Since October, 2004, the insurance industry has been under a significant level of scrutiny by various regulatory bodies, including state Attorneys General and the departments of insurance for various states, with respect to industry practices, including contingent compensation arrangements. We have received subpoenas from the Office of the Attorney General of the State of Connecticut, the Office of the Attorney General of New York and the Florida Attorney General’s Office requesting documents and seeking information as part of their industry-wide investigations relating to pricing and placement of insurance. We have also received an Investigative Demand from the Department of Justice of the State of North Carolina seeking similar information. While these investigations are continuing and the ultimate outcome cannot be predicted, the investigations center upon, among other items, allegations of bid rigging, tying arrangements and other fraudulent or unlawful business practices. We have cooperated fully with these requests and will continue to cooperate with regulators as they refine, prioritize and/or expand the areas of inquiry in their subpoenas and information requests. For example, in recent weeks, requests from the Office of the Attorney General of the State of New York have sought information regarding our New York benefits business, and our outside counsel is working with personnel in that business unit to respond to the requests.
On October 14, 2004, the New York Attorney General announced that its investigation into brokers’ compensation practices had led to its filing a complaint against Marsh and McLennan Companies, Inc. and its subsidiary, Marsh, Inc. (collectively, “Marsh”), stating claims for, among other things, fraud and violations of New York State antitrust and securities laws. Marsh announced on October 15, 2004 that it was suspending its use of contingent commission agreements. Since then, three other large insurance brokerage companies, Willis Group, Aon Corporation and Arthur J. Gallagher & Co., each announced that they would discontinue contingent commission agreements and unwind such arrangements by the end of 2004. Three large insurers have announced that they would stop the use of such agreements as well. On January 30, 2005, Marsh entered into an agreement with the New York Attorney General and the New York Insurance Department in which Marsh agreed to pay $850 million into a fund to compensate Marsh’s policyholder clients. In addition, Marsh announced that it had agreed to implement, among others, the following changes in its U.S. brokerage business: (1) Marsh has discontinued the practice of receiving contingent commissions; (2) Marsh will provide clients with a comprehensive disclosure of all forms of compensation received from insurers; (3) Marsh will adopt and implement written standards of conduct for the placement of insurance; (4) Marsh will provide to its clients all quotes and terms as received from insurers; and (5) Marsh will establish a compliance committee of the board of directors and appoint a chief compliance officer.
Following the allegations of bid rigging and price fixing in the lawsuit filed by the Office of the Attorney General of New York against Marsh, we retained outside counsel, Akin Gump Strauss Hauer & Feld, LLP
For more discussion on our business please refer to Part I, Item 1, “Business,” in this report.
On November 19, 2004, we acquired Benefit Partners of America, a Specialized Benefits Services operation. The aggregate preliminary purchase price of approximately $11.4 million, consisting of $10.4 million of cash, shares of common stock valued at $0.6 million and notes issued of $0.4 million, was allocated primarily to goodwill and other current assets.
Please read Note 1-“Nature of Operations and Summary of Significant Accounting Policies” to our Consolidated Financial Statements included in Part II, Item 8 of this report for a description of other significant accounting policies.
Other Operating Expenses. Other Operating Expenses increased $23.6 million, or 30.9%, to $100.1 million for 2004, from $76.5 million for 2003. For 2004, the increase was primarily due to the effect of acquisitions and the impact of expenses related to the fourth quarter 2004 margin improvement plan of $6.1 million. Additionally, for 2004, we incurred a net increase of $2.6 million in costs related to the implementation of Sarbanes-Oxley Section 404 procedures and a net increase of $0.7 million related to legal fees and costs related to various insurance industry investigations over the comparable period in 2003. As a percentage of revenues, Other Operating Expenses were 24.6% for 2004, compared to 22.1% for 2003.
The Corporate segment results reflect the following margin improvement plan, integration efforts and other charges: $3.6 million, $0.4 million and $3.9 million in 2004, 2003 and 2002, respectively.
In the fourth quarter of 2004, we announced that our Board of Directors had approved a margin improvement plan in order to reduce ongoing operating expenses. As a result of this action, we recorded expense of $12.4 million in the fourth quarter of 2004. The expenses related to employee severance and related benefits for 28 employees of $3.4 million, facilities closures of $3.4 million, the modification of 34 sales professionals’ agreements of $2.9 million and service contract termination fees of $2.7 million. See “Contractual Obligations,” below, for further discussion on the service contract termination fees.
Upon the consummation of our IPO in October 2002, the Long-Term Incentive Plan was terminated and replaced with the 2002 Equity Incentive Plan.
We routinely enter into employment agreements with management and other key employees. Some of these contracts may provide for severance benefits in the event that we terminate the employment relationship without cause. Severance costs are expensed as incurred in accordance with GAAP.