Smaller brokers should not fear the FSA's move towards mandatory disclosure of commission - they will benefit from knowing the preferential arrangements larger brokers enjoy, says Simon Burgess
The unexpected decision by the FSA to look at mandatory commission disclosure left many brokers quaking at the prospect. But why? Surely this can only be a good thing - especially for the smaller and medium-sized brokers and, of course, for the consumer.
I am only surprised that the FSA has not peered into this murky pool much earlier as it clearly militates against the consumer and against business.
There is a clear split between the larger corporate risks and those of the small-to-medium-sized enterprise market and there clearly needs to be a move towards a level playing field for all operating in the market.
The FSA would prefer the market to devise a solution to end shifty commission payments, but what would the incentive be for doing this? The loudest voices at the table are the big brokers and they also dominate the thinking in the larger trade bodies.
Needless to say, they have most to lose from any movement towards commission disclosure. Even FSA chief executive John Tiner admitted that because of the "diametrically opposed incentives of both sides" an agreed industry-led solution was likely to be "light years away".
Mandatory broker commission disclosure now looks increasingly likely after the regulator appeared to be losing patience with the industry finding a solution itself. That's even though it persists in saying it will listen to industry-led solutions.
It is unsurprising that the FSA is frustrated at the pace of change. Since brokers and underwriters are permanently locked in conflict, an agreed industry-led solution seems unreachable.
In a damning indictment of brokers' standard commissions as well as contingent commissions - which insurers pay brokers for bringing them business - Tiner cited an "unlevel playing field", lack of transparency and the creation of an inefficient market.
Already, elements of the broking industry have gone on the defensive, throwing up smokescreens about commission having little to do with the quality of the product, the end-price or the service in some markets.
They claim that the level of charge from the broker is irrelevant as long as the total price is competitive. They just don't get it. It is all about transparency and providing the customer with the information that leads them into making an informed choice about a product or service level.
And that is true of every level of broking. If the market is working well and no one has anything to hide, then why not disclose it?
The reason why there is not a stampede towards disclosure is that commission levels lead to provider and product bias and that falls foul of the regulor's remit concerning treating customers fairly.
Commission bias and salesmen taking as much commission as they can get away with, irrespective of the quality or value of the work undertaken for the client, have been endemic black marks on our industry since time immemorial.
The ordinary purchaser of insurance has no idea that the broker he selects may be receiving hidden payments from insurance companies, or that the advice he receives from the broker may be compromised.
Most of us at the better end of the advisory market are taking steps to address these issues and not always easy ones. And of course difficult questions will lead to a wider debate about whether such a move will lead directly to broker consolidation and the effect of such broker consolidation on the dynamics of the insurance market, and the impact of regulation on the insurance cycle.
But the focus of the FSA's review, the results of which will be announced next July, must be to understand how commission leads to consumer detriment through product bias, and its impact on the sales process and the competence level of brokers.
The best solution to the problem of commission abuse must be absolutely clear disclosure of commission plus a signed agreement with the client in respect of each and every product sale to the effect that they have been given the opportunity to examine alternative methods of remunerating their adviser (fees for example).
If accepting that the broker is paid commission, it should be pointed out to the client that commission levels are not carved in stone and can be adjusted. This instruction should apply to anyone broking any insurance product.
But there is no reason why the small or even mid-sized broker should fear disclosure. On the contrary, the smaller brokers will benefit because if all commissions are upfront they will be better able to compete.
For too long the big brokers have been allowed to rip apart the market by stitching up preferential deals - often to the detriment of consumers and business.
It is this blatant conflict of interest that first alerted New York District Attorney Eliot Spitzer to the shenanigans of the broking industry where the receipt of contingent commissions and other hidden payments from certain insurance companies for steering client business to preferred insurers was widespread.
He further discovered that not only do brokers receive contingent commissions to steer business, but many brokers, with the assistance and collusion of insurers, engage in systematic fraud and market manipulation in order to ensure that profitable and high volume business goes to a few selected insurers.
The initial indignation stateside has now somewhat abated with the three biggest brokers receiving approval from the insurance regulators to accept so-called 'soft' contingent commissions in some circumstances.
They will now be able to accept commissions, which can be based on profits, when the broker acts as an agent for the insurer.
With the FSA now to carry out objective market failure analysis and corresponding cost benefit analysis, covering both customer and market transparency, it is to be hoped that it won't bend so easily to the major broking powers and put instead, transparency and customer protection first. IT
Simon Burgess is managing director of British Insurance