Are broker chains the weakest link?

In February, a number of brokers were facing a nightmare scenario. The cover they thought had been arranged for a number of clients did not exist.

The cover had been placed through a sub-broker, Preston Whiteside. It was alleged that Preston Whiteside had been collecting the premiums, but had not actually placed the cover. Investigations followed and Preston Whiteside was placed in run-off. And the SFO is now set to investigate.

The demise of Preston Whiteside brought the issue of broker chains - where one or more sub-brokers are involved in the placing of a risk -to the regulators' attention..

It showed just how precarious such chains could be and how disastrous the consequences can be if they fail. Only one link in the chain has to break for the whole structure to collapse. And the damage to the industry's reputation will take a long time to heal.

In the following weeks Insurance Times' columnist John Jackson called on the industry to "wake up and take action now" to stamp out broker chain gangs.

"The broking fraternity must clean up their own house in this regard - or the FSA will do it for them," he said. "The 'chain gang' means of placing risks must be stopped."

But are broker chains the evil that Jackson suggests? Are the criticisms levelled against them valid? Or do they play a legitimate part in the insurance market?

Broker chains are creatures of the hard market. When capacity is scarce, brokers will look to other brokers with access to alternative markets to place their clients' risks.

They are also becoming more relevant as insurers put pressure on their agency brokers to provide ever larger accounts. A broker can develop a large book of business by setting up a wholesale scheme with an insurer and selling through other brokers, says

Stuart Alexander joint managing director Stuart Reid.

The size of the chains can vary. At their simplest, they consist merely of two brokers: the producing broker who has the relationship with the client and a placing broker who has the relationship with the insurer. But they can become more complex with a number of additional brokers sitting in between the producing and the placing broker.

Broker chains have been the subject of strong criticism. First, it is not always easy to identify the insurer at the end of the chain. And as the number of sub-brokers increases, the more difficult it can be to determine the insurer.

A further problem for the producing broker is that it is not always easy to check the financial viability of the sub-brokers. There is also the danger that risk information can become 'skewed' as it is passes along the chain toward the insurer. And there is the problem of grossing up where each 'link' adds its own fee to the premium. All these problems are magnified the greater the number of brokers in the chain.

Ultimate market
Giles Insurance chief executive Chris Giles believes that these criticisms are, in part, valid. "We always want to check on the ultimate market. We are looking for DTI approval and a reasonable AM Best rating. But we have come across a number of schemes claiming to use a particular insurer. We phoned the insurer and they didn't know about it - but insurers have a number of branches and they may not know of all the schemes."

But Giles is not persuaded by the argument that broking chains dilute risk information. "You can use the same argument for an insurer who has an office in Scotland, but who writes business located elsewhere in the country. How can you completely understand a risk that is 200 miles away? Insurers have to rely on the quality of the wholesale broker," he says.

"There is a slight conspiracy theory in the argument. Insurers feel they are being selected against. They need to work with brokers they trust. If a broker asks the right questions then everything is fine. The problem arises if an individual account executive three units down starts to provide inaccurate info. But that is easily fixed - you just don't work with that broker."

Reid recognises that problems can arise in relation to the monitoring of brokers' financial stability and the control over other brokers in the chain. As a result, the company heavily vets and audits the brokers with which it wholesales. But he thinks that the problems have been over-exaggerated, as the incidence of large chains is rare.

"In the bog standard provincial market, we rarely get involved in chains of more than one broker," he says. "The big chain is a storm in a teacup."

The issue of grossing up is a contentious one. Reid believes that the undisclosed addition of fees is "fundamentally unacceptable". Even adding a fee that is disclosed is questionable and "smacks of shoddy broking", he says.

Giles, on the other hand, believes that grossing up is inevitable. "There is only so much commission to go around, so there will always be additional fees. The important thing is that it is done in the right way and is disclosed."

But Giles believes that the chains have their value if they work correctly. "If they provide access to products that are not available elsewhere then they are beneficial. They can help small brokers - but they need to be wary of the insurer and how they present the quote to the client and what is happening down the chain."

Rowett Insurance principal Glyn Rowett is more sceptical. His company does not act as a wholesale broker, and occasionally places business via a sub-broker.

"We do not like to use sub-brokers, but we have to - although we are not comfortable with it. We worry about the ultimate market for the risk, but a lot of the time it is down to who will take the risk. It is difficult to make checks at Lloyd's. We advise clients that it is a bit of an unknown and, if the client is prepared to take it, then it is his choice."

Rowett warns against using wholesale brokers too much. "If you go to just wholesale brokers you will lose your agencies, as you will not be supporting your local markets. Brokers need to be careful.

"They need to look at business they can place with their panel insurers."

Insurers are also cautious of the practice. NIG's agency agreement requires brokers to obtain the insurer's consent before taking business from another broker. The insurer was caught up in the problems involving Preston Whiteside. A spokesman for NIG said that the company is tightening up its wording and engaging in audits to check the origin of business received.

And Allianz Cornhill does not get involved in broker chains. "They are often problematic and do not improve either the quality of the business or our relationship with the primary broker and the policyholder," says a spokeswoman.

More remote
Zurich however takes a different view. "We don't have any issue with sub-broking," says head of business operations, UK commercial, David Smith.

"It is a necessary part of the market. It allows clients use their local brokers who can access markets they would not otherwise have access to.

"There is a problem of becoming more remote from the customer. But it depends on what you, as an insurer, are after. If it is purely a transactional client, with which you have no relationship, there is no problem."

Smith says that the company's attitude has not been changed by the collapse of Preston Whiteside. "It was a big issue and it did not do any good for the industry. But there is a potential for over reaction and to assume that the problems are widespread in the industry. There is a natural tendency to react immediately."

Broker chains do present some problems, but they can provide a useful and necessary service to the market. While there is a need to be cautious when becoming involved in them, they are not the scourge of the insurance market that some might suggest. Preston Whiteside did the cause of the sub-broker no favours.