Why are corporate insurance customers such suckers?

Why are corporate insurance customers such suckers?

Why are corporate insurance customers such suckers?

Moneybox
Commentary about business and finance.
Oct. 26 2004 5:55 PM

Insurance for Suckers

Were the corporate customers ripped off by the big insurance brokers victims or fools?

Jeffrey Greenberg, the embattled CEO of Marsh & McLennan, resigned yesterday, another scalp taken by New York Attorney General Elliot Spitzer. Marsh also announced it would change the business practices that Spitzer had found objectionable when he sued the company on Oct. 14. Spitzer alleged that Marsh, a broker for corporate insurance, was screwing its clients by rigging bids and steering business not to insurers who offered the lowest premiums but to those who offered Marsh the largest contingent commissions—or, put another way, kickbacks. (Marsh & McLennan seems to have been a seething mass of conflicts of interests. Read about that here.)

The insurance cases suggest an alarming level of gullibility in American business. In the stock research and underwriting cases that Spitzer pressed two years ago, the conflicts of interest thrived because consumers—largely amateur individual investors—didn't know any better. How could a guy in Kansas watching CNBC know that analyst Jack Grubman's positive recommendation on WorldCom was influenced by a desire to garner more investment banking fees? But the insurance cases are different. The victims of Marsh's alleged fiduciary faithlessness were highly paid professionals whose job it is to find the best deal for their employers. And while the overwhelming proportion of blame for the scandal should rest on Marsh's shoulders, insurance bid-rigging could only work if the pros who bought business insurance—corporate risk-management officers—failed to perform their most basic duties.

Advertisement

It's easy to overlook just how smart and tough-minded the modern corporation is when it comes to buying goods and services. Companies scour the globe for the cheapest supply of raw materials. They move manufacturing to lower-cost locations and invest in energy efficiency. Above all, they use the power of the marketplace to get the best price. At every large company, cadres of managers—procurement officers, logistics executives, vice presidents for purchasing—live and breathe to get what the company needs on the most favorable terms. They'll set up a bake-off between Dell and Hewlett-Packard to get the best deal on desktops, play hardball with Federal Express and UPS, and constantly haggle with AT&T, MCI, and Sprint. As a result, the markets for business services are incredibly competitive.

Yet there are strange gaps in corporate ruthlessness. When it comes to certain big-ticket items—especially in financial services—big businesses for some reason prefer not to even try to get better deals. Chief financial officers don't aggressively demand better prices for services like stock underwriting. General counsels don't browbeat white-shoe law firms to slash hourly billing rates, and CEOs rarely quibble with the fees submitted by trusted advisers. And apparently, few of Marsh & McLennan's customers questioned whether their brokers were getting them the best deal on insurance or bothered to seek out better deals on their own.

Why are companies so aggressive when it comes to buying paper but lax when buying liability policies or selling stock? In some matters, it's because the reputation of the provider matters more than price. Companies want their stocks and bonds sold to the public by Goldman, Sachs or Merrill, Lynch, not by a lesser-known firm that offers lower underwriting fees. The same holds with insurance, to a degree. Companies seek an insurer with a sound credit rating and history, as well as low premiums.

In addition, insurance generally isn't considered a commodity product the way PCs are. So, the perceived costs of switching insurers, or even switching brokers—in time, paperwork, and anxiety over uncertainty—seem comparatively high.

But there is also a Dilbert-like tendency to seek the path of least resistance at work. Imagine if your real-estate broker only showed you homes that were listed by his own office and simply ignored all the homes with signs from rival brokers in their front yards. Most prospective home-buyers would be smart enough to ask about the plainly visible alternatives. But purchasers of business insurance simply relied on their broker at March & McLennan to solicit a few bids and took it at face value that they were getting the best price. How difficult and time-consuming would it have been for a risk manager at XYZ Corp. to call up another broker and get some bids or to check out Business Insurance?

In the end, many of the senior executives who decided to purchase expensive insurance policies through Marsh cost their employees millions of dollars in excess fees. They were the victim of an apparently sleazy company. But dishonest brokers can only prosper when their customers are too lazy or blinkered to ask for a better deal.