Updated from Oct. 14

Eliot Spitzer took aim at the insurance industry Thursday, charging a big broker in an alleged price-fixing scheme. The move continued to depress insurers' shares early Friday after huge declines Thursday.

The New York state attorney general alleged at a midday news conference that Marsh & McLennan ( MMC), one of the nation's biggest insurance brokers, had led an industrywide kickback and price-fixing scheme.

In a civil complaint filed Thursday in New York Supreme Court, Spitzer's office charged Marsh with fraud and taking billions in allegedly improper payments to steer work to a select group of insurers. Marsh is accused of putting its own financial interests ahead of its customers' in securing insurance coverage for them.

One of the most serious allegations against Marsh is that it convinced other insurers to go along with a system of creating fictitious and noncompetitive bids in order to give the customer the appearance of a competitive marketplace for insurance coverage where one didn't exist. The lawsuit contends the rigged bidding process led to higher insurance premiums and fatter payments from the insurers to Marsh for steering the work their way.

The charges against Marsh stem from a nine-month investigation that threatens to be as damaging to the insurance industry as Spitzer's earlier crusades against conflicts of interest on Wall Street and improper mutual fund trading.

In conjunction with the suit against Marsh, Spitzer's office secured two guilty pleas from executives at American International Group ( AIG), who allegedly took part in the improper steering arrangements. The AIG executives agreed to cooperate with Spitzer in the ongoing probe that officials say is likely to lead to additional charges against other firms and individuals.

Four insurers already in Spitzer's sights are AIG; The Hartford ( HIG); Ace Insurance, a unit of Ace Limited ( ACE); and Munich American Risk Partners. All were implicated but not charged in the complaint.

"These charges go to the heart of Marsh's and the industry's business model," says Spitzer. "There was craven disregard for ethics and the law at some of our nation's largest companies."

The filing of the charges sent insurance stocks spiraling downward Thursday with some follow-through on Friday. Shares of Marsh fell another $2.49, or 7.1%, to $32.36 in the premarket Friday, after falling 25% yesterday. AIG dropped a penny to $59.99 in the premarket, after a 10% plunge Thursday. Ace fell $3.84%, or 9.5%, to $36.47. The stock shed 10% Thursday.

Other insurers and insurance brokers plummeted on the news, including Chubb ( CB), which lost $4, or 5.7%, to $65.71 Thursday, but was edging up 10 cents Friday. Aon ( AOC), an insurance broker that had received a subpoena from Spitzer's office early on in the probe, fell $4.3, or 15%, to $23.30 Thursday.

Investors in insurance stocks have a right to worry because Spitzer made no secret of his desire to bring additional cases.

But he voiced particular anger with Marsh, which has figured prominently in other investigations by Spitzer's office. Marsh's Putnam Investments was one of the worst offenders in the mutual fund scandal. In addition, the company's Mercer consulting business was implicated in the lawsuit Spitzer filed this summer seeking to recoup some of former New York Stock Exchange Chairman Richard Grasso's enormous $140 million pay package.

Spitzer advised Marsh's board to take a long, hard look at the firm's current management, claiming the firm had "corrupted the marketplace.''

"The leadership of that company is not one I will negotiate with,'' said Spitzer. He added that senior management had misled his office early on in the investigation about the nature of the payment agreements with insurers, called "placement service agreements,'' or "market services agreements.''

In 2003 alone, Spitzer says Marsh took in $800 million from these payment agreements. He says Marsh's actions could make it liable to its customers for billions of dollars in damages, stemming from insurance overcharges.

Marsh issued a statement saying it is "cooperating'' with Spitzer and is "committed to getting all the facts, determining any incidence of improper behavior, and dealing appropriately with any wrongdoing."

AIG, in a late Thursday press release, also said it is cooperating with Spitzer's office. The company said it is "saddened" by the guilty pleas of two of its employees.

"We take these charges seriously and will continue to cooperate with the attorney general's office," AIG said, adding that it plans to hold a conference call at 10 a.m. EDT Friday.

The two AIG executives who pleaded guilty are Karen Radke and Jean-Baptiste Tateossian. Both women work with AIG's American Home subsidiary, where Radke is a senior vice president and Tateossian is a manager.

Radke, in her plea agreement, admitted taking part in Marsh's bid rigging scheme and taking instructions from several Marsh employees on how to prepare the bid.

Spitzer's pursuit of Marsh and AIG creates an odd family twist. Jeffrey Greenberg, Marsh's chairman and CEO, is the son of AIG Chairman and CEO Maurice "Hank" Greenberg.

Evan Greenberg, CEO of ACE, is another son of Maurice Greenberg.

Spitzer's investigation into the insurance industry has been going on for much of the year and became public in April when his office served subpoenas on a number of firms, including Marsh, Aon, Willis Group ( WSH) and Aetna ( AET).

The Spitzer allegations are likely to cause much consternation in the insurance business. Some contend the kinds of compensation deals Spitzer has been investigating are routine in the business and not secret. Spitzer, however, contends the deals are kickbacks paid by the insurers to the brokers to peddle their products.

Analysts at J.P. Morgan Chase estimate that such deals account for 5% of brokerage revenuesand nearly 20% of earnings year to date in the insurance brokerage sector.

But Spitzer contends Marsh and other insurance firms have not told the public the whole truth about these agreements. He says the agreements are nothing more than a reward from the insurers for steering business to them and a violation of Marsh's fiduciary duty to negotiate the best deal for its customers.

Earlier this year, the Washington Legal Foundation, a nonprofit public interest group, urged state officials in New York and California to investigate compensation deals in the insurance industry. In a February press release, the foundation said compensation deals can create a conflict of interest between insurance brokers and lead them to do what's best for them and not necessarily in their client's interest.

Spitzer's office, as has become customary in investigatory cases, is using some of Marsh's own internal emails to build the case against the firm.

In one of the more damaging emails, a Marsh executive says some agreements with the insurers "are better than others" because they make bigger payments. The email writer goes on to advise a Marsh employee to be on the lookout for advice about "who we are steering business to and who we are steering business from."

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