The issue of broker transparency is now firmly back in the spotlight with the industry anticipating another regulatory crackdown, this time at the hands of the European Commission. Richard Bucknall and David Margrett suggest the best way forward.
After the Insurance Mediation Directive from Brussels in 2002, the Spitzer probe in 2004, and the regulatory oversight of insurance brokers in the UK by the Financial Services Authority from 2005, the latest hurdle for brokers to negotiate is the European Commission's sector enquiry into business insurance. Although it is not due to issue its final report into business insurance until September 2007, the sector enquiry has already highlighted the issue of transparency of insurance broker remuneration.
The insurance broking sector has faced greater external scrutiny, regulation and review in the past three years than in the previous 300 years. However, the fact remains that practices in this sector, particularly in relation to transparency, are as different now on both sides of the Atlantic and across the European Union as they have ever been.
The interim report issued by the European Commission has highlighted inconsistencies of approach across Europe in particular. The practice of spontaneous disclosure of remuneration differs from country to country and in some cases, such as Italy, requests by the policyholders for remuneration disclosure were even ignored or rejected, according to the report. In other countries the rebating of commissions by independent insurance brokers is prohibited.
In the US, recent approval has been given by certain state regulators to supplemental commissions, which most observers consider have most, if not all, of the characteristics of the much-criticised contingent commissions, which originally attracted the attention of the New York attorney general Eliot Spitzer. This latest development is likely to further confuse both the insurance broking sector and their clients.
So given this backdrop, what are the overriding principles which should guide the insurance broking community in addressing the concerns of the regulatory authorities? Also, more importantly, how can brokers win and retain the trust and respect of their clients? There are four key issues to address:
- Contingent commissions;
- Conflicts of interest; and
- Fees versus commissions and net pricing.
Disclosure - On the subject of remuneration disclosure, Willis subscribes to the view that the client should know what services are being provided to them and what the broker is being paid for those services. This applies to both large corporations as well as small and medium-sized enterprises.
Willis has found this to be a difficult experience, involving changing practices within the industry that are decades, if not centuries, old. However, it has found it to be ultimately rewarding insofar as it has created a more open and professional partnership with insurance broking clients. In addition, the disclosure of what the company earns for the services it provides has forced us to articulate more clearly the depth and breadth of those services and the resources that we bring to providing solutions to our clients. In this arena at least, the insurance brokers have much to learn from other occupations such as investment bankers, lawyers, accountants and management consultants for whom transparency has never been a deterrent to being properly paid for the value they bring.
Contingent commissions - Turning to contingent commissions, Willis announced in October 2004 that it was voluntarily abandoning the acceptance of contingent commissions from insurers in respect of its worldwide insurance broking or placements activities. Contingent commissions can create a perception, rightly or wrongly, of potential conflicts of interest in relation to how that revenue may influence the independent advice that is given to clients.
Part of the justification for contingent commissions rested on the assumption that the services that the brokers provided in relation to policy administration, various accounting services and other administrative matters were for the benefit of insurers. Whilst the insurers did benefit from an efficient and seamless service, these services were and are undertaken on behalf of clients and are part and parcel of the overall service offered. Brokers are not in a position to abandon them - most clients have neither the resources nor the willingness to assume these responsibilities. In this sense it is time to recognise that the services are being provided ultimately for the benefit of clients rather than insurers.
Specifically, if one looks at policy documents, it is custom and practice for the more standardised wordings to be prepared by the insurers and checked by the brokers on behalf of the clients, whereas for the more bespoke customised wordings, the contract is often prepared by the broker and checked by the insurers. It is a service provided to the client by the broker and would be similar to a lawyer drafting and preparing a document for his client.
Conflicts of interest - It is a fact that brokers face many potential conflicts of interest - where they act for clients who are competitors, where they act for a company that is the subject of a takeover, as well as acting for a company that is in the midst of an acquisition, and where they act for both clients and insurers in the operations of an underwriting binding authority. Regulators correctly expect that brokers have in place procedures and protocols to be able to handle conflicts of this nature and, on some occasions, will require the broker to resign from a specific situation.
It is the management of a binding authority or managing general agency that attracts the most regulatory attention and scrutiny. The aggregation of a number of small or specialist risks into an overall facility may provide individual clients with price or coverage benefits that they would not be able to achieve on their own. In addition, under such a facility the broker is likely to achieve contract certainty at or prior to inception which, in certain jurisdictions of course, responds to an important regulatory imperative.
But the question remains as to how best to manage the broker conflict of interest. Firstly, the broker needs to disclose that in the operation of the underwriting facility he is acting in a different role - on behalf of the underwriter - and so may not canvas a wider market. Secondly, the broker needs to disclose and highlight the revenues that he may receive as a result of operating this underwriting function, including service fees or profit commission as applicable. Thirdly, in an ideal world, the underwriting element would be handled within a discreet department or unit.
Fees versus commission - Finally the issue of fees and commission, as well as the question of net pricing, also deserves some attention. The purists may argue that all independent insurance brokers should be remunerated by fee rather than by commission. There does not appear to be any evidence that suggests this is what every client wants. Far from it, apparently most clients want the commercial right to choose how their broker will be paid. Our experience suggests they want transparency and choice. Many clients prefer remuneration by way of commissions for an insurance placement. Why? Because it is simple, easily understood and requires less resource and time than is needed to negotiate annual fee agreements. Also, for smaller clients, the time taken to calculate and negotiate fees may become disproportionate to the overall cost.
However, it is not only smaller clients which enjoy commission arrangements. Some larger multinational clients may find that an effective and simple solution to apportioning costs around the globe is by reference to premiums and commissions, subject to full disclosure. And what about those market practices and/or laws in the Nordic region which seek to prevent acceptance of commission by brokers and require payment only by way of fee?
For all the rhetoric, the purpose behind the changes appears to be to allow control of distribution by local insurers and restrict competition from international insurers, who may not have a distribution network in "their market". Not only may this reduce competition but it stops the client from having the commercial right to determine how its broker will be paid for services. Unfortunately it does not stop there as agents and multiple agents may continue to receive commissions and contingent commissions in these countries.
So where do we go from here in the evolution of the insurance broking industry? First, a plea to our colleagues in the insurance broking and intermediary sector to acknowledge that some change is inevitable and that continued resistance is only likely to raise the suspicions of clients and enhance the resolve of regulators to demand greater transparency by all insurance intermediaries.
Second, a plea to those charged with regulation and oversight of our industry that the current inconsistencies of industry practices, in particular in relation to transparency and the confusion over the desired interpretation of certain directives, should be resolved and clarified for the benefit of the industry and its clients.
Richard Bucknall is outgoing chairman & CEO of Willis Ltd and David Margrett is chairman, Global Specialities & Global Markets and chairman & CEO of Willis Ltd.