Secret agents in administration: if program administrators are involved in activities related to selling insurance products, they could be required to comply with new compensation disclosure requirements.

Defining a program administrator can be a slippery task. Many describe themselves as wholesalers, general agents, managing general agents or surplus line producers. Still others act as captive managers, employee-benefit program administrators or administrators of group self-insured programs. Recent investigations into compensation and disclosure practices of the largest insurance brokers raise issues about compliance requirements for program administrators and suggest that they should do their own investigations to make sure they understand what those requirements are.

The key to determining whether program administrators are subject to producer licensing laws, and the laws on disclosure of compensation, lies in four critical words: "negotiating, selling, soliciting, and procuring. If, in promoting products, one is engaged in sales or related activities involving insurance products, even when those products are a small part of a bundled program of financial and other services, the chances are good that a program administrator is required to be licensed as an agent, broker, surplus lines broker or MGA, or some combination.

The New York Investigation

Following New York state Attorney General Eliot Spitzer's investigation, Marsh & McLennan Cos. agreed to the following in its settlement with the attorney general earlier this year: "In placing, renewing, consulting on, or servicing any insurance policy, Marsh shall not directly or indirectly knowingly place, review, consult on or service its clients' insurance business through a wholesale broker unless agreed to by the client after full disclosure of: a) the compensation received or to be received by Marsh; b) any Marsh interest in or contractual commitment with the wholesaler, and c) any alternatives to using a wholesaler."

Now consider the exemption of wholesalers and MGAs from the compensation disclosure requirements in Section C of the National Association of Insurance Commissioners' Producer Licensing Model Act: "This section shall not apply to a person licensed as an insurance producer who acts only as an intermediary between an insurer and the customer's producer, for example, a managing general agent, a sales manager, or a wholesale broker or a reinsurance intermediary."

The National Association of Professional Surplus Lines Offices and the American Association of Managing General Agents made a very compelling argument to the NAIC in December 2004 that these types of producers should not have to disclose compensation since they do not have direct contact with the purchasers of insurance. New York is not so convinced, however, as evidenced by the settlements with Marsh and Aon and past opinions and circular letters published by the New York Insurance Department. Clearly, those settlements do not only impact these brokers' activities in New York. Further, some of the pronouncements about wholesalers in the settlements have indirectly found their way into New York State legislation on disclosure of producer compensation.

New York Broker and Agent Law

New York Insurance Law [section] 2101(c) defines "insurance broker" to include "any person, firm, association, or corporation who, for any compensation or other thing of value acts or assists in any manner in soliciting, negotiating, or procuring insurance contracts or in placing risks on behalf of any licensed insurance broker."

If no compensation is derived by the subject individual or entity, then despite this activity, a broker's license is not required. However, if there is both licensable activity and compensation for licensable activity, a broker's license must be applied for and maintained.

This language does not appear in the definition of "insurance agent." If an individual or entity is selling, soliciting, negotiating, or procturing insurance on behalf of an insurer, an agent's license must be applied for, regardless of whether compensation is derived from the relationship.

Another interesting observation about New York's definition of "broker" is that it is broad enough to include wholesalers, program administrators and others, however they describe themselves.

New York Proposed Legislation

By the terms of one of the New York State proposed bills, [section] 2120 of the New York Insurance Law would be amended by adding a new subsection to read as follows: "On a form devised and distributed by the department, every agent and every broker or insurance producer shall disclose to all clients or potential clients, the existence and nature of all compensation, including but not limited to the source, nature, form, value and method of calculation of such compensation."

There are exemptions from the proposed compensation disclosure requirement for gifts of minimal value and statutory fees or expenses. There is also an exemption for a) an insurance producer who does not receive compensation from the client for the placement of insurance, consistent with the statutory exemption from the definition of a broker; b) a producer who in connection with such placement of insurance represents a client that has formally appointed such insurance producer; c) a producer who has disclosed to the client, prior to the purchase, that the producer received or shall receive compensation from the insurer; and d) a producer who represents the insurer and who may also provide services to the client for the insurer. The proposed New York legislation however, does not exempt wholesalers.

Further, in a key New York Insurance Department Office of General Counsel Opinion dated Nov. 30, 2004, the department, citing a decision entitled Citron vs. Curiale, rejected a wholesale broker's argument that he was not acting as an insurance broker because he did not deal directly with the insureds. The decision specifically stated that direct dealing with insureds is not an element of New York's statutory definition of "insurance broker." By extension, this reasoning is applicable to the obligation, stated in Insurance law [section]2119, to disclose service fees.

Now, because the attorney general's office, in its settlements with Marsh and Aon, appears to be reinforcing, even expanding, this long-held position of the New York State Insurance Department, and because Marsh and Aon do business nationwide, important precedents are being set with respect to producers who do not have direct contact with the end users of insurance, despite the incorporation in the NAIC Producer Licensing Model Act of language seemingly exempting wholesale brokers.

Further, under [section] 2119, and the new proposed New York legislation, any entity involved in some manner in negotiating, soliciting, selling or procuring contracts of insurance, or contracts of which insurance is an element, whose customers include New York customers, may in the future have to abide by the rules laid out for Marsh and Aon as regards compensation disclosure.

Other State Regulations

New York is not alone in regulating wholesalers. New Jersey law does not distinguish between wholesalers and retail producers as to the obligation to disclose service fees charged an insured or prospective insured for the placement of insurance. The term "wholesale insurance producer" is defined by Oregon law as an "insurance producer who solicits or sells an insurance policy through a retail insurance producer or negotiates an insurance policy for a prospective insured with a retail insurance producer and does not solicit or sell directly to or negotiate directly with a prospective insured" if the wholesale producers' fee or commission is passed onto the insured as any element of the commissions paid, this must be disclosed to the insured in a written agreement between the retail producer and the insured.

