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Wholesale insurance brokers should expect 'serious scrutiny' from FCA, says expert

Large insurance brokers dealing in the wholesale market can expect to be "under serious scrutiny" from the regulator in the year ahead, an expert has said.14 Nov 2017

Nick Bradley of Pinsent Masons, the law firm behind Out-Law.com, was commenting as the Financial Conduct Authority (FCA) published the terms of reference for a full market study of the sector, as trailed in its business plan for the 2017/18 financial year. The market study will consider whether wholesale insurance broking is "working well, and fosters innovation and competition in the interests of its diverse range of clients", the FCA said.

The London insurance market is one of the world's leading centres for large scale, complex commercial and specialist risks, and controls more than £68 billion worth of gross written premiums, according to the FCA. It is also a market which has undergone significant recent changes, which have led to brokers developing whole new services and business practices, the FCA said.

The FCA is seeking views on its terms of reference until 19 January 2018. It intends to publish its interim findings by the end of next year.

"This marks the beginning of a potentially long examination of the market by the FCA with promises to gather data and information, engage in discussion, carry out roundtables and research to make sure competition is working effectively," said Bradley. "An interim report is expected one year from now therefore large broker practices in the wholesale market can expect to be under serious scrutiny in the year ahead."

"The timing of this study could arguably be better given firms are in the midst of grappling with Brexit. Nonetheless it is better for brokers, to the extent possible, to engage as openly and fully from the outset. There is much to be gained by all parties from this comprehensive review of the market, which last happened ten years ago under the Financial Services Authority," he said.

Insurance brokers play an important role making sure that their clients obtain appropriate cover that meets their needs, while providing value for money, the FCA said. However, the prolonged 'soft' market and declining premium rates have resulted in brokers developing new and additional services for both their clients and insurers, something which could potentially create competition issues.

As an example, the FCA said in its terms of reference that larger brokers could potentially be using their market power to compel insurers to sign up to and pay for additional services, such as data or analytics facilities. There could also be the potential for conflicts of interest, with brokers receiving additional fees for enrolling their clients into facilities "even where it may not be the best option", it said.

"Ultimately, that may have the effect of limiting the number of insurers underwriting business in a particular sector or impact on the selection process, putting end clients at a disadvantage," it said.

"The FCA refers to 'data and analysis services (for insurers)', product and programme design and new approaches to market selection' and 'placement (including the development of facilities)' as three new areas of new insurance broker work developed in recent years that warrant attention," said Nick Bradley.

"It is fair to say, however, that the regulator is specifically focusing on the development of facilities as an area for particular scrutiny. It is concerned that large brokers may be exerting market power to oblige insurers to sign up for facilities; that conflicts of interest may be coming up because of the higher commissions some facilities can attract; and that broker conduct may be compromised if smaller underwriters are being squeezed out because risks are not being placed on the open market," he said.

Competition law expert Alan Davis of Pinsent Masons said that although the study was a market-wide inquiry into possible market failures rather than a "fishing expedition" for potential competition law infringements by individual firms, "it wouldn't be the first time that an FCA market investigation ultimately leads to individual enforcement action".

"Of particular concern is the reference to the potential existence of tacit coordination between brokers, that is, an implicit understanding rather than a formal agreement arising from the direct or indirect sharing of competitively sensitive information. The FCA also reminds brokers of Principle 11 of the FCA’s Principles for Business which 'requires firms to deal with the regulator in an open and cooperative way and to disclose anything relating to the firm of which the regulator would reasonably expect notice'. This includes where a broker may have committed a significant infringement of any applicable competition law and encourages brokers to engage with the FCA 'if they are aware of any potential infringements of competition law committed by either competitors or suppliers'," he said.

"When cooperating with the FCA's market study by responding to requests for information, brokers should take care to consider carefully whether any potential competition law issues arise and, if so, consider the options for benefiting from the leniency regime," he said.