Charles Maddocks explains in simple terms the complexities of the FSA's client money rules

Unbreakable codes, hidden instructions even conspiracy theories - we've seen it all in relation to the FSA's client asset sourcebook (CASS) and client money.

The FSA issued its Guide to client money for General Insurance Intermediaries just as the film of The Da Vinci Code was released. The guide may not be seen by so many, but it is invaluable reading.

It is intended to unravel CASS and explain how intermediaries should handle client money. But it also takes away any possible excuse for not understanding the rules.

The FSA feels that firms have now had sufficient time and guidance to construct their client money systems. It follows that enforcement action is likely against firms that continue to flout the rules.

The FSA has announced a major review of how firms are complying with the rules, involving visits to over 200 firms. Note that the FSA "wants to see a significant improvement in how firms are complying with client money rules".

The pilot studies that led to the review highlighted the following failures:

  • To perform a client money calculation or doing so incorrectly
  • To keep track of money held at third parties
  • To observe trust law and thereby potentially jeopardise trust account status
  • To inform customers of how their money is being handled.
  • Client money is money, such as premiums, claims money or premium refunds, held by a broker for clients. While holding it there is a fiduciary duty to clients to look after it. This duty lasts until the money reaches the insurer or another party who has risk transfer from that insurer.

    It follows, therefore, that if you have risk transfer from an insurer, then any money you receive from clients for that insurer is not client money - it is insurer money.

    If a broker has risk transfer from all insurers then client money rules don't apply.

    However if not all insurers or wholesalers give risk transfer, and risk transfer and non-risk transfer monies are co-mingled, then it is all client money and the rules apply.

    The FSA insists on trust status for safekeeping money. Statutory trusts are the easiest. No trust deed is needed, the trust is imposed by the FSA's rules. Check the following and have evidence to show the FSA if required:

  • The account name contains "client" or "client money"
  • There is a letter from the bank confirming the trust status - that the bank cannot combine or exercise any right or set-off or counter claim against other accounts.
  • Non-statutory trusts require more effort and evidence. This is because the benefit of being able to provide credit to customers from this account brings increased risk. Therefore, in addition to everything above, the following should be in place and evidenced:

  • A formally executed trust deed
  • Systems and controls adequate to monitor and manage money transactions and credit risks
  • Current, written confirmation from the account auditor
  • A designated manager to oversee day-to-day compliance with the rules
  • Capital requirement of £50,000 if retail customers' money is held
  • An explanation of the non-statutory trust approach in the terms of business agreement (Toba)
  • Clients' informed consent to hold money in this way.
  • The FSA expects client money to be paid into the client money account by close of the following business day. Automated transfers should be paid direct into the client money account.

    A broker's duty to its client ends when the money reaches the insurer or an agent with risk transfer from that insurer. Until it does so, that money must be included in the client money calculation. It follows that there should be a mechanism in place to track and report on this money until it reaches its destination. The duty is not discharged until the cheque or order clears.

    Premium refunds and claims monies are slightly different. A broker's fiduciary duty only starts when it receives the money. It is discharged once the client has presented the cheque and it has cleared.

    Cleared funds are an important consideration. A firm operating a statutory trust that knowingly draws on an uncleared cheque is extending credit (either to clients or itself) and is in contravention of its trust. A firm operating a non-statutory trust drawing commission from uncleared funds is extending credit to itself.

    Again this is not allowed. The FSA recommends a prudent three to five working days to allow a sterling cheque to clear, and five days for a credit card payment. It is wise, therefore, to have evidence of this being taken into account.

    Commission and fees can only be withdrawn for the client account when:

  • Received from the client or premium funding company
  • Payment has cleared
  • In accordance with insurer and client agreements.
  • This last point is important. The intention is to clarify when commission or fees cease to be client money. But it demands that the broker has an up-to-date summary of the insurer's Tobas. For instalment cases, commission can only be withdrawn on the proportion of the premium actually received and as long as the insurer's Toba allows it.

    The client money calculation is top of the FSA's list of failings and the subject that causes the most confusion.

    The aim is to verify that the amount in your client account and held at third parties is enough to meet all obligations to clients.

    A broker's own accounting records should be used, as these are the most up-to-date figures. The calculation must be done every 25 business days as a minimum. Records must be kept for at least three years.

    There are two methods - the accruals method and the client balance method. The former incorporates the client money recorded in the ledgers, and as insurance debtors and creditors. The latter uses individual client balances to calculate the client money requirement. Whichever is used, the choice must be recorded in writing for examination.

    The calculation simply works out the resource (client money) and the requirement (amount needed to be segregated to meet obligations to clients) and compares the two.

    Shortfalls or surpluses can occur. For example money paid to clients before being received from insurers would give a shortfall. Similarly commission due and payable, but not taken by the firm will give a surplus.

    Other reasons for a shortfall are commission taken before due and payable, or premiums paid to insurers before received from the client (if statutory trust). These are likely to be breaches of the client money rules.

    Within 10 business days the amounts in the ledgers must be reconciled to bank statements. This can be done on the same day if preferred.

    A word of warning. The FSA has said that it is the responsibility of a broker to ensure that software systems are generating the correct figures. The onus is on the broker to identify any shortcomings in the systems and to resolve these. Also the auditor should check that the systems comply. IT

    ' Charles Maddocks is marketing director of Compliance Insurance Solutions