted create a center for our business around the Seattle location, and so with Dave’s decision to step aside, I felt the right answer was for me to assume his responsibilies as well and to continue to the push toward making Seattle a more important part of our business. The move west probably would have happened anyway. Dave’s decision to leave probably accelerated some of the thinking.

IN&V: In your previous structure, you had one person (Shea) at an executive level who was solely focused on the AMS agency management systems. Under this new hybrid management model, what would you tell agents to allay their fear that the management system side won’t get the attention it did in the past?

EM: First, Dave and I worked very closely together on what I would call big issues—major product development initiatives, operational changes, investments. He and I were discussing those together anyway. One change that offsets the focus issue is that the decision making will be more streamlined. AMS Services was always really the first amongst equals, and with it being the largest unit and the core of our business, I spent more time with it than I did with other customers due to the law of averages. We’ll continue to stay focused on that area because it is the heart and soul of what we do. I don’t think customers should be at all perturbed about this change; in fact, I think just the opposite. I feel that it is such an important part of the business that I want to spend more of my time there.

IN&V: What do you think the biggest changes will be in the next one to three years in the ways that agencies use your system and technology in general?

EM: One trend that has to play out is what impact the regulatory changes are going to have on the lives of agents large and small. It’s an area we’re keeping a close eye on, and depending on what customer you’re talking to or segment you’re dealing with, people are either highly attuned or relaxed about those changes. Regulation is going to change things, and we need to make sure that our systems and processes are designed to help our customers maneuver through those changes.

Negotiations continue this week as Senate Judiciary Chairman Arlen Specter (R-Pa.) attempts to move the Fairness in Asbestos Resolution (FAIR) Act through his committee. Hill insiders say it could emerge Thursday despite defections on both sides of the aisle. A markup was scheduled to begin Wednesday, with a number of amendments possible, if not likely, emerging from a list of more than 80 offered during an April markup.

Congress Daily reports that Specter spent last week’s recess in Washington working to gain the support of conservative committee members who thus far have been skeptical of the bill. But no sooner did Specter move to shore up opposition on his right than he faced a new attack from the left. Sen. Edward Kennedy (D-Mass.) was quoted Monday as saying the bill would short-change victims of asbestos-related diseases and give companies the upper hand in determining how much they are willing to spend to settle claims. Among Democrats on the committee, only Sen. Patrick Leahy (D-Vt.) and Sen. Dianne Feinstein (D-Calif.) have signed on to the bill, and it is expected that even if it gets through committee, it will face a difficult time on the floor.

The bill essentially would halt asbestos lawsuits and pay claims from a $140 billion trust fund to compensate claimants, but there has been discussion that claims not settled in a set period of time could "leak" back into the court system. While the Big "I" supports reforms to the system, it has serious concerns about establishing a trust fund yet still potentially allowing for lawsuits.

"Certainly, we must have resolution to this issue, but it should be a final resolution, not a partial one," says Charles E. Symington Jr., Big "I" senior vice president of government affairs and federal relations. "It is crucial that the proposed solution put an end to court claims. We believe policymakers should not require insurers to pay vast sums into a trust fund that may not ultimately solve the problem."

Although the Big "I" Virtual University faculty members have written about the latest edition of the CG 20 10 peripherally in the past, its "Ask an Expert" service still receives questions about it almost monthly. When this endorsement was revised, ISO removed completed operations coverage. The coverage is still available, but not in this endorsement.

Read on for some of the questions, including one issue with the "solution" to the new CG 20 10, the CG 20 37.

Question: "I have referenced the additional insured endorsement CG 20 10 03 97 since this is the endorsement on my contractors GL policy. Because of how this endorsement is worded, it will not give completed operations coverage. It specifically applies to the insureds ‘ongoing operations’ and specifically states that no coverage will apply for the additional insured when ‘all work has been completed’ or ‘that portion of the work has been put to its intended use.’ My question is this: When my insured is requested to provide an ‘additional insured’ endorsement for ‘two years following completion of the project,’ how do I accomplish this? Even if I name the party as an additional insured for the next two renewals, I do not think the above mentioned additional insured endorsement will work. What is your opinion and how would I accomplish this request other than providing an ‘additional insured’ endorsement giving completed operations coverage?"

Question: "We insure several subcontractors who are required in their contract to provide the ‘additional insured’ form CG 20 10 11 85 edition. None of our companies are filed to use this form, so we provide them with the ‘additional insured’ form that can be used. My question is: because this requirement is part of their subcontract agreement and we are not able to meet that requirement, does this then mean the insured will be responsible for any ‘gap’ between what is required and what is provided? Should we be advising the insured to have this part of the contract changed before signing?"

Question: "I am quoting coverage for a subcontractor. One company is quoting with CG 20 10 11 85, the other is using CG 20 26 11 85. The CG 20 26 extends coverage to the A/I for the subcontractor’s ‘operations.’ Is the word ‘operations’ in the CG 20 26 form as broad as the word ‘completed operations’? The wholesale broker claims that CG 20 26 11 85 meets the test of ‘or equivalent coverage’ often written into construction contracts that ask for CG 20 10 11 85 coverage."

Question: "We have a general contractor who requires all sub-contractors to provide an Additional Insured Endorsement on the sub-contractor’s CGL Policy naming the GC as additional insured. The general contractor requires the Additional Insured Endorsement to read ‘your work,’ not ‘ongoing operations’ so as to afford coverage after the work is completed. Is the correct form CG 20 10 or is there another form we can use to comply with this request from this General Contractor? Do you know if this coverage can be obtained?"

Question: "I’ve had several agents tell me their insurers won’t write the CG 20 37 10 01. This certainly leaves the agent in a bind when trying to comply with contractual obligations. I would assume the insured would be in a ‘breach of contract’ situation of he can’t comply with the terms of a contract he’s signed. I agree that many attorneys and risk managers don’t understand how difficult it is to comply with certain contract terms. One of our regional companies has a nice feature in their Blanket Additional Insured endorsement. It automatically provides completed operations coverage to the extent a contract requires it. Wouldn’t the contractual liability coverage comply with the requirement on an indemnification basis? I don’t think the liability would be imposed on the insured in the absence of the contract, but on the indemnitee. If the indemnitee comes after the insured for reimbursement, I think this meets the definition of ‘insured contract’ and there would be coverage. I think I need to take a nap."

Completed operations coverage can still be provided if you have a market for it and can afford it. When ISO revised the CG 20 10, it took out completed operations coverage and put it in the new (at that time) endorsement, the CG 20 37. Unfortunately many attorneys and risk managers just don’t seem to understand that insurers normally can use only filed forms. So, as Paul Harvey says, here’s the rest of the story...