Developments in insurance broker remuneration


The current UK regime for general insurance is made up of a mixture of legislation, regulatory rules and case law and is likely to be subject to further change particularly under the European Commission’s review of the Insurance Mediation Directive (see our RegZone report on IMD II here)

New rules under proposals for a revised Insurance Mediation Directive

In July 2012, the European Commission adopted a proposal for a revised Insurance Mediation Directive (“IMD 2”). (This is currently subject to the trialogue negotiation process with the European Parliament and Council.) The Commission’s proposal would impose significant new requirements for the disclosure of insurance broker remuneration. However, a working document on IMD 2 published on 29 October 2012 by Werner Langen, the rapporteur for the European Parliament’s Committee on Economic and Monetary Affairs (ECON), noted large-scale opposition to the proposed disclosure requirements, raising the possibility that the disclosure requirements may be watered down in the final text. Please see our RegZone report on IMD II for further information.

Under the IMD 2 proposal, intermediaries would be required to disclose their commission in advance (i.e. disclosure would not be dependant on a request from the insured). They would have to give the full amount and nature of any remuneration, whether paid by a client or insurer, including:

• Fees from customers and/or commissions deducted from premiums; and

• Target based commissions, where the target and amount payable must both be disclosed. This
will capture volume based commissions and probably profit sharing arrangements.

Details of the application of the mandatory disclosure regime to the sale of life insurance products and non-life insurance products, including during an initial transitional period, may be found in our RegZone report on IMD II.

The IMD 2 proposals also introduce mandatory disclosure of the nature and basis of any variable remuneration received by employees. This will capture structures such as employee remuneration which is based on sales volumes.

Certain categories of insurance market participants will be exempt from the new rules. These include brokers intermediating contracts of large risks; brokers placing reinsurance; and the professional consumer category. Please see our RegZone report on IMD II for further details of the exempt categories.

The new disclosure requirements, if adopted in the form proposed by the Commission, would be a significant new development and would have a major effect particularly in connection with the sale of general insurance. Although mandatory prior disclosure of commission has been debated many times over the years, it has been strongly opposed by the general insurance industry and has never been introduced under domestic rules. This would therefore be a major change in this sector. The new requirements would affect insurer and intermediary relationships and commercial structures within the UK, as well as possibly leading to changes in staff remuneration structures.

The new requirements proposed under IMD 2 are not likely to come into force until 2015. We will have to wait and see whether the full mandatory regime for general insurance survives the trialogue process, in the light of the opposition to certain proposals noted in the rapporteur’s working document on IMD 2 referred to above.

General law on fiduciaries and agents

Under general law on fiduciaries and agents, brokers and certain other insurance intermediaries are not permitted to make a ‘secret profit’ and should not put themselves in a position where their own interests conflict with the duties they owe to their principals. They are liable to account for any secret profits.

Where a customer employs an insurance intermediary by way of business and does not remunerate the intermediary, 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 for commissions which do not exceed the usual market rate but if the customer asks what the firm's remuneration is, it must inform the customer.

Case law has clarified that, in the context of a client who has paid a fee, an intermediary may only be entitled to retain commission if the client has given informed consent. In addition, an agent or fiduciary is always obliged on request to disclose any remuneration and other benefits received as a result of acting on the principal’s behalf.

The practice whereby a broker who acts for the insured also undertakes work for, and is remunerated by, insurers is well established in the UK, particularly in the London Market and on subscription business. The broker must however reconcile its duties and remuneration with its primary obligation to the insured, the general law on fiduciaries and the FSA’s regulatory ‘Principles for Business’ below. In essence it will need to establish disclosure, consent and systems to manage potential conflicts satisfactorily.

FSA rules

In addition to the general fiduciary obligation of an agent, insurance brokers are subject to compliance with FSA disclosure rules. The rules are found in the Insurance: Conduct of Business sourcebook (“ICOBS”) in the FSA Handbook.

The current ICOBS rules are unusual in that FSA has imposed additional requirements (beyond the general law above) on business with commercial customers but not for personal lines/retail business. FSA has been more concerned about commercial customers because it believes that they are better able to make use of information about commission than retail customers.

On a commercial customer's request, an insurance intermediary must promptly disclose the commission which it, as well as any of its associates (e.g. companies within its group or other persons/companies with whom the intermediary has a common interest which may involve a conflict of interest in dealings with third parties), receives in connection with a policy. Disclosure must be in cash terms (estimated, if necessary). If this is not possible, the basis for calculation must be provided. All forms of remuneration from any arrangements the intermediary may have should be included; i.e. arrangements for sharing profits, for payments relating to the volume of sales, and for payments from premium finance companies in connection with arranging finance. These enhanced disclosure-on-request requirements for commercial customers apply whether or not the intermediary is a broker acting as agent of the insured.

