A Sticky Situation

Mandatory commission disclosure is on the lips of may in the market and while some feel it will sweeten the insurance pot, others say the idea is a bit rich.

Rachel Gordon explains...

Buy a pot of jam and what matters most is the taste and the price. No one is interested in how much the fruit pickers were paid or how much it cost to market the product, or the mark up the retailer has put on the pot. So how different is insurance from this?

Mandatory commission disclosure – and whether it should be imposed – has become a huge issue in the insurance market lately. In particular, London market insurers, the Association of Insurance and Risk Managers and national brokers say this should be a Financial Services Authority priority. However, countless other brokers, both London market and provincial, are adamant it should not.

Jeff Herdman, managing director of Oval, comments: “This is a non-issue that some people are making a lot of noise about – and coming from some, it is a bit rich.”

He adds: “This is an inappropriate model for the small to medium sized enterprise market, which makes up the majority of businesses in the UK , and it will drive many good brokers out of business if mandatory disclosure is forced across the whole market. Is that what the regulator wants?”

However, other markets offer good examples of how this can work. Chris Cummings, director general of the Association of Independent Financial Advisers, urges: General insurance brokers should look at the mistakes of the IFA community. They should not see commission disclosure as a negative. They should not see themselves as just a distribution channel, they should make the changes to become a profession.

“Opting for full transparency increases competitiveness but it is not necessarily bad news for small firms. Banks, for example, may well be charging higher levels of commission.”

Seeing Red

Another protagonist is lawyer Kenneth Underhill , partner with Reynolds Porter Chamberlain, who says: “It is inevitable that brokers will have to start disclosing their commission earnings. Our experience is that while some brokers have taken appropriate steps to manage conflicts, many are accepting inducements that the FSA is likely to conclude conflict with the duty firms owe to customers.”

He says contingent commissions merely encourage brokers to place more business with particular insurers, which could be a disadvantage for the client. According to Mr Underhill, the possibility for conflict is so great that Marsh, Aon and Willis agreed to outlaw the use of contingent commissions in their settlement agreements with New York Attorney General Elliot Spitzer.

Not all lawyers are of the same view though. William Surge, partner at Lawrence Graham, asks: “Where is the wrong that needs to be righted?”

He argues that brokers caught up in this debate are in the main doing a good job for clients, and points out that fees would strip out costs but could also mean that there would be less investment in servicing accounts. “Brokers often do an excellent record-keeping job in long-tail accounts – this is something worth retaining.”

Mr Sturge adds: “The transparency argument is proceeding on a false premise. Which other transactional advisers act on the basis that both of the parties to the transaction know how much the intermediary is making? It seems to be a recipe for squeezing the middle man.”

While brokers in the US have been hauled over the coals following the Spitzer investigation in New York , Mr Sturge comments: “The individual who seems to have benefited most is Mr Spitzer himself, as he is currently standing for governor. I’m not aware of any better terms being passed onto clients as a result of the contingent commissions saved by insurers.”

Hot and cold

As it stands, the FSA has been blowing hot and cold on the subject. It is clear that the regulator has enough on its plate without having to create yet more rules.

In April, FSA chief executive John Tiner, said: “If during the next months we do not see any discernible improvement in transparency, then we will seriously consider mandating disclosure.” However, two months later at the Airmic conference, Mr Tiner stated: We do not believe regulatory intervention to be an appropriate response. Making commission disclosure mandatory will not necessarily address the conflicts themselves that arise from commission sharing arrangements or delivery any other regulatory benefits.”

Meanwhile, Airmic has said transparency is increasing but that the much talked about ‘level playing field’ will only materialise with mandatory disclosure. Its former chairman, Peter Berring, has hit out at the SME market, accusing it of continuing with contingent commission arrangements.

In March, the International Underwriting Association and the Lloyd’s Market Association produced research to say buyers favoured mandatory disclosure. The study also found that many clients did not understand how brokers were paid – or know of the existence of contingent commissions.

The survey revealed that buyers often under estimate commission levels by as much as 50%. If asked, most companies would probably say they wanted to know about remuneration, if only to appear responsible. However, the 500 companies questioned were all mid to large corporate organisations that would have been more likely to have expert buyers in-house, and were also likely to have paid their brokers in fees.

Simon Sperryn, chief executive of the LMA, says if it is standard practice in banking to reveal charges, it should be no different for brokers. “The London market is embracing change and we are seeing more fees being charged. I want to see the sector show leadership.”

He admits that some brokers are opposed to disclosing commission and see it “as a thinly disguised attempt to bring brokerage down but insurers want them to be successful”.

Mr Sperryn argues conflicts of interest continue to exist and the best way to end these is to have all brokers on an equal footing, even if the FSA is required to step in. “Costs may come down but the end customer is going to benefit. Contingent commissions are wrong,” he says.

