On 27 May 2014 the FCA published the outcome of its thematic review into conflicts of interest in the intermediation of insurance for small and medium enterprises (“SMEs”). The report raises concerns about the way in which conflicts are managed.
Traditionally, the role of a broker was to search for the most appropriate insurance and put it in place on the customer’s behalf. However, intermediaries’ business models have evolved, and many of them no longer carry out this traditional role: for example it is now common for intermediaries to source capacity from a particular insurer, to act as the insurer’s agent in placing cover, or to act as the agent for the insurer in some transactions and the agent of the insurer in others. This evolution gives rise to potential conflicts of interest.
The FCA expresses concern that some conflicts of interest are not identified and managed properly, which increases the likelihood of individual broking and placement decisions being made in the interests of the firm, rather than its customers. As a result, some SMEs may pay more for core insurance products than they need to, buy add-on insurances and services that they do not need, or pay more for secondary products such as premium finance.
The thematic review refers to the following rules, with which intermediaries will be familiar.
The Principles for Business require a firm:
- to take reasonable care to organise and control its affairs responsibly and effectively with adequate risk controls (principle 3);
- to pay due regard to the interests of its customers and treat them fairly (principle 6);
- to pay due regard to the information needs of its clients, and communicate information to them in a way which is clear, fair and not misleading (principle 7); and
- to manage conflicts of interest fairly, both between itself and its customers and between a customer and another client (principle 8).
SYSC chapter 10 sets out various rules relating to the management of conflicts of interest.
ICOBS chapter 4 requires intermediaries to disclose the nature and scope of services provided, and their remuneration.
The FCA is concerned that the disclosure given to customers before concluding their insurance arrangements is often too generic or unclear about the scope of the services being provided for the specific transaction – for example, whether the intermediary is the agent for the customer or the insurer, whether a survey of the market will be carried out, how the insurer will be chosen, and is any whether any advice given is independent. This makes it difficult for the customer to make an informed decision about the insurances being offered
The FCA suspects that some firms are failing to recognise, centrally-log and record some requests for commission disclosure. This could result ICOBS 4.4 being breached, because customer-facing broker staff may be unaware of all remuneration relevant to the customer who requested disclosure.
Systems and controls
The FCA notes that firms must be able to demonstrate compliance with the Principles for Business, and with SYSC which requires firms to “maintain and operative effective … arrangements with a view to taking all reasonable steps to prevent conflicts of interest … from constituting or giving rise to a material risk of damage to the interests of its clients.” It is important for customers to be given adequate disclosure, but that alone does not discharge the duty to comply with these broader obligations.
The FCA expressed several concerns regarding compliance procedures, including the following:
- Firms should be able to demonstrate how the insurer was chosen for a particular customer (for example, was the selection made customer-by-customer using open market broking, or when an insurer was chosen to underwrite the product?).
- Firms should also be able to identify whether they are acting as agent for the customer, in a dual or mixed agency capacity, or as agent for the insurer. Without management information about these matters, the firm cannot be confident that it is identifying and managing any conflicts of interest properly.
- Firms should be able to demonstrate that placement decisions made as the agent of the customer are being taken in the customer’s best interests.
- In integrated firms or groups, i.e. ones which include both broking and insurer agents, there is a greatly increased need for clear controls and management information to address potential conflicts of interest in the selection and placement process and to help demonstrate that all reasonable steps have been taken to mitigate the risk to customers. The ability of individual brokers to be impartial may be affected by group relationships or differential remuneration structures.
- Separating the areas responsible for insurer agency and broking activities (in terms of entities, locations, reporting lines and knowledge of remuneration arrangements) helps to demonstrate that conflicts of interest have been appropriately managed.
- The risk of placement conflicts of interest is increased if retail broking staff are given information regarding the firm’s remuneration for particular products. Marketing material from the insurer describing benefits to the intermediary (e.g. high commission levels) should not be mixed with materials describing customer benefits, and should not be sent to the customer-facing broker area.
- Where a particular insurer has a preferred status, or is used without other markets being considered, work which is performed centrally in selecting the insurer may not be enough to enable individual customer-facing brokers to fulfil their obligations to customers.
- Firms should keep an audit trail showing how and why they chose the insurer. If a market is chosen because it can supply additional benefits to customers, the intermediary should keep clear evidence of the additional benefits secured, their value, and their impact on the price.
- To ensure that products remain suitable, intermediaries should review insurer facilities, insurer panels and binding authorities periodically to consider the insurer’s performance from a customer perspective.
- Firms should be able to demonstrate that they have appropriate procedures and that these are effective in practice. They should have measurable output to demonstrate that they have properly identified and managed conflicts properly, and that they have consistently acted in the customer’s best interests.
- When tendering for capacity, intermediaries (particularly those who are the agent of the customer) should put customer needs at the heart of the process, and not focus predominantly on the levels of remuneration for the intermediary.
The thematic review is a useful reminder of the need for intermediaries to be conscious of the exact role which they play in any transaction: for whom are they the agent, what responsibilities do they have, and is that position clear to the customer?
The FCA warns that all general insurance intermediaries should reflect on how they manage the conflicts of interest arising in their business model, and should make any changes required to ensure that they are complying with their regulatory obligations in this area.