) when it announced third-quarter earnings on Nov. 9. After all, the world's largest insurance broker has lost its chief executive -- and a significant chunk of market value -- since October, when New York Attorney General Eliot Spitzer socked it with charges of bid-rigging and kickbacks.
But the sheer scope of bad news demonstrates that the fundamental business model of Marsh's brokerage operations has to change. And investors are right to wonder how the insurance giant can maintain margins at the heart of its business.
STAGGERING DROP. Certainly, new CEO Michael Cherkasky didn't inspire optimism in announcing that MMC would cut 3,000 jobs -- about 5% of the workforce -- and set aside a $232 million reserve for a possible settlement with Spitzer. The stock closed at $26.80, down 2%.
Marsh executives admitted that amount is the minimum likely to be needed and that any final settlement could be much more expensive. Putnam, its mutual-fund unit, also has agreed to pay $40 million to settle charges with the Securities & Exchange Commission over its brokerage-allocation practices.
While Spitzer's investigation became public only a few weeks ago, the damage it has caused to MMC's bottom line is profound. While revenues rose 5%, to $3 billion, in the third quarter, net income plummeted to $21 million from the $357 million of a year earlier, a 94% decline. Much of that drop is due to the creation of the reserve fund, but the permanent loss of certain fee income also was a significant factor.
WRONG INCENTIVES. The problem is finding ways to replace the lucrative income streams that are now at the heart of the investigation. Revenue from so-called market-services agreements, the controversial contingency commissions that Marsh execs got for channeling business to particular insurers, declined to $46 million, from $177 million a year ago. From here on, that number is likely to be zero, as everyone from clients to state regulators have loudly condemned the practice.
Marsh ended such commissions Oct. 15 -- though it has since had the gall to say it's taking steps to collect all market-services fees that were due prior to that date. The money will go into a special account to settle with Spitzer who, presumably, may pave the way for clients who feel duped by such fees to seek retribution. One problem with the commissions is that, instead of inspiring Marsh brokers to work toward the best deal for their clients, they provided strong incentives to channel business to the insurer that offered top dollar to Marsh.
With rivals now circling to pluck off both key customers and Marsh staffers, the outfit may be hard-pressed to recoup the lost income through higher client fees. Moreover, the sudden resignation of key executives -- including CEO Jeff Greenberg, General Counsel William Rosoff, President Roger Egan, and Christopher Treanor, chairman of the unit's global placement division -- suggests that broader cultural issues have to be addressed.
GREED'S DIVIDENDS. These weren't a few rogue players on the margins, though Marsh continues to insist that any problem with the way business was conducted did not extend beyond a small group. Critics, on the other hand, are charging that the entire fee structure was designed to reward brokers motivated by greed more than the best interests of their clients.
Reversing Marsh's fortunes will require more than drastic job cuts or a quick settlement with Spitzer. The company needs to take steps to regain the trust of its customer base and offer a level of service that clients are willing to fund from their own pockets. Otherwise, the continued skepticism of investors, who have dragged the stock down to almost half of its high earlier this year, will remain justified. Brady is an associate editor for BusinessWeek in New York