Insurance broker remuneration: law and regulation
This guide is based on the law of England and Wales.
It was last updated on 27th March 2008.
Types of remuneration
Insurance brokers acting on behalf of an insured can be paid for
their services in a variety of ways. The most straightforward is a
simple fee arrangement between broker and client. More
commonly, however, the broker earns a commission, which is agreed
with the insurer but taken out of the premium paid by the
client.
In some circumstances, the insurer and the broker may have
entered into a further arrangement whereby the broker receives an
additional fee or commission from the insurer for bringing in a
certain volume of business. This is sometimes known as a contingent
commission, placement service agreement or market service
agreement.
In recent years, the issue of commissions, particularly
contingent commissions, has raised difficult questions about lack
of transparency and the potential for conflicts of interest between
broker and client.
The broker's duties
When a broker places insurance, it is usually assumed that he is
acting as agent of the prospective insured. As agent, the broker
has a legal duty to act in good faith in what he believes to be the
interests of his client. This means he must account for any secret
profit that he makes, and he is not allowed to put himself in a
position in which his interest and duty conflict.
More specifically, an agent must not, without his client's
knowledge, acquire any profit or benefit from his agency other than
that contemplated by the client at the time client and agent
entered into their contract. Where a broker is found to have
breached a fiduciary duty, anyone knowingly assisting in the breach
of that duty (such as an insurer) can also be held directly liable
to the broker's client.
Brokers must also abide by the FSA's Handbook, including the
Insurance Conduct of Business Sourcebook (ICOBS) which replaced the
more detailed conduct of business rules in ICOB on 6th January
2008. The new rules are subject to a six-month transitional
period, but the relevant standards and requirements are effectively
the same as under ICOB.
At the heart of the Handbook lie the high-level principles for
businesses (PRIN). Particularly relevant for brokers are
Principle 8, which provides that "A firm must manage conflicts of
interest fairly, both between itself and its customers and between
a customer and another client" and Principle 6, which requires
firms to treat customers fairly.
Fees
In terms of transparency and potential conflict of interest, a
fee arrangement is perhaps the least problematic form of
remuneration since the amount will normally be negotiated and
agreed with the client.
The broker must provide the client with details of any fee (or
the basis of calculating any fee) before the client incurs
liability to pay, or before the conclusion of the insurance
contract, whichever is earlier (ICOBS 4.3.1R). This extends to
all fees charged over the lifetime of the contract, but not to
premiums or commissions.
There used to be a rule that an intermediary must ensure its
charges to consumer clients are not excessive, but this has not
been carried forward into ICOBS because the expected standard is
already set out in the Principle 6 requirement to treat customers
fairly.
Commission
The main issue with a normal commission arrangement is
transparency. Under current market practice, the insured, at best,
is likely to have only a vague idea of the amount of commission the
broker will earn for placing a contract on his behalf. In December
2007, a report by CRA International found that, typically,
mid-sized commercial clients believe commission is around 10% when
it is nearer 20%.
A wider question raised by the European Commission in its
business insurance sector inquiry is the extent to which lack of
transparency affects competition because commercial clients are
unable to make informed decisions about which broker they use.
ICOBS only requires a broker to disclose his commission to a
commercial client if the client requests it (4.4.1R). But in March
2008, the FSA published a discussion paper putting forward options
for reform, including mandatory disclosure of commission to
commercial clients. If it decides new rules are needed, it will
carry out a consultation exercise in the autumn of 2008.
There is, however, no provision in ICOBS for the disclosure of
commission to consumers and no proposal to change this
situation.
If a consumer client asks for commission information, the broker
is not obliged by the regulations to respond, although ICOBS
reminds firms that the disclosure rule is additional to the
broker's obligations under the general law - including the duty to
account for any secret profit and avoid conflicts of interest.
But unless the amount of commission is excessive, a client may
have difficulty succeeding on a secret profit claim. Provided the
level of commission is consistent with the market "norm" for
placing that type of business, the client will be deemed to have
knowledge of it (whether or not he actually does) so the broker
will not be considered to have made a secret profit.
A successful claim, however, could result in the broker being
ordered to pay the insured the amount of commission earned in
excess of the market norm. Arguably, the court could order the
broker to repay the entire brokerage earned on the account.
Contingent commission
The fact that a broker may be earning additional commission if
he brings business to a particular insurer gives rise to a
potential conflict between his commercial interests and the
objectivity of the advice he provides his client.
The fact that the broker's client may not be aware that he is
earning additional commission also raises the question whether such
payment might breach the broker's duty to account for any secret
profit.
There is no regulatory ban on offering or accepting inducements
(defined as any benefit offered with a view to the recipient
adopting a particular course of action). But insurers and
brokers are reminded of the Principle 8 requirement to manage
conflicts of interest fairly and that this extends to soliciting or
accepting inducements that would conflict with a firm's duty to its
customers (ICOBS 2.3G).
A firm should also consider whether offering inducements
conflicts with its obligations under Principle 1 (to act with
integrity) and Principle 6 (to treat customers fairly).
The commission disclosure rule (ICOBS 4.4.1R) applies to all
forms of remuneration, including arrangements for sharing profits,
payments relating to the volume of sales, or payments from premium
finance companies in connection with arranging finance. But the
rule itself only requires a broker to disclose commission to a
commercial client on request.
A broker who discloses the fact that he receives contingent
commission (whether or not obliged by the regulations to do so)
cannot be said to have made a "secret" profit. But in order to
avoid any suggestion of breach of duty, he may have to consider
disclosing the actual amount as well, particularly where the client
is vulnerable and unsophisticated.
In Wilson v Hurstanger (2007), a loans broker whose consumer
clients were made aware that he might receive an additional
commission from the lender, was found by the Court of Appeal to be
in breach of duty because, without knowing the actual amount, his
clients could not give their informed consent to the potential
conflict of interest.
Whatever the FSA's final decision on commission disclosure, an
increasing emphasis is being placed on the effective management of
conflicts of interest. This ties in with the European Commission's
comment in its business sector insurance report that disclosure
alone might not be enough to mitigate the conflict issue.
The FSA will be carrying out thematic work during 2008 on the
nature and extent of conflicts of interest between brokers and
their clients. It also plans to consult on whether to extend to
insurance brokers the requirements to establish and maintain
effective conflicts policies currently found in SYSC 10 of the
Handbook.
Contact: Martin Membery (martin.membery@pinsentmasons.com
/ 020 7667 0244)
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