Standard & Poor’s Rating Services lowered its credit rating on Marsh & McLennan Cos. (MMC), and warned that the investigation into the insurance industry could ultimately hurt cash flows and credit ratings of other firms.

Marsh’s rating also remains on CreditWatch with negative implications, where it was placed on Oct. 15, 2004, after the New York State Attorney General Eliot Spitzer filed a civil complaint against MMC and its brokerage and consulting subsidiary, Marsh Inc.

“The rating action reflects our revised expectations for Marsh’s earnings and cash flow given Marsh’s recent announcement that market service agreements (MSAs) are suspended,” said S&P credit analyst Steven Ader. MSAs are agreements under which contingent commissions are received from insurers. The reduced earnings will diminish MMC’s ability to rapidly retire the short-term debt that was assumed in conjunction with the US$1.9 billion acquisition of Kroll Inc. this past summer, it notes. The expectation of a fast reduction of this debt was embedded in S&P’s previous rating conclusion.

S&P says that this rating action also reflects its belief that the Marsh franchise has–at least to some extent–been damaged by the allegations of bid-rigging by the State of New York. “The ratings remain on CreditWatch negative to reflect the ongoing uncertainties of the situation, including the potential for further negative developments with respect to the bid-rigging allegations and the possible adverse effects such developments might have on Marsh’s competitive position, earnings, or cash flow,” Ader added.

S&P said that it is closely studying the rapidly unfolding events in the insurance industry stemming from Spitzer’s complaints. It notes that as long as these events continue to develop, there will be limits to any definitive statement that it can make.

The ratings agency says that the complaints filed by Spitzer have drawn attention to three separate issues: contingent commissions, bid-rigging, and tying. Thomas Upton, property/casualty ratings team leader at Standard & Poor’s says this distinction is important because each issue could have different effects. A contingent commission is not illegal, but may be unethical, whereas bid rigging (price fixing) is illegal.

“In the long run, the damage to a broker’s reputation by any proven allegations of bid rigging could compromise its competitive position,” said Upton. The risk runs considerably lower and could be short-lived for brokerages that depend heavily on contingent commissions or on tying. Although, in an extreme scenario, the loss of contingent commissions could reduce brokerages’ cash flow and hurt the credit ratings on these companies. “If contingent commissions were suspended, this could result in a material decline in the cash flow of insurance brokerages in the short run, and that will be a key driver in any rating adjustments,” said Upton. “But we believe that insurers, for the most part, will not be seriously hurt by the contingent commissions issue.”

In the long term, however, the changing landscape in the insurance industry might not be entirely fraught with risk, S&P says. “Brokerages could replace the lost earnings from contingent commissions with other revenue streams, for example, if the manner in which brokers are compensated were changed.” It suggests that regulators may require greater transparency.

Also, market leadership could change. “ Some believe that competition will be advanced in a market where no one participant enjoys excessive power. Conversely, if the smaller members of the brokerage industry react to the current scandal by consolidating, some could see better competition in the presence of more large players,” it says.

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