On May 27, the Financial Conduct Authority (FCA) published the results of a thematic review into how conflicts of interest are managed by commercial insurance intermediaries arranging cover for UK small and medium sized enterprises (SMEs). The FCA has undertaken this review to better understand what conduct risks may exist amongst such firms. This latest report by the FCA continues the regulatory interest into the relationships between insurers and commercial brokers and revives the concern that firms are failing to sufficiently manage the conflicts that may arise when acting for both insurers and commercial clients. The thematic review was announced in July 2013 and was completed over the course of late 2013 into early 2014. A sample of seven large intermediaries and intermediary groups were part of the review.
The evolution in intermediaries’ business models over the past decade has resulted in some complex conflicts of interest arising which have the potential to influence the placement process. The FCA has found that some intermediaries have failed to sufficiently understand where conflicts arise in their business and have not taken appropriate steps to mitigate the risks of conflicts influencing placement of SME risks.
Business models have evolved without necessarily taking conflicts into account
Over the past decade there has been a rise in the number of SME risks being placed via either binding authorities or through Managing General Agents (MGAs). In some instances, risks are placed without the intermediary undertaking any broking activity for the individual risks with the result that business is placed without the intermediary considering other options available on the market. In particular, where intermediaries act in a dual capacity (i.e. for both the insurer and customer) there is an increased risk that the SME will not understand the role being performed on their behalf. Firms operating under new business models have not always ensured that their systems and controls have kept up with the changing conflict risks and do not reflect the size or complexity of the business.
The FCA’s review has found that traditional broking models appear less exposed to conflicts of interest. Where such firms act in a dual capacity the review found that they maintained defined roles and dedicated staff in different teams or locations. Similarly, where MGAs operate solely on behalf of insurers few conflicts arose. Consequently, there is an increased risk of a conflict of interest occurring where firms fulfil multiple roles in the distribution chain and act as agent for both the SME customer and the insurer. The review has, however, found that firms and groups using integrated models which include a mixture of open-market broking and activities undertaken as agent of the insurer (including MGAs) have greater risks of conflicts. In such business models activities are often performed for both customer and insurer in the same transaction. The FCA has found that in these business models there can be a lack of clarity over who the firm is acting as agent for and the different ways in which a product might be provided to the customer. In some of the firms reviewed, the management could not always demonstrate whether decisions to place SME risks with a particular product were taken by the broker acting for the SME or had been taken when the insurer was selected to underwrite the product.
In some businesses operating under an integrated business model, communications were sent from the MGA to customer-facing broking teams promoting the potential for enhanced remuneration rather than focusing upon the customer benefits of the product. The message therefore being sent to customer-facing teams was not to consider the customer’s interest as their primary concern but to focus on the remuneration return.
Although most integrated firms have segregated the areas responsible for broking and insurer activities the FCA found examples of overlap and a lack of clarity around the roles that each part of the business should perform. Furthermore, where enhanced remuneration arrangements such as over-riders or work transfer arrangements had been secured, Chinese Walls were not always applied consistently.
Concerns about systems and controls
The FCA review has found that most of the firms in their sample were unable to provide accurate information about how customers’ policies had been sourced on the open-market or by using other arrangements such as through panels or binding authority. Some of the firms had not been able to provide information about the number of cases where they had acted in a particular capacity (i.e. as agent of the insured or in a dual capacity). With insufficient information evidencing these relationships the FCA questions whether management in firms can be confident that they are adequately managing conflicts of interest. In a number of cases the FCA found that management relied heavily upon individual brokers’ assurances that a conflict had been suitably managed. The FCA is concerned that individual files may not be able to present a complete view of the reasons for a decision to place business with a particular insurer. The review indicates that firms place too much reliance upon company policies without developing robust procedures and controls supported by management information to ensure that such policies are followed.
The FCA has identified that it is not always evident that customers’ needs are placed at the forefront of consideration when tender processes are undertaken. In a number of cases the processes to renegotiate underwriting capacity for SME business focused predominantly on the levels of remuneration available for the intermediary.
The review identified that in some firms there was too much reliance upon disclosure (as required under the Insurance Conduct of Business sourcebook) to address conflicts of interest. The FCA is concerned that, rather than rely on disclosure, intermediaries should place more emphasis upon having robust systems and controls in place to prevent conflicts from arising and to ensure that they are appropriately managed when they occur (as required by the Senior Management Arrangements, Systems and Controls handbook).
Add-ons and premium finance
The FCA has found that amongst the sample reviewed, all the intermediaries selling add-on insurances describe these products as sold to their customers on an advised basis. However, in some cases the FCA found little or no evidence to establish whether the add-on product was suitable for the customer’s demands and needs. Furthermore, it was not always apparent that firms had ensured that add-on products were compatible or overlapped with the core product being sold.
Administration fees and premium finance
The thematic review has identified that premium finance and administration fees provide a material source of revenue for intermediaries. However, intermediaries often did not consider that when offering premium finance they were under any duty to act on behalf of their customers or should seek out the cheapest possible deal. The review indicates that intermediaries are not doing enough to ensure that SME customers are getting the best deals on premium finance. Many of the arrangements in place provide revenue and cash flow benefits through advance commissions based on anticipated sales volumes. Any such arrangements have the potential to create conflicts of interest where the intermediary does not ensure that their customer has the most suitable arrangement in place for their demands and needs.
What happens next?
The FCA expects intermediaries to reflect on how they manage conflicts of interest in light of the findings of the thematic review. Firms should take note of the areas identified and may expect greater FCA scrutiny especially where firms are operating on an integrated business model. In particular, firms should ensure that conflict management procedures are more than just written policies. The FCA will expect firms to have systems and controls in place throughout the organisation supported by management information that evidences where conflicts may arise and how they are managed. Much of the thematic review points to an inability to prove that intermediaries are in control of the conflicts that may arise. It is in evidencing that suitable measures are in place to avoid conflicts that firms may avoid coming under FCA scrutiny.
For further information:
TR14/9 - Commercial insurance intermediaries - conflicts of interest and intermediary remuneration