Mr Sperryn adds that the London market is setting the right example and this can be shown in the new market reform slip, launched in June, which he says will boost transparency. However, there are plenty of brokers including those inside the London market that are adamant that FSA intervention is not necessary.

Their views are clearly represented by David Hough, executive chairman of the London Market Brokers’ Committee, who firmly states: “Our view is that disclosure is a matter between brokers and their clients.

To begin telling brokers what to do is pompous. There is no pressure from clients to disclose and we’ve adopted the Biba toba.

“We produced a terms of business agreement recommendation – which reminds clients of their right to ask how the broker is being remunerated – and this has subsequently been taken up by British Insurance Brokers’ Association, which recommends its use across the market.”

Many commentators who did not want to be named expressed exasperation that mandatory commission disclosure was being discussed – and there were damming comments directed towards insurers, risk managers of large corporations and national brokers. In the end, however, it was the provincial brokers that were prepared to stand up and be counted.

One angry broker said: “There are a lot of agendas at play. Airmic members want cover to be as cheap as possible. Likewise, insurers are looking to cut costs. National brokers that have had their hands caught in the till have been forced to switch to fees, and they want to lumber this model on everyone else. It’s no surprise one of these failed to make a profit in the UK .”

One who has not been afraid to speak out on the topic is Andrew Holman, chief executive of Lloyd’s broker Holman’s. He comments: “Some brokers were caught red-handed. They abused their position and tried to manipulate markets. They had an advantage and now they are forced to use fees –and so they want everyone else in the same position.”

Mr Holman insists that in most cases customers do not request brokers to disclose commission: “They can ask if they want to know but few, if any, do.”

He also believes that customers who constantly push for more brokers to use fees are out of touch. “The vast majority of brokers are not set up like solicitors or accountants to bill clients by the hour of their time. We would end up with too many finger in the air estimates and we would face severe cash flow problems. Other firms would start undercutting on fees and the larger firms would exert dominance. It would be totally unfair.”

A taste test

Alec Finch Group has approximately half of its clients paying fees. Chairman Alec Finch says this works well with larger clients but it would never work for the SME sector.

“It’s increasingly a commodity purchase, a sausage machine,” he explains. “Competition is fierce in SME – all the business owners I know in the sector are only interested in the bottom line, there is no scope for padding.”

He adds that brokers in the SME market are competing with direct insurers: “Those selling direct are not subject to the same disclosure, I would have felt this was a good a reason as any for brokers to resist mandatory disclosure.”

There is also a feeling among brokers that Airmic’s pronouncements on the smaller end of the market are not appreciated. “Airmic members will to a man be working with their brokers on a fee basis. Why are they so concerned about the SME sector – do you wonder whether the contingencies debate is being driven by vested interests,” says Mr Finch.

Another unnamed broker says fee only brokers are under massive pressure to win more business as only volume can keep them afloat. He says: “They are going round in desperation to clients and saying they will guarantee a 20% discount in return for the business.”

Mr Finch adds: “Longer term, SME products will become more commoditised with brokers specialising in this opting for multi-tied agencies. However, to begin telling brokers what to do is pompous. There is no pressure from clients to disclose and we’ve adopted the Biba toba recommendation. All this talk that we should be doing things differently is nonsense.”

Stuart Reid, chief executive of Stuart Alexander, agrees: “This is a complete non-issue and I hope the FSA will see through those that are bleating about commission disclosure.”

He adds insurers should be able to remunerate brokers flexibly. “We handle claims on behalf of several insurers and so would earn more commission. There have been no complaints and no requests from clients to find out more. Already, the market is hugely competitive and it is frustrating to hear these arguments.”

Feeding the issue

Ian Mason, partner with Barlow Lyde and Gilbert, was formerly head of the enforcement division’s wholesale group at the FSA. He believes the regulator will not be pushed into forcing mandatory disclosure. “It is trying to cut the rule book and wants the industry to find solutions, as with contract certainty. Although more disclosure will come, new rules will be a last resort,” he says.

Solicitor James Stockwell of Reynolds Porter Chamberlain adds that the FSA may also be sensitive to the fact it is smaller brokers that will be worse off under new rules. “The Biba move with its toba has been welcomed by the FSA and for the time being, it won’t want to upset the many small firms that are regulated.”

The row over commission disclosure has resulted in hostility between national firms and provincial brokers. Judging by the fact that there are plenty of thriving provincials, it is understandable that they are not looking for the commission regime to change.

For the nationals, it is a different story. There have been redundancies, constant rumours of takeovers and the smell of Spitzer lingers even though they are now subject to rigid rules. However, with limited evidence of client detriment, the market looks set to continue this debate for some time.

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