Recent reports suggest a lack of transparency in the commercial insurance market. But it also seems that customers aren’t that bothered …

Commissions have the potential to cause a broker ‘agency’ problems as it can act for two principals: the insurer and the insured.

Incentive problems arise because the insured (principal) cannot always observe and/or have perfect information about the broker’s (agent) actions. For example, if the broker earns contingent commission – commission paid by an insurer to a broker dependent on the volume of (profitable) business that the broker places with him – conflicts of interest in relation to the insured can arise.

The issues

Two reports published in 2007, one by the European Commission and the second by CRA International, following instructions from the FSA, concluded that there was a lack of transparency in the commercial insurance market in relation to intermediary remuneration (commission disclosure) and services.

The CRA report identified three major segments within the commercial insurance market. It maintained that commission disclosure was not an issue for two of these segments – micro-enterprises or companies with an annual turnover of less than £500,000 and large corporate customers, companies with annual turnovers of more than £100m – as they had alternative ways of comparing prices and, as a result, worked efficiently. Micro-enterprises make up about 17% of the market; large companies about 33%.

Problems were identified in the middle segment – companies with an annual turnover between £500,000 and £100m that make up about half of the market. Customers here were often unaware of their right to ask for commission information and those who were, rarely exercised it. As a result, many significantly underestimated what they paid their broker believing commission was about 10% when, in fact, it was often closer to 20%.

Why do transparency problems exist?

Three major trends have led to changing market structures within the middle market:

• Consolidation amongst intermediaries, particularly in the regions. Large national intermediaries (‘consolidators’) have been acquiring small independent brokers, a trend given momentum by the large number of ‘baby boomer’ owners reaching retirement.

• A blurring of the roles of insurer and intermediary. Insurers have been taking stakes in intermediaries and intermediaries have been acting on behalf of the insurer.

• The increased use of delegated authority. Brokers may accept risks on the insurer’s behalf (binding authority) or may take on other administrative functions, including issuing policies, claims adjustment and general administrative support. Such arrangements are increasingly becoming formalised through the use of managing general agents (MGAs).

These market changes more easily lend themselves to profit-based contingent commissions payable by the insurer to the broker, resulting in more conflicts of interest for the broker.

As the 2007 CRA study showed, middle market customers have developed strong relationships with their brokers and appear less willing to demand greater transparency of insurer commission payments. They also do not have alternative cost-effective ways to obtain it.

A further FSA-commissioned study in 2008 established that middle market customers are generally not overly concerned about the lack of disclosure. This implies they may not be fully aware of the impact of the above market changes, and how they impede efficiency if the market operates at a sub-optimal level: less benefit from insurance premium changes and less product innovation.

What are the existing legal and regulatory positions?

The existing UK legal framework is very clear about ‘agency’. The FSA Handbook also contains several sections that provide further clarification of what firms must do to comply.

The legal framework: Agency is covered under civil law. It states that an agent has fiduciary (loyalty) duties to those for whom he acts to avoid conflicts of interest. He is forbidden from taking secret profit. Under criminal law, if the agent fails in his duty to provide a full account to the principal, he can be guilty of corruption if he accepts a bribe for doing, or not doing, something, or favouring, or not favouring, a person.

Generally speaking, an agent can avoid a breach of his fiduciary duties if he obtains the consent of the person for whom he acts. Also if the principal (the insured) leaves the agent to look for remuneration (commission) from a third party (the insurer), or knows that the agent will receive something from the third party, the agent may take commission from the third party. But if the principal pays a fee to the agent, any undisclosed commission paid to the agent by a third party could be considered to be a bribe.

FSA Handbook regulatory requirements

Several sections apply. Under the disclosure of remuneration sections (ICOBS 4.3.1R & ICOBS 4.4.1R), general insurance intermediaries must provide details about fees for services but, for commercial lines, are only required to disclose details of commissions if asked to by a customer. Such disclosure must be prompt, in cash terms (estimated if necessary) and, if this is not possible, the basis for calculation must be provided.

ICOBS 2.3.1G reminds insurers of their obligations under the FSA’s principles of regulated businesses: Principle 8 requires a regulated firm to manage conflicts of interest fairly both between itself (broker) and its customers (insured) and between a customer (insured) and another client (insurer); principle 1, to act with integrity; and principle 6, to treat customers fairly.

Finally, ICOBS 4.1.2R requires that intermediaries provide customers with details of their status, including whether they have more than 10% of the voting rights or capital in a given insurance undertaking, or if an insurance undertaking or its parent has a direct or indirect holding representing more than 10% of the voting rights or capital in the intermediary. ICOBS 4.1.6R requires the intermediary to tell its customers prior to the conclusion of the initial contract of insurance and, if necessary, on its amendment or renewal, whether it gives advice on a basis of fair analysis of the market or whether it is under contractual obligation to an insurer.

What is the FSA’s position on commission disclosure?

The FSA is aware of market developments. Following the CRA report, it concluded that requiring full commission disclosure would not be a cost-effective way to deal with the problem, that is, the existing regulatory arrangements will remain.

However the FSA subsequently issued a discussion paper (DP08/02) that acknowledges there are compliance failures around contingent commissions disclosure. Although feedback has been gathered, the FSA has taken no further direct action in relation to changing regulatory requirements. It has, however, issued a feedback statement (fs08/07) and acknowledged that as the regulatory body, it will continue to monitor customer outcomes. IT

Where can I find out more commission disclosure?

FSA discussion paper:

FSA follow-up:

CRA International report:

General insurance disclosure research commissioned by FSA: