An oligopoly built by a small number of insurance brokerages over the past two decades is being shaken severely as the industry’s basic business model comes under attack by legal authorities, according to a new report by Standard & Poor’s Ratings Services.

The report details how a small number of large brokerages built an oligopoly over the past 20 years with an aggressive expansion strategy. Today, just three brokerages share 60% of the global market, with Marsh & McLennan Cos. at 31%, Aon Corp. at 22%, and Willis Group Holdings Ltd. at 7%, S&P says.

In the process, brokers created a starkly uncompetitive and distorted market, gaining excessive power in the relationship among insurers, customers, and intermediaries. Until they disavowed contingent commissions, brokers dictated which customers insurers sold insurance to, instead of the other way around. “The distribution tail at times has wagged the insurance dog,” said Thomas Upton, property/casualty ratings team leader at S&P.

Now, in response to New York state Attorney General Eliot Spitzer’s investigation of the insurance industry, the three largest brokerages have agreed to stop charging insurance companies contingent commissions, which comprised a material portion of their revenue. As a result, brokers can expect rates of return to fall from current highs of about 20% at a time when interest rates are rising from historic lows. The net effect is an unraveling of the delicate fabric of an industry that was financed by a phenomenally wide gap between ROR and borrowing rates, the report explains.

As for what will replace the industry’s business model, S&P foresees two possible scenarios, one of which suggests that brokerages could succeed partially in maintaining their dominance over insurers and customers. The other suggests a much less important role for market intermediaries, with implications for highly leveraged players such as Marsh.