In a landmark case earlier this year, the Hong Kong Court of First Instance decided that commissions received by an insurance broker from an insurer do not constitute illegal secret profits provided that they do not exceed what is normally paid in the insurance market.
When an insurance broker is engaged by its client to find an insurer to cover a risk, insurance brokerage fees or commissions will be payable; it might be assumed that the client would pay those fees or commissions as the insurance broker’s principal. However, in practice, insurance brokers are usually paid by the insurer concerned by deducting the commission from the premium before paying it on to the insurer.
This practice of allowing an insurance broker (acting as the agent of the insured) to take commission from the insurer has been the subject of much debate as it may contravene the equitable principle that an agent cannot make a profit from his office without disclosing the profit to his principal (the insured).
It has also been argued that the practice breaches section 9 of the Hong Kong Prevention of Bribery Ordinance (Cap. 201 of the laws of Hong Kong) (PBO). Section 9 prohibits an agent, without lawful or reasonable excuse, from soliciting or accepting any advantage as an inducement or reward for doing any act in relation to his principal’s affairs unless he has been given permission by his principal and his principal had regard, before giving the permission, to the circumstances in which it was sought. Section 9 also prohibits a third party, without lawful authority or reasonable excuse, from offering an advantage to an agent as an inducement or reward for doing any act in relation to his principal’s affairs. It should also be noted that section 19 of the PBO provides that it is not a defence to show that such an advantage is customary in the trade.
The Hong Kong Confederation of Insurance Brokers (CIB), the Professional Insurance Brokers Association (PIBA) and the Hong Kong Federation of Insurers (HKFI) have respectively in December 2008, February 2011 and October 2011 issued guidelines to their various members on this subject. These three guidelines are not identical but all attempt to strike a balance between the legal considerations as expressed by the regulators (i.e. the Insurance Authority and the Independent Commission Against Corruption) and the practical considerations as raised by the insurance industry on this subject.
Jeremy Paul Egerton Hobbins v Royal Skandia Life Assurance Ltd & Anor HCCL 15 of 2010 is the first case before the court in Hong Kong regarding the legality of insurance brokers receiving commissions from insurers.
The Plaintiff purchased several investment-linked assurance scheme (ILAS) products from Skandia and other insurers. The ILAS products were arranged by Clearwater International Ltd (Clearwater) as an insurance broker for the Plaintiff. The Plaintiff signed client agreements with Clearwater which acknowledged that Clearwater would be paid commission by the insurers as a result of the Plaintiff having purchased the ILAS products, but the amount of such commission was not disclosed at the time.
The ILAS products performed badly and the Plaintiff sought to avoid the entire transaction and to recover his investments. He alleged that the client agreements and insurance contracts were unenforceable and void for illegality or misrepresentation because Clearwater had never informed him of the amount of the commission it would be receiving on each ILAS product purchased and that the contracts were either contrary to section 9 of the PBO or tainted by an underlying fraudulent misrepresentation.
Mr Justice Reyes rejected the Plaintiff’s claim. The judge found that the practice of paying commission as in the present case was more than just a customary practice and had been validated by over a century of judicial authority. Furthermore, he took the view that when the PBO was promulgated in 1971, the Hong Kong legislature had never intended to ban the practice of insurers paying commissions to brokers.
Reyes J did not determine in this case the requisite standard of disclosure necessary to validate any permission given. He indicated that, as the minimum good practice for insurance brokers, they should disclose the fact that they would be receiving commission from the insurers; it was also necessary for that commission not to exceed the amount normally paid in the insurance market. If the receivable commission would exceed what is normally paid in the market, the broker would be required to disclose the amount of such commission to his principal (the insured).
The Court rejected the Plaintiff’s contention that Clearwater was acting as Skandia’s agent and held that the mere fact that an insurer pays commissions to a broker does not mean that the broker is undertaking to perform any obligation on behalf of the insurer.
The Court held that commissions paid to an insurance broker by an insurer do not constitute an illegal secret profit provided that they do not exceed the amount normally paid in the insurance market.
The judgment has been welcomed by the insurance industry as it upholds the long-standing commercial practice of insurance brokers receiving commission from an insurer for their services provided to their client, provided only that the client is made aware that the broker will be paid a commission and the commission does not exceed what is normally paid in the insurance market. It is unclear how a broker or insurer should identify what is normally paid in the insurance market and if such a norm was established, whether that norm would constitute un-competitive practice.
It should be noted that where the commission exceeds what is normally paid in the insurance market, the broker should make full disclosure of the commission arrangement and the amount of such commission to its client and obtain the client’s express written consent before soliciting or accepting the commission. It should also be noted that if a broker acting as agent of its client earns and shares the commission with a third party, the broker may need to disclose that fact to the client as that conduct is not customary in the market. Clearly it will also be important for insurers to ensure that these conditions have been satisfied before paying commission to an insurance broker.
In view of the Hobbins case, the Insurance Authority has urged the CIB, PIBA and HKFI to review their guidelines and work out a solution acceptable to all and which conforms with the law as now clarified by the Court.