Background

On 27 May 2014 the FCA published the results of its Thematic Review into broker conflicts of interest and intermediary remuneration.

The FCA first announced this Thematic Review in July 2013 as one of a number of FCA investigations into the general insurance market. Other investigations into the general insurance market include: a Thematic Review into claims-handling for retail travel and household insurance; a forthcoming Thematic Review into commercial claims; and competition style Market Study into the sale of general insurance add-ons (which was the subject of our RegZone report ‘Competition problems in general insurance add-on sales’).

Since announcing the Thematic Review in July 2013, the FCA has reviewed information from 7 large intermediaries/ intermediary groups and surveyed a sample of 1,000 UK SMEs before reaching the results published earlier this week.

Sitting behind the Thematic Review are the changes to commission disclosure being debated in Europe in the recast Insurance Mediation Directive (IMD II), alongside other domestic developments summarised in our previous report ‘Thematic Review into conflicts of interest for insurance brokers’.

Overview

The Thematic Review focused on the treatment of SMEs because the FCA was concerned that, while SMEs have more complex insurance needs than retail customers, they are not necessarily more sophisticated customers. SMEs tend to rely on intermediaries for advice and recommendations, and treat them as independent advisers – even when their broker may in fact be also acting on behalf of the insurer.

Prior to undertaking the Thematic Review, the FCA was particularly concerned that broker business models have diversified from pure “vanilla” insurance broking potentially leading to a greater risk of conflicts of interest. In particular, the FCA was concerned about the emergence of ‘integrated models’ (e.g. intermediary groups operating both open market broking and MGAs), where brokers have multiple roles in the distribution chain, sometimes acting as agent of both customer and insurer in relation to the same insurance.

Where business models had diversified, the FCA found that conflicts of interest would be much more likely to arise than in the traditional broking model and existing systems and controls to deal with conflicts of interest were found to be out-of-date and inadequate. Therefore, firms risk non-compliance with the FCA Handbook chapters on broker conflicts (SYSC 10 and PRIN 8 (conflicts of interest)).

Particular concerns

The FCA identified the following particular concerns:

Inadequate management information: systems and controls processes often did not have any measurable outputs impacting on competition in the market and the customer’s freedom of choice. FCA reports that firms’ management were unclear:

  • whether an insurer had been selected in advance for a particular product or whether an individual broker had selected the product for the SME concerned. In some cases there was confusion about the possibility of both models being in operation within the same intermediary.
  • what the reasoning was behind the choice of a particular market to underwrite the customer’s insurance (with the lack of an audit trail to demonstrate how this would have benefited the customer); 
  • how insurance policies had been sourced and placed: e.g. by open market broking, by reference to a panel or placed to a single insurer without any consideration of alternatives.
  • in how many cases they acted as agent of the customer, agent of the insurer, or both;
  • what work had been done to establish the suitability of any add-on insurance products sold on an advised basis; and
  • in general, whether placement decisions made by a broker acting as agent of the customer were taken in the customer’s best interests.

Inadequate systems and control frameworks, including: 

  • a reliance on principles and company policy – and the simple belief that brokers acting as agents of the customer would always act in the customer’s best interests – without any procedures or controls to ensure that these policies were followed; 

  • inadequate review processes to consider product performance from the customer’s perspective; and

  • relying on compliance with the ICOBS 4 disclosure requirements to alleviate problems of potential conflict of interest. (The FCA particularly stressed that such reliance on disclosure was wholly inadequate to comply with SYSC 10.1.7R and the requirement to maintain arrangements for taking reasonable steps to prevent conflicts of interest.).

Disclosure was also often generic and unclear; and, in particular, it was not always clear whether the intermediary was acting as agent of the customer or the insurer or both.

Failure to segregate remuneration information in intermediary groups between the broking arm and the MGA, e.g. inadequate Chinese walls. It was also found that brokers were often more than aware of the enhanced commission that was available to them from placing certain products.

Promotional materials sent between different arms of intermediary groups concerning new insurance products sometimes focused too heavily on the commission available to the intermediary from the new product, rather than any customer benefit.

Very high levels of commission being charged for:

  • add-on products; and
  • products where the end cost is ultimately borne by a third party (e.g. a tenant).

Particular problems arising with the supply of premium finance.

FCA’s next steps

The FCA will engage with the industry and with SMEs to enhance understanding of the issues. However, the onus is on intermediaries themselves to reflect on the findings and how they manage conflicts of interest with a view to ensuring that they make any necessary changes to ensure that they are in compliance with the existing regulatory requirements on conflicts.

Where problems at specific firms have come to light during the course of the Thematic Review, the FCA intends to take appropriate regulatory action.

The findings of this Thematic Review will also be taken into account when conducting current and future Thematic Reviews (in particular the Thematic Review into commercial claims). The Competition & Markets Authority is also involved at present in a case concerning high levels of commission for general insurance where the cost is borne by a third party (specifically, residential tenants).

Commentary

While the results of the Thematic Review are not unexpected, they should serve as a warning to brokers to get their houses in order before the FCA comes knocking. Intermediaries should stress test their existing procedures questioning not whether the procedures are strictly complied with but whether the focus is on ensuring good customer outcomes.

Senior management in particular should take heed that they are expected to set a culture of good customer outcomes from the top. In particular, they should focus on management information and whether the information provided is sufficient to enable the board to identify (and resolve) poor practice.

We anticipate that the FCA will continue to shine a brighter spot light on brokers than its predecessor, the FSA, and that broker conflicts will remain a hot topic for the foreseeable future.