The Financial Conduct Authority (FCA) recently published a report which sets out its findings into how general insurance intermediaries are identifying and managing potential conflicts of interest where they receive revenue from both their customers and insurers.
Specifically, the FCA is looking to understand whether, when acting as agent for an insurer (or other third party), this might unduly influence a broker to recommend an insurer against the customer’s best interest and to cause it to improperly perform its duties to its customer. In other words, the concern is that certain brokers may be acting more in their own interests rather than their customers’ interests and, as a result, the customers are not getting the best deal or the deal which they thought they were getting.
This report should not really have come as a surprise to the broking community. We have after all been here before. The FCA is picking up an issue which its predecessor had looked into a number of years ago, but which was somewhat put on the backburner when the fallout from the financial crisis began to otherwise occupy it.
The segment of the market which the FCA has focussed on is small and medium-sized enterprises (SME). About 10 years ago, the FSA (as it was then) commissioned a report into this issue, and that report highlighted that the SME market was the area probably most at risk from any poor management of conflicts – unlike with retail customers, products sold to SME customers are less commoditised, and, unlike with larger customers, SME buyers tend to have less sophisticated in-house risk management expertise (if any).
As a result of its findings, the FCA is taking a number of follow-up actions including, amongst other matters, supervisory engagement with the firms involved in the review to address specific issues, providing feedback to the wider industry, and engaging proactively with the industry to enhance understanding of the findings.
Practical steps to manage conflicts
There is a concern that a number of firms simply pay lip- service to the requirement to manage conflicts of interest fairly. A number of practical steps can be taken to ensure such management which include the following:
- Having a management and control framework in place, with specific senior persons responsible for ensuring compliance with agreed policies and procedures
- Clarifying the capacity in which a broker is acting (i.e. whether the broker is acting for the client or for the insurer (e.g. as a MGA) or, in some cases, for both and to whom fiduciary duties are owed)
- Describing clearly what service is being provided (e.g. is advice being given or not, is the broker conducting activities exclusively with one or more insurers or is the broker conducting activities on the basis of a fair analysis of the market, will the broker be involving another intermediary in the process?)
- Confirming what the broker is being paid and by whom for providing the relevant service (including the extent to which revenue is derived from, for example, arranging premium finance, administration charges, commissions on add-on insurances, profit shares, over-riders, contingent commissions and fees for work transfer)
- Regularly reviewing management information and systems and controls, including tracking revenue flows and their sources, monitoring the impact (if any) of any differential commission and other remuneration arrangements on placement activities, reviewing insurer facilities, insurer panels and binding authorities to ensure that these arrangements still represent the right choice for customers, and ensuring that there is an audit trail to support broking decisions made
Disclosure along the lines described above may in many cases be an adequate way of managing a conflict or potential conflict. For example, the disclosure could set out the basis and sources of remuneration which the broker is entitled to. This should enable the customer to make an informed judgement as to the relationship between the broker and relevant third parties, and the extent to which the broker is incentivised to promote certain products. If, however, any disclosure is only generic or not very clear, then the disclosure may not, in fact, be adequate. Such disclosures (however detailed or otherwise) will often be made in a terms of business agreement (TOBA). Brokers would be well advised to keep such TOBAs under regular review to check whether any amendments or tweaks are required to the wording from time to time.
Sometimes, additional measures may be required. For example, firms and groups operating integrated models including a mixture of open-market broking activities and insurer agent activities (including MGAs and coverholder or delegated authority arrangements) are more likely to have more inherent conflicts of interest. In such an integrated model, the broker will frequently be acting in a dual capacity (i.e. as agent for both the customer and the insurer) on the same transaction. In this situation, to manage the conflict, it is critical to have in place measures to protect the customer.
These measures could include setting up information barriers or “Chinese walls” or having staff who carry on open-market broking activities located in one place and staff carrying on insurer agent activities located elsewhere each with different reporting lines and knowledge of remuneration arrangements. In some cases, these activities will be carried on by different legal entities within the same group in order to ring-fence and separate them. The risk of conflict will be increased where there is no such clear segregation of roles, revenues, and information between the relevant operations.
Occasionally, though, none of these measures will be a panacea and the broker may have to decline a particular engagement. An example of this could be where a broker is handling a claim for a client in circumstances where the broker has also been delegated authority by the insurer to handle that claim. The broker’s position would become particularly untenable if, for example, the broker were aware that, in settlement discussions, the insurer would be willing to settle for a higher amount than had initially been offered to the insured.
Time for brokers to act
The regulators understand that conflicts arise regularly in the insurance market. They always have done so. Indeed, one judge noted when giving judgment in a case concerning brokers that they hunt with the hounds and run with the hares.
However, it is probably fair to say that conflicts are increasingly more likely to arise now as many brokers adopt new business models and these models continue to evolve. As noted above, some of these models are likely to have more inherent conflicts of interest, many of which can be managed.
What is clear though is that a number of brokers are not implementing even basic conflict management systems, such as making clear and full disclosures to customers, monitoring the impact of arrangements with third parties, and ensuring there is segregation of activities where there is a clear potential for conflict. Brokers have now been put on notice that they will need to put their house in order on this, or else the regulator will have to step in and do so.