Program Administrators

Three pronouncements in state regulation affecting program administrators are found in New York, Illinois and Minnesota.

New York: A 1991 New York Insurance Department Office of General Counsel Opinion merits close consideration. These were the facts: A company would administer a purchasing system by which it would offer subscribers a bundled product from businesses that would contract to offer their products and services to those subscribers. For each purchase made through the program, the vendor would transmit approximately 7% of the amount of the purchase to a master fiduciary escrow account consisting of individually named subscriber sub-accounts at a bank. The member would be given the option at the time of enrollment of either periodically receiving cash payments from the bank or a tax-deferred annuity underwritten by a life insurance company. The department stated that the most fundamental problem with this proposal is that the program administrator would be acting as an insurance agent without a license with respect to annuities, and would be acting as an insurance consultant without a license.

In its marketing brochures, the program administrator would make suggestions about the need for consumers to purchase annuities. Since there was only one insurer that would be writing annuities under the program, this brochure would be a solicitation on behalf of the insurer to prospective insureds to buy annuity contracts. The insurance portion of the program was part and parcel of the entire business enterprise. Additionally, the program administrator would be using a check-off method in its application procedure, which has been held by the department to constitute solicitation.

There was admittedly no direct contact with the insured. However, the MGA was nonetheless clearly acting as an authorized or acknowledged agent of the insurer in the negotiation for or procurement or making of insurance contracts.

Thus, program administrators must be particularly careful when they distribute bundled products and services that include options for insurance products, including, but not limited to, annuities. Distribution of products with insurance features or elements may constitute selling or soliciting insurance and thus, require a license as an insurance agent.

Minnesota: Minnesota has regulation on administration of claims that requires each self-insurer to designate those employees who will administer their self-insurance program and specify their qualifications to administer the program. If a self insurer contracts with an outside party to administer its program, including adjusting, loss control, or safety engineering, the third party must be licensed for these specific areas of program administration.

Illinois: Illinois's regulations define "administrator" as follows: "Any person, partnership or corporation, other than an insurer or health service corporation or health maintenance organization holding a certificate of authority ... or sell-insured employer, employee benefit trust fund or other ERISA-exempt organization, that arranges, contracts with, or administers contracts with a provider whereby beneficiaries are provided an incentive to use the service of such provider."

The next section of the administrative code states that an administrator may negotiate and make arrangements with providers, and may market and otherwise make such arrangements to insurance companies, health service corporations, fraternal benefit societies or self-insuring employers, and to their subscribers, provided, however, that in performing such functions, the administrator may not accept any underwriting risk in the form of a premium or capitation payment for its services.

Service Fees

The Marsh and Aon cases, among others, brought a good deal of scrutiny on the subject of brokers' receipt of service fees, in addition to, or in place of, brokerage commissions. New York Insurance Law [section]2119 may be followed as a model. It requires that a written agreement must be entered into with the insured customer, clearly specifying and itemizing the fees to be charged where those fees are unrelated to the customary commission charged for procuring the insurance policy.

The New York state attorney general's settlements with Marsh and Aon clearly specify the permissible and the impermissible forms of compensation for these large brokers.

The settlements prohibit receipt of contingent fees from insurers based on placing a particular volume of policies, or achieving a particular volume of policies, or achieving a particular level of growth, or meeting a particular rate of retention or renewal of policies, or providing preferential treatment in the placement process in any way. The Marsh and Aon settlements do not prohibit specific flat fees or payment of a percentage commission on premium, as long as they are disclosed in writing, quantified, or if not possible to quantify, then explained unambiguously. The customer's consent in writing to compensation is also required.

In some states, such as California, the law requires a statement be made to the insured specifying that information and service concerning insurance policies may be obtained directly from the insurer without charge.

A 1980 bulletin of the California Insurance Department on broker fees and other similar fees makes rules regarding broker fees specifically applicable to wholesale producers. Thus, wholesalers in California have the same duty to disclose to those dealing with them as do those brokers that deal directly with the insuring public.

In other states, such as Delaware, an agent or broker may not accept consideration when a consultant's fee has been paid. New Jersey sets specific dollar limits on fees charged for certain specific services.

Still other states, such as Arkansas, California, Massachusetts, Oklahoma and Texas, only regulate service fees with respect to certain types of producers or policies of a certain nature.

Referral Fees

The subject of referral fees is also worthy of mention. Referral fees are permitted in New York and in Pennsylvania.

The basic concept is that a licensed producer for an insurance company may not share compensation with unlicensed entities, including those who are unlicensed producers. However, New York and Pennsylvania have made an exception in their laws to recognize the fact that banks and other financial institutions, which are not licensed under insurance law, often refer client lists to affiliated or unaffiliated licensed agents and to others so that they need to receive some sort of compensation without violating the law.

Although there probably will continue to be different frames of thought for some time, it is apparent that program administrators cannot ignore licensing laws and cannot ignore the emerging body of law on the disclosure of compensation paid in an insurance transaction.

Key Points

* Program administrators are not directly regulated by most states.

* The key to determining whether program administrators are subject to the laws on disclosure of compensation is whether their activities involve, in the chain of production, selling, soliciting, negotiating or procuring insurance.

* New York law has set important precedents with respect to producers who do not have direct contact with the end users of insurance.

Contributor Frederick J. Pomerantz is a partner in Wilson, Elser, Moskowitz, Edelman & Dicker LLP, New York.