We are sure you have heard or read about the FCA’s announcement yesterday that it is to conduct a thematic review into conflicts of interest in the insurance broking sector. This is a chance for everyone in the sector to check and then demonstrate their compliant conflicts management policies and arrangements. The rules and laws don’t prohibit conflicts so the sector need not fear discussing their arrangements. Those who don’t engage and fail to demonstrate compliance expose themselves and the sector as a whole.
We await publication of the full speech but it is reported that Simon Green, Head of General Insurance and Protection at the FCA, said:
“Insurance brokers’ business models have changed radically over the last 20 years. Some brokers have shifted from being straightforward distributors to product designers, underwriters and claims handlers, and an increasing number now take on many functions historically performed by insurers; this means that conflicts of interest may be occurring.
This piece of work will help us test whether the essential everyday insurance products that those businesses need are designed and delivered fairly and will focus particularly on SME and microbusiness customers. We will look to trade associations such as BIBA and LIIBA to work with us collaboratively as this work progresses. We hope to deliver our findings, and final recommendations, by the end of the year.”
Mr Green reportedly confirmed: “I am keen to explore conflict of interests and how insurance brokers identify and manage potential conflicts. One of the areas we are very focused on is integrity and integrity of the market”.
He explained that the review will focus on two key areas: first, payment flows between insurers and brokers, with an emphasis on ensuring that brokers “are really acting in the interest of the client”; and, second, several aspects of the value chain such as claims handling and management. He is quoted as saying: “An increasing number of brokers now take on many areas of the value chain, functions historically taken on by insurers”.
This is apparently addressed at the SME sector and not just general insurance for consumers – a sector undergoing its own intense conduct supervision and thematic work (click here for our Regulatory Blog). Green described recent financial services scandals, for example the interest rate swap debacle, as prime examples of smaller businesses not being entirely ‘sophisticated’ in terms of understanding how financial services can operate. The review will likely exclude ‘contracts of large risks’ for ‘commercial customers’ to which the ICOBS rules do not apply, but many brokers will be operating binding authority agreements which apply to risks for SME and larger risks, which may result in the net being widened.
What are the issues?
Standard market practices are not above retrospective criticism by the regulator. The FCA will not be afraid to challenge sacred cows. The sector has one chance to show that its house is in order.
Buoyed by its apparent success in banning commission in the retail investment sector following the Retail Distribution Review, the FCA is bound to query the advantages for customers of a commission-based broker remuneration model.
The IMD2 reforms looming on the horizon may still result in a hard commission disclosure requirement for SME commercial business. In its recent Mortgage Market Review, the FCA has demonstrated its preparedness to act even where the European Union is considering relevant legislation. The conclusion of this thematic review will likely coincide with the FCA taking up the mantle on IMD2 implementation.
Certain remuneration models create inherent conflicts of interest. Conflicts are not, however, prohibited. Principle 8 requires only that “A firm must manage conflicts of interest fairly, both between itself and its customers and between a customer and another client” and not that a firm avoid conflicts altogether.
This is reflected in ICOBS 2.3.1 on inducements which provides: “This principle  extends to soliciting or accepting inducements where this would conflict with a firm’s duties to its customers. A firm that offers such inducements should consider whether doing so conflicts with its obligations under Principles 1 and 6 to act with integrity and treat customers fairly”.
Insurance regulation has been relatively light to date. For example:
- ICOBS 2.1 does not require that customers be notified of their client categorisation
- ICOBS does not require commission disclosure to consumers at all
- ICOBS 4.4.3 guidance provides, on commission disclosure to commercial customers, “where a customer employs an insurance intermediary by way of business and does not remunerate him, and where it is usual for the firm to be remunerated by way of commission paid by the insurer out of premium payable by the customer, then there is no duty to account but if the customer asks what the firm’s remuneration is, it must tell him”
- For those advising clients on a ‘fair analysis’ basis, the rules on panel selection criteria say only that the “selection should be based on product features, premiums and services offered to customers, not solely on the benefit offered to the firm”.
The LIIBA guidance on status and remuneration disclosure is more onerous, requiring brokers to notify customers of the capacity in which they act and reminding the client of their ability to ask for details on remuneration, and this disclosure cannot be buried in a terms of business agreement. London Market brokers have been operating within these guidelines for three years.
There is, therefore, no reason, within the current regime, that the insurance sector cannot highlight good practice and, having cut out any bad practices, satisfy the FCA of its compliance with the rules and principles.
Green apparently insisted: “Our starting hypothesis is not that there is a problem, but that the market has evolved quite considerably and we want to test how conflicts of interest are identified and managed.”
Insurers and brokers alike will want to make sure no problems are identified and that they don’t suffer collateral damage in the event problems are identified elsewhere. More positively, the industry has an opportunity now to work with the regulator and trade bodies to arrive at a thematic review outcome that is beneficial for the insurance sector as a whole. As this will impact the entire sector, insurers’ trade bodies and associations should be involved and not just BIBA and LIIBA.