A substantial insurance broker goes into administration one Friday morning in March 2005. The administrator's first concern is to establish continuity of cover for the firm's clients, and closely examine the agency position with insurers.

Throughout 2004, insurers had re-issued their agency agreements to exclude liability for credit risk transfer, as permitted by the FSA.

Some of the broker's clients have heard of the problem and start to contact the administrator regarding continuity of cover.

The vast majority of clients have paid their premium and assume that the insurance companies will stand by the contract, as the broker was acting as agent for the insurer in attaching cover.

The administrator's staff learn that, because of the exclusion of risk transfer, the broker's clients should pay again to secure cover.

The clients fall into three camps: those who refuse to pay on the basis that they are holding insurer documents; those who wish to pay, but don't know who to pay; and those who know nothing about the broker's insolvency and carry on, unaware that their cover may be void.

Over the following weeks some of the broker's clients are involved in accidental damage claims and seek an indemnity from the insurers in line with their expectations, having paid the annual premium. The insurer has received no monies and protracted discussions start as to whether indemnity is provided.

Meanwhile, the administrator has established that the new trust account, which should hold premiums of about £7m, has a balance of £100,000.

Since his appointment, the two shareholding directors have disappeared and attempts to locate them are proving unsuccessful. A cursory examination of the paperwork shows that the two have siphoned off the insurance premiums overseas during the previous three months.

The administrator advises non-shareholding directors (with their legal advisers) of their personal liabilities as trustees of the premium trust account.

These directors, who are all brokers with client responsibilities, are starkly aware that their personal assets could be seized to redress the liabilities in the premium account.

Meanwhile, the administrator is directing clients to the financial services compensation scheme (FSCS) to secure return of premiums.

There will also be an additional call on the fund from the broker profession this year, as two weeks previously, a broker had arranged incorrect cover on a local stately home. This was only established when the property burnt down, resulting in a £400m claim.

The individual policyholder has the protection of the regulation but, unfortunately, the broker carried the minimum PI cover of £800,000, which is inadequate for the claim.

Clearly, the compensation fund will be totally inadequate and a substantial call will be made on the broker market.

Broker liquidations are uncommon, I hear you say, but what of the new pressures on firms down the line?

  • No longer able to use the premium account to prop up trading or provide short-term loans to cover cash flow dips
  • Increased cost of compliance
  • Increased cost of technology
  • Market softening
  • Lack of capacity
  • Reduction in commissions
  • Increased cost of PI
  • Increased costs in training and competence
  • Skills shortage
  • Competition from new players
  • Cash calls for FSCS
  • The purpose of the FSA is set out in statutory objectives:

  • Maintaining market confidence in the financial system
  • Promoting public awareness of the financial system
  • Providing the appropriate degree of protection of consumers
  • Reducing the opportunities for financial crime.
  • I will leave you to judge whether, in the circumstances above, the FSA can achieve its stated objectives.

    Paul Meehan is managing director of Smart and Cook Group