Net agreement

The recent round of commission cuts by top insurers coupled with the Financial Services Authority's (FSA) veiled intention to disclose broker commission has added further fuel to the debate surrounding net-based premiums.

For years insurers have been championing the cause of net- or fee-based payments and, traditionally, it is something brokers have objected to. Recently, however, it seems brokers have become more open to the idea.

While large commercial brokers have been operating on fees rather than commissions for some time, personal lines brokers are now considering the idea. Towry Law, which has a strong pesonal lines book, has just started a root and branch examination of its cost structures to find out how sustainable or otherwise it would be in a market more orientated to net premiums and fee income.

"Costing out what it costs to service clients is our top priority at the moment," says Towry Law managing director Martin Wright. "We consider it crucial to the ongoing profitability of the business."

Wright adds that 25% of its annual premium income, or £60m, is derived from fees, but only a third of that is priced adequately.

"Brokers are not good at pricing their business. We are not good at costing the service we deliver or even differentiating the service by dealing with low-end clients by phone or mail rather than face to face."

Budget Insurance uses net premiums to which it adds an appropriate and varying commission rate to calculate the premium it offers to its clients.

There is, however, a caveat. "Insurers need to keep a good eye on the margin added by intermediaries, as very high or very low commissions being added may well indicate how an intermediary behaves overall," says Budget director Paul Cosh.

"Large differences in gross premiums, generated from the same net price, may well cause selection against the insurers attracting clients who were not intended and driving away some of those the insurer wanted."

Among the insurers in favour of the move to net premiums is Norwich Union. Intermediary business director Ken Wallace says it is his personal belief that net premiums represent the way forward. "We would be keen to put a net-rated product into the market to give the broker the option."

Wallace says net premiums will favour brokers who understand their cost base.

"My view is that the broker who is involved in technology, with good segmentation and a well-run business will know how to generate fees and gain margin.

"They'll be able to operate at two points less than anyone else, reduce their rate and attract more customers."

Arcane system
Wallace adds that a move to quoting net premiums is something for the medium to longer term and in the meantime there is much to be done to prepare the market, not least the issue of insurance premium tax, which is charged on gross written premiums.

The move will probably not be a minute too soon for Groupama Insurances managing director Tim Ablett who describes the current system as "arcane".

"If commission is to remain, a more meaningful approach is needed," he says. "This might mean brokers earning more for more complex cases and less for straightforward business that requires no real intervention, given that the process is so highly automated."

Ablett says net premiums have worked well for commercial classes of business and he sees, "no real reason why a similar situation should not apply more widely in connection with personal business."

Massive change
"The current situation does not reflect the massive change that the industry has experienced in recent years. However, it does require as a prerequisite an understanding by brokers and insurers alike of their respective costs in doing business together - and perhaps this is the nub of the problem."

However, most large ticket business now being put out to tender is being advertised on a fee basis. British Insurance Brokers' Association chief executive Mike Williams says that some customers like the idea of negotiating a fee that might be lower than the commission.

It can include a menu of services and the fee will be negotiated based on the hours the broker puts in and seniority of staff. Services include placing the business, servicing the account and risk management. The problem with this, according to Cosh of Budget, is that fees are seen just as a convenient way of filling the gap between income and expense, when they should be seen as the proper compensation for a job well done by the broker.

However, brokers might not have a choice because, as Williams says, the "government is hell-bent on getting rid of commissions".

The timing element to all of this is crucial and best estimates suggest that it will take the broker market five years to effect a smooth transition.

And that's important for 2004 when the FSA takes over from the General Insurance Standards Council (GISC) in the regulation of general insurance brokers.

The current GISC regime - with commission disclosure on request - might add further fuel to the debate as brokers might be reluctant to expose their commissions. The FSA says the issue is at an early stage and that the GISC foundations will provide the basis on which the FSA will develop its authority.

"Questions of a regime for commission, which we will have as part of our rule book are at an early stage," says an FSA spokesman. "Issues such as the regime's scope and registration will precede all this."

Williams says that so far the current regime has caused few problems and there have been no complaints to his organisation from customer or clients.

Budget's Paul Cosh says disclosure of commission would not be a totally unreasonable requirement, but adds that direct insurers should be made to disclose their acquisition cost per policy to prevent them claiming they are cheaper because they charge the customer no commission.

In the meantime, he says the broker community should be able explain the value added by brokers, thereby dispelling the myth promoted by advertising asking: "Why pay commission to the middle-man?"

Given the FSA's desire for greater transparency on premiums, brokers will need to think carefully about the implications of the necessity for disclosure. More than ever before, they will need to demonstrate the value of what they provide for their customers.