Grant Ellis says the blunt instrument of disclosure is not achieving its aim

I received another 'Dear CEO' letter from the FSA last week reminding me of my obligations under the ICOB rule 4.6.1R. Now I'm sure most of you will know straight away what ICOB 4.6.1R says, but just in case you've forgotten, it covers a broker's obligation to disclose to a commercial customer on request, information about any commission the broker receives in the placing of a customer's business.

This is nothing to do with the recently announced review of the commission disclosure rules - it was to remind me of the rules that exist today, and to suggest that I ensure I had procedures in place to comply.

However, on rereading the rules, I was struck by just how blunt an instrument commission disclosure really is, and the unforeseen consequences that can result from such prescriptive action.

It reminded me of a story I read recently about an airline which, in an effort to improve customer satisfaction, decided to incentivise its baggage handlers to unload passengers' luggage from the aircraft more quickly.

They introduced a performance measure to support the new initiative, measuring the time it took from the aircraft landing up until the first bag from the hold reached the carousel. They then observed a team of baggage handlers in action to see how much of an improvement was being achieved.

They saw the team standing around chatting and smoking, until the hold was open whereupon two of them leapt into action - the first grabbed a small bag and threw it to a second who sprinted across the tarmac and placed it on the carousel.

He then sauntered back to the rest of the group, who, unmoved by this frenetic activity, finished their cigarettes and conversation before sauntering up to the hold and unloading the remainder of the luggage.

Clearly management hadn't foreseen this outcome when they put the incentive in place.

But how is this relevant to commission disclosure? Let me try to explain. The current rules require a broker to disclose the commission that he receives from a transaction (including any potential profit share), but does not differentiate between remuneration received for the placing of the risk, and remuneration received for any other activity, such as administration of the policy, for example.

In other words, if the broker is being paid to do work that would otherwise have to be done by the insurer, he must disclose this to the client. The more he does therefore, the more he is disclosing.

Fair enough you might say - there is a potential conflict of interest in that the broker is working for two paymasters, the client and the insurer. So I guess there is merit in this catch-all approach, although it clearly has the potential to be confusing for the end customer.

Unfortunately it doesn't stop there. The rules not only require the broker to disclose the earnings he receives, but also that which any associate of his receives from the transaction too. An associate is, broadly speaking, anyone under similar ownership or parentage.

Think about this for a moment. You are an underwriting agency dealing exclusively with intermediaries, using capacity provided by an insurer, but employing your own underwriters, issuing your own policies, and handling claims and credit control.

You are therefore working exclusively in the interests of the insurer and your binder with it. However, if you happen to distribute your product through an intermediary which has the same parentage as you, then not only does the intermediary have to disclose his earnings to the client, but he also has to disclose yours too.

Compare that with the situation where the insurer owns the broker. No such disclosure is necessary - the broker only need disclose his earnings. No need for the insurer to measure, never mind disclose, how much of its 'premium' is being eaten up in administrative costs.

Now I appreciate there are potential conflicts of interest in both scenarios which each 'parent' firm is obliged to manage, and quite right too. However when announcing a review of the commission disclosure rules at the beginning of October, the FSA chief executive John Tiner seemed to be suggesting that there needed to be a 'level playing field' on disclosure to help manage conflicts of interest.

I agree wholeheartedly, as I don't believe that the current prescriptive rules around earnings disclosure achieve that today. However, adding more prescriptive rules will simply exacerbate the problem. IT

Grant Ellis is chief executive of Broker Network Holdings