25/06/2015
Welcome back to our series on insurance broker negligence. In this article, we will be discussing the issue of conflicts of interest. Points covered in this piece will include:
- How potential conflicts of interest between an intermediary (the broker) and their client can arise
- The role of disclosure
- Steps taken by the Financial Conduct Authority (FCA) mitigate the risk
Research conducted by the FCA for Commercial Insurance Intermediaries – Conflicts of Interest and Intermediary Remuneration - Report on the Thematic Project, published in May 2014, found that a majority of small to medium enterprises (SMEs) relied on an insurance broker to arrange insurance in order to begin their projects. It also unearthed the fact that many SMEs did not understand the role of an insurance broker and how it may have changed in recent times. Many believed that all brokers looked for the best quote from multiple insurers and presented the one that best suited the client’s needs and budget and relied on the intermediary’s advice and experience.
How Potential Conflicts of Interests Can Arise Between Clients and Insurance Brokers
The two main ways conflicts of interest can arise between a client and an insurance broker which may lead to the broker breaching his or her duty of care to the client centre around the structure of the company the agency works for and remuneration.
The Structure of the Insurance Broker’s Business
The risk of a conflict of interest rises sharply in situations where an insurance broker is fulfilling multiple roles and acting for both the insured and insurer. Many businesses nowadays operate a model that incorporates both brokerage and insurer agent. Conflicts of interests can arise when segregation of these functions is unclear. The Thematic Review (the Review) also found that some companies failed to have implemented risk-management policies that effectively addressed the conflicts of interest created by their business model. In particular, reports given to management did not contain sufficient information to allow them to intervene and mitigate where conflicts were at risk of occurring.
Remuneration
Insurance brokers are largely remunerated via a commission or a fee for their services. A commission is paid by the insurer as consideration for the broker introducing new business. A fee constitutes agreement with their client, whereby, the client will pay them a fee for finding them the best insurance solution for their business.
If the insurance broker is being paid on commission there is an inherent conflict of interest because, although the broker owes a duty of care to his or her client, their individual best interests (i.e. the amount of money they can make off a deal) relies on a third party and their offerings, which in some cases may not necessarily fulfil the client’s needs, but gain the broker a high commission.
Insurance brokers can also earn additional revenue from insurers in the form of profit shares or bonuses based on the volume of business they bring into the company.
The Review noted that “where intermediaries increasingly earn commissions as agent of the insurer or in a dual agency capacity, but continued to purport to be independent insurance brokers, acting for the customer, this increases the risk of customers misunderstanding the role they are performing in arranging their insurance”.
The Role of Disclosure
When an insurance broker sets up insurance for a client, it is assumed he or she is acting as an agent for the insured party, and therefore, he or she has a duty to act in good faith and the best interests of his or her client. Therefore he or she must:
- Fully disclose any profit made on the deal
- Not make any profit that was not contemplated by the client at the time the contract between them and the agent was signed
Fees
If the client is paying the broker a fee, then, under ICOBS 4.3.1R, the insurance broker must disclose this fee in full before the fee is due to be paid or the insurance contract is put in place (whichever is earlier).
Commission
Currently under ICOBS 4.4, an insurance broker is only required to disclose his or her commission to a commercial customer if the customer requests it. However, in 2012 the European Commission published its proposed revisions to the Insurance Mediation Directive supported the mandatory disclosure of commission by brokers but this change in directive is likely to remain in the background until at least 2019.
In the meantime, industry guidance advises brokers to send written reminders to their clients advising them that they have the right to ask for disclosure on any commission earned from the deal.
Contingent Commissions
The commissions most likely to cause a conflict of interest are contingent commissions. This is where an insurance broker can earn an additional commission if he brings clients to a certain insurer. These are also required to be disclosed if the information is requested by a commercial client.
Steps Taken to Mitigate the Risk of a Conflict of Interest Arising
The FCA identified that a key risk to SME consumers related to some general insurance intermediaries not being able to show that they have put in place an effective control framework and taken all reasonable steps to manage and mitigate the conflicts of interest in their business.
To tackle this problem in the future the FCA has taken some initiatives including:
- Engaging with firms who identified as posing a potential risk for SMEs due to conflicts of interests arising, on a supervisory level
- Sharing their findings with the wider industry to create awareness and provide a platform for potential solutions
- Educating SMEs about their rights, particularly the right to receive full commission and remuneration disclosure on request
In Summary
It seems clear that the FCA and the European Union directives will continue to increase the pressure on insurance brokers to disclose fully their commissions and earnings to a client and mitigate the risk of conflict of interest within their business practices. How far this requirement will go and how it will affect the industry as a whole remains to be seen.
If you would like more information on insurance brokers and conflicts of interest, then please phone our London office on 0207 993 6917 to make an appointment.
Fisher Scoggins Waters is a leading construction, engineering and manufacturing litigation firm, specialising in disputes and disasters. For further information on this article or any of our litigation services, please contact us on +44 (0) 207 993 6960.