On 20 March, the FSA published a discussion paper on Transparency, disclosure and conflicts of interest in the commercial insurance market. This paper has been produced following the publication last year of two reports on the commercial insurance market. The first was published by the European Commission in September following its competition inquiry into business insurance. The second, published in December, was an independent piece of research carried out by CRA International on the FSA's behalf, which focused primarily on commission disclosure.
Both reports found evidence of a lack of transparency in the commercial insurance market over intermediary remuneration and services that could give rise to customer detriment and impair market efficiency. CRA's report, which analysed whether the FSA should mandate commission disclosure, concluded that the benefits of introducing such a rule by itself were not justified by the costs, because the benefits would be focused on middle-sized customers. However, during that work, CRA identified a wider set of issues affecting the efficiency of the commercial insurance market. The FSA's paper considers these wider issues and explores how best to address them in a proportionate way. It also addresses at the UK level some of the issues identified by the Commission in its September report.
The Legal And Regulatory Regime
Under the law of agency, an agent owes certain fiduciary duties to his customers, including the duty, in the absence of informed consent, not to place himself in a position giving rise to a conflict of interest or to make secret profits. In addition to the general civil law duty requiring the agent to account to his principal, criminal sanctions will follow if an agent is guilty of corruption (for example if he accepts a bribe for favouring or not favouring a person). The FSA's rules build on these duties in the high-level Principles for Businesses (Principles 1, 6, 7 and 8) and ICOBS (see ICOBS 4.3.1R fee disclosure; ICOBS 4.4.1R commission disclosure; ICOBS 4.1.2R status disclosure; ICOBS 4.1.6R scope of service; and ICOBS 2.3.1G inducements).
The FSA's Concerns
The FSA considers that full and transparent information is necessary to enable customers to operate more effectively in the market but that, in some respects, current market practice falls short of this standard.
In particular the FSA is concerned that:
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commercial customers appear to be poorly informed about the cost and scope of mediation services. Identifying the cost and extent of such services is complex and gives rise to a number of issues. For example, in the context of contingent commissions the FSA is concerned that some firms are failing to give the customer a clear indication of the likely amount payable' as required by its ICOBS rules. The FSA also questions some firms' views that remuneration earned from work-transfer' agreements such as market service and placement service agreements falls outside the definition of commission in ICOBS. It is also concerned about the lack of transparency over commission received elsewhere in the distribution chain (eg by wholesale brokers) and the fact that, under current rules, this does not have to be disclosed. In the FSA's view this could lead to market inefficiency, potentially hindering the development of more efficient distribution models and increasing the length of chains. Concerns have also been expressed by the FSA over the quality of information provided to customers on the extent to which their intermediary searches the market and the capacity in which their intermediary is acting;
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commercial customers do not always receive information in a form that enables them to compare the services and costs of one intermediary with those of another on a like-for-like basis;
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commercial customers do not always exercise their rights to obtain commission information; and
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conflicts of interest arising from intermediaries' commission arrangements or relationships with third parties are not always properly managed. The FSA considers that the the risk of conflicts of interest is almost certain to become more pronounced' in the future given a blurring of the distinction between insurers and intermediaries'. This blurring arises from a number of features in the market, including the increased use of delegated authorities under which intermediaries accept risks on an insurer's behalf (under binding authorities) or provide administrative services for the insurer (for example as managing general agents), the trend towards consolidation at the small independent intermediary level and the move by some insurers to acquire stakes in intermediaries.
Possible Solutions
The FSA has identified three broad and potentially cumulative options for addressing its concerns and has indicated that each would need to be supported by improved conflict management processes.
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The first is more rigorous supervision and enforcement of the FSA's existing rules and principles. This would involve further guidance on what is expected of firms, more targeted supervision and additional reporting requirements on remuneration arrangements and business models likely to create conflicts of interest and the processes firms have in place to deal with these.
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The second is enhancing the information that intermediaries are required to provide to their commercial customers when they request such information or receive it voluntarily. The purpose would be to improve the transparency and comparability of disclosure requirements relating to remuneration, services and status.
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The last is to introduce the second option but to make the disclosure requirement mandatory. The draft rules appended to the paper for illustrative purposes would require all customer-facing UK-based intermediaries to provide their commercial customers automatically and before conclusion of the contract with information (in cash terms) about the total commission payable throughout the whole chain. Where precise amounts could not be given in cash terms (eg for contingent commissions), the draft rules would require firms to provide an estimate based on the maximum sum they may earn (assuming there are no claims). The paper suggests that the insurer be obliged to ensure that the total commission payable throughout the chain is provided to the commercial customer but allow responsibility for the actual disclosure to be delegated to the customer-facing intermediary.
The territorial scope of the FSA's proposed rules would, however, be restricted. For example, the FSA could not impose requirements directly on non-UK-authorised intermediaries and there may be limits on the FSA's ability to impose requirements on insurers over risks in other EEA member states and on intermediaries that passport into the UK under a European directive. The FSA also proposes that reinsurance contracts would remain outside the scope of any regulatory solution.
Additional FSA Work
The FSA is carrying out additional work on the issues covered by its paper to inform its understanding and thinking on possible solutions. This includes conducting a thematic survey of intermediaries' remuneration arrangements and business models in the commercial insurance market. The FSA intends to investigate the nature and extent of the conflicts of interest to which these give rise and the effectiveness of the mitigation practices that intermediaries employ to address them. It also plans to undertake customer research looking at how commercial customers use information about intermediary commission and services. This will investigate the effect of oral disclosure requirements and the use of prescribed formats.
Next steps
The FSA has indicated that it would prefer a market-led, rather than a rules-based, solution wherever possible but it will decide whether to make changes to its rules and/ or supervisory practices based on the feedback it receives and the results of its thematic work and customer research. If it decides that changes are necessary, it will formally consult on them in the fourth quarter of 2008. Whichever solution is adopted, the message is clear. Insurance intermediaries should prepare themselves for a more rigorous disclosure regime as well as increased FSA scrutiny over conflict management procedures. The FSA is inviting comments on its paper by 25 June 2008.
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