In addition to complying with the ICOBS rules, insurance brokers should be aware of and ensure compliance with the relevant FSA high-level principles on which those rules are based:

• To act with integrity;

• To pay due regard to customers’ interests;

• To communicate information to clients in a way which is clear, fair and not misleading; and

• To manage conflicts of interest fairly.

It should be noted that the requirement for insurers and intermediaries to manage conflicts of interest fairly (above) applies if they solicit or accept inducements where this would conflict with their duty to their customers. FSA clarifies in the ICOBS rules that inducements could include cash, goods, hospitality or training programmes.

FSA perspectives on insurance broker remuneration

Issues surrounding insurance broker remuneration have attracted regulatory attention in the UK and the EU as well as the US. FSA in particular has raised concerns over recent years about the lack of transparency in commission information and conflicts of interest relating to broker remuneration in the commercial insurance market.

In 2008, FSA set out five ‘outcomes’ for commercial customers. These included receiving clear and comparable information about the commission that brokers receive; and being alerted to their rights to request this information. FSA subsequently held discussions with a number of trade associations such as the British Insurance Brokers’ Association, the London and International Insurance Brokers Association, the Institute of Insurance Brokers and the Association of British Insurers. These trade associations developed guidance for intermediaries and insurers which was formally confirmed to have “industry guidance” status by FSA in March 2009 for a three-year period, renewed in February 2012.

The guidance builds on the FSA requirement that a broker must disclose its commission to a commercial customer on request, and that disclosure should include all forms of remuneration from any arrangements, including those relating to profits or volume of sales. (“Intermediaries must have policies, procedures and systems to be able to disclose commission on request.”) It includes suggested wordings for making the disclosure, which could be used in various ways including being incorporated within a broker’s TOBA. The guidance also recommends that brokers remind commercial customers in plain language and at regular intervals about the customer’s entitlement to request information on remuneration. “Regular intervals” is suggested to mean no longer than 12 months between reminders.

Provided that brokers adhere to the guidance, FSA will take this into account and will generally not take action against a broker for behaviour that is in line with the confirmed advice. Anyone departing from the guidance would need to convince FSA that the steps they took were equally valid.

The Bribery Act 2010 and Lloyd’s guidance

New guidance issued by Lloyd’s in February 2012 for managing agents and brokers is of general interest to the insurance broker industry as it addresses the impact of the Bribery Act 2010. In addition to raising a number of issues affecting organisations generally, such as whether corporate hospitality is caught, the Bribery Act has generated particular concerns in relation to current insurer remuneration practices, for example, whether the payment of commission could constitute a bribe. The Bribery Act re-enforces pre-existing FSA principles which incorporate general fiduciary duties and are concerned with issues such as conflicts of interest and bias.

The Lloyd’s guidance states that it expects managing agents “to adopt a very cautious and rigorous approach to compliance” with the Bribery Act. It concludes the following:

• Payment of brokerage where the amount agreed is an ordinary amount, within the usual range for
that type of business, and has been fully disclosed to the client, would not lead to prosecution.

• However, payment of additional fees/commission could in certain circumstances raise the risk of
being seen as inducing a broker to place business with the insurer contrary to its client’s best interests or might otherwise cause improper performance by the broker of its duties. This could relate to, for example, payments which are contingent upon receiving target volumes of business.

The guidance recommends that considerable care should be taken by managing agents before agreeing any additional payments, and that a number of questions should be considered before additional payments are agreed. The questions include the commercial motivation behind the payment, whether any additional services provided by the broker are of real value and how well those services have been documented, and whether the broker has agreed to provide clear disclosure to its clients. If a managing agent does decide to agree additional payments, it must keep a clear record of how it reached that decision.

It was clarified in further Lloyd’s guidance issued in April 2012 that an agreement to pay profit commission was considered to represent a high risk under the Bribery Act. In order to alleviate such risk when agreeing profit commission under a line slip, the guidance recommends that managing agents should satisfy themselves that various obligations have been complied with, such as disclosure to the broker’s client of its remuneration arrangements.

The effect of the Bribery Act and the Lloyd’s guidance is clearly to increase the need for insurers, managing agents and brokers to document the specific details of brokers’ services and to establish that remuneration is commensurate with those services. In addition, Solvency II, when implemented, is likely to increase governance and outsourcing requirements for insurer and intermediary services.

Life assurance

FSA’s Retail Distribution Review (“RDR”) will introduce new rules prohibiting the payment of product provider commission to advisers, applying to life insurance investment products. A key objective behind the new rules, which will come into effect in the UK from 31 December 2012, is to ‘address the potential for adviser remuneration to distort consumer outcomes’. Under the new rules, instead of being paid by commissions set by product providers, adviser firms will be required to be paid by charges that they have set out upfront and agreed with their clients. Adviser firms will not be permitted to receive commissions offered by product providers even if they intend to rebate the payments to the client.

The above will not apply to pure protection products (i.e. critical illness, income protection and non-investment life insurance). Brokers dealing in these products will still be able to earn commission on sales, although they will be subject to new requirements to explain and disclose their remuneration to the client.