Brokers are concerned about solvency requirements in the European Directive that suggests a flat rate capital requirement. Geoffrey Boardman says such systems have already proved ineffective in protecting policyholders

When the draft EU Directive on insurance intermediaries was published, suggesting a flat rate 8% of premium as a capital requirement, few took much notice. It was just Brussels meddling in something it did not really understand.

Now the final EU Directive has been approved, a great deal of attention has been focused on the reduced 4% capital requirement of intermediaries. Why?

There is no reason to believe that a flat rate solvency is going to be imposed in the UK. The Directive actually proposes that client funds should be protected by "one or more" of four possibilities, only one of which is a "financial capacity" equal to 4% of the premium throughput.

Of the alternative means suggested, a strengthened insurance broking account (IBA) system would be uncontroversial, effective and easy to incorporate in local legislation. Legal definition of the status of premiums and claims held by the intermediary would be acceptable, if complex, for some types of business, although causing difficulty whenever premiums are offset against claims. A guarantee fund would be inappropriate for many classes of business, although the IBA system already exists in the policyholders' protection fund.

Flat rate inadequacy
Capital requirements are meaningless unless accounting policies on basic matters such as recognition of income and servicing costs are standardised. Furthermore a flat rate requirement is a blunt instrument that is unsuitable for an industry as complex as insurance broking.

The 4% of premium throughput may be reasonable for a small high street broker operating on a commission rate of 20% or even higher, but is a totally inappropriate burden for a wholesale or reinsurance broker on 5% or less and a complete nonsense for major international brokers.

Capital requirements have been shown to be of little practical value in preventing failures among London Market brokers. Brokers have failed through catastrophic property problems, enormous uninsured legal claims and, occasionally, fraud, not through the lack of an imposed solvency requirement.

The only possible justification for solvency requirements is the vain hope that there will be enough money left behind to pay to clear up the mess and look after the clients.

Bitter experience shows that capital shown in the past year's audited accounts can mysteriously disappear at remarkable speed. A bank guarantee or insurance bond at least cannot be spent by the board. These together with the alternatives offered in the Directive are far more effective in protecting both the client and the market as a whole.

At the same time, very few brokers really need capital to run their businesses efficiently. They have no expensive plant, stock or other assets to finance.

Undemanding GISC
The Insurance Brokers Regulatory Council (IBRC) never had any significant capital requirement, GISC requirements were never demanding. Only Lloyd's imposed major solvency margins on its brokers which it abandoned two years ago.

Why would the UK government impose something that has been shown to provide little or no protection when better alternatives are available?