In Spring last year, Broking Business announced the FCA’s Market Study on the wholesale insurance sector. Its key aim was to assess whether competition was working effectively in the market. Paul Goldwin reports on what the results mean for brokers.
The study focused on three main areas: market power, conflicts of interest and broker conduct. Its overall outcome: “the FCA has not found evidence of a significant level of harm to competition that requires immediate remediation”, appears to have taken the market by surprise. But could there really have been smoke without fire?
In spite of its decision to conclude the wholesale market study, the FCA has identified three areas that require ongoing review and monitoring. These are conflicts of interest, information disclosure to clients and certain contractual agreements between brokers and insurers. I will examine each of these and assess their possible impact on the market. But first a re-cap of the FCA’s conclusions on the three key areas of the study.
1. Market power
Overall, the wholesale broking sector is not as highly concentrated as originally thought. But there is evidence of high levels of concentration in some markets – for example in aviation, where the three largest brokers account for 80% of all GWP. The study found no evidence of excessive profitability. Remuneration rates vary significantly across brokers and, in particular, while the largest brokers may have ‘market power’, it is not reflected in higher commission or fees. Plus there are some barriers to entry, but not enough to lead to significant restrictions in competition.
2. Broker conflicts
The analysis shows that brokers receive a higher remuneration from placing risks via their own in-house facilities and broker-owned MGAs than on the open market. Although these methods can be cost-effective, and thus good news for the client, the higher rates can lead to a pattern of broker behaviour that may not always be in the client’s best interests.
The FCA considers the whole area of brokers’ conflicts of interest policies as one where more work is required. As a result it will continue to look at this as part of its ongoing supervisory work.
3. Broker conduct
The study reviewed various aspects of broker conduct, such as ‘pay to play’ arrangements, onerous conditions in contracts and broker coordination. And although these could not be ruled out, the FCA concluded they were not market-wide issues and significant enough to warrant immediate intervention.
Conflicts of interest – a closer look
In its results, the FCA said that it would be examining broker conflicts of interest and their management in more detail. The main area giving rise to conflicts is where broker incentives encourage business to be placed with a particular insurer. Surprisingly though, the FCA decided there is sufficient information available for clients to make an informed decision about using placement methods such as facilities or MGAs. Its FWD research supported this, revealing that over 80% of respondents see no conflicts of interest in the sector.
Interestingly, the FCA’s principal concern is that there appears to be a general weakness in the market in firms’ conflict of interest management. Only around 50% of firms were able to properly identify conflicts inherent in their businesses. What’s more, there was a lack of evidence of procedures, controls and MI built around policies to lessen potential harm to customers from using facilities or other placement structures. Also in short supply were clear governance processes to oversee placing of business via facilities.
The FCA suggests that conflicts of interest policies need to be detailed, properly articulated and ‘appropriate’ for the particular conflict. It urges all firms to reassess their current ‘conflicts management policies’, and make the necessary changes to ensure they comply with regulatory requirements, particularly as business models in the market change.
The FCA also took the opportunity to remind firms that they have a regulatory obligation on conflicts of interest as per its Principles for Business and Senior Management Arrangements, Systems and Controls rules.
Broker remuneration disclosure
The other key finding from the study related to broker remuneration disclosure. Standards of disclosure in the market are still inconsistent. Although there has been some improvement, there’s still a lack of transparency. Around one third of brokers disclose the amount of commission they receive as a matter of course. Some 50% declare the nature of the remuneration they receive, but will only disclose commission if they are specifically asked.
A small number of respondents also expressed concern about conflicts of interest and the fact that they could never be quite sure if brokers were hiding commission. Others said the lack of consistency in broker remuneration disclosure made the selection process difficult, as in many cases they couldn’t compare like for like.
The FCA reminded brokers to consider the information needs of their clients when deciding the extent of their remuneration disclosure. It also said to present information which is clear, fair and not misleading and to comply with the Insurance Distribution Directive (IDD) general principles communicated by the FCA in CP 17/7.
There was particular emphasis on the fact that firms are now required to act in the ‘customers’ best interests’ when it comes to broker remuneration. This is a step up from FCA Principal 6, where a firm has to ‘pay due regard to customers’ interests’.
Full disclosure likely
What does the FCA really expect then? Our view is that although not yet obligatory, it seems to be moving towards a preference for full disclosure of all details of remuneration in the broking chain. Why? Because although this will incur expense and provide practical challenges, it’s the only way for it to guarantee a level playing field, ensuring that information is presented in a manner that is clear, fair and not misleading – in order to facilitate like for like comparison.
To quote some respondents from the FCA survey, “The only concern, and it is a large one, is that remuneration needs to be more transparent so that people know
what they are paying for and who is ‘getting a cut’” and “Although pricing is more obvious now, the LIM is still an ‘opaque industry’ and this is detrimental as it allows people to speculate as to ‘who gets a cut’. Please have an Insurance summary with pounds and pence on it.”
Contractual agreements between brokers and Insurers
Although the FCA found evidence of contractual agreements between brokers and insurers which could be harmful to competition, it found nothing to imply tacit market collusion. As a result it decided that no immediate regulatory intervention was necessary.
How it affects the market
What can we conclude from the study and what is its impact for the market? It’s clear the FCA had use of a huge volume of collected data as well as the results of FWD research through customer interviews and a review of profitability and performance data. But despite the extent of the data, the scope of the study was, in the end, very narrow.
The interviews were very focussed and conducted with a limited sample. So it would be interesting to see whether the findings would have been as conclusive with a more representative and wider sample and scope.
Irrespective, there are some interesting points that have come out of this study which will impact the market:
It is clear the FCA now knows a lot more about the wholesale market and will use this information if necessary.
The results of the study now allow firms to move on with more certainty, but they do not eliminate the tensions that continue to exist in the market between small and larger firms.
The study has provided clearer guidance on the expectations for transparency of broker commission disclosure and given us an indication of where this might end up.
The FCA has clearly stated that it will be keeping an eye on the conflicts that exist in the market. There is also, of course, still scope for it to review other areas of potential conflict such as marketing advances, overo riders, PC, insurer loans or investments by insurers.
The study has put a lot of information in the public domain. It’s given smaller firms the opportunity to think about breaking out services from the main commission and adopting some of the services offered by larger firms.