The FSA will have to tread carefully on commission disclosure to avoid disadvantaging UK brokers, argue Elborne Mitchell's Tim Brentnall and Alexandra Booth.
Until recently, it seemed the Financial Services Authority (FSA) was set against mandatory commission disclosure by brokers to commercial customers; but their recent discussion paper signals a possible change of heart.
While previously the FSA's view was that the benefits of mandatory disclosure were not sufficiently high to justify the cost to the industry, the regulator is now suggesting that imposing yet more onerous requirements could increase the benefit enough to make the cost worthwhile. The focus has widened from disclosure of commissions earned by a customer-facing broker on a particular piece of business to include commissions earned by every broker in a chain and on contingent commissions.
The suggestion is that all customer-facing UK based intermediaries should automatically provide commercial customers with information in cash terms about the total commission payable through the whole chain (although not how it is shared). That begs a number of questions.
The FSA proposes that the obligation to disclose total commission would be placed on the insurer but with permitted delegation to the customer-facing intermediary. They acknowledge that wholesale intermediaries might need to facilitate the process where there is a long chain – but how will that be enforced outside the UK?
The suggestion is that the customer-facing intermediary will discharge its commission disclosure obligation provided that it has used "best endeavours" but the question of what that entails is left open. Will the proposals perversely lead to further "legislation-arbitrage" by encouraging the deliberate siting of the customer-facing intermediary offshore in amore relaxed regulatory environment? Alternatively, the FSA is considering whether the insurer should be required to provide commission information as part of the policy documentation after the point of sale – but given that the customer will already have entered into the contract the benefits of this approach appear distinctly doubtful.
On the question of contingent commissions the FSA is concerned by anecdotal evidence that brokers are telling commercial customers that they may receive additional commission on a profit or volume related basis without giving any details of how it will be calculated.
Clear Indication
The regulator accepts contingent commissions are dependent on a future event as they are typically paid across a book of business with a precise figure not always available at the point of sale. But in their view the broker should give the customer a clear indication of the likely amount payable, calculated in cash terms on a standardised basis – perhaps the maximum amount an intermediary stands to make if there are no claims, or a historical average of what the intermediary has received in a previous period?
There is a large question mark over whether such information will be meaningful to a customer whose insurance may be an extremely small part of the book of business which is the subject of a contingent commission arrangement. Doubtless it is information that will be of interest to competitors, but would it drive down commissions for the benefit of customers?
And on the issue of competition, Concerns must also be raised over the prospect of the FSA once again "gold plating" regulatory standards and moving ahead of their European counterparts. The FSA discussion paper identifies the perceived lack of commission transparency as potentially creating an unlevel playing field.
International intermediaries who disclose voluntarily have argued that a lack of mandatory commission disclosure gives UK intermediaries an unfair advantage. But how many international intermediaries are disclosing voluntarily? A distinctly unlevel playing field in favour of non-UK intermediaries may result if the FSA decides to impose mandatory commission disclosure in the UK in the absence of comparable rules elsewhere.
The FSA's approach to contingent commissions differs from their colleagues in the US who have opted for prohibition not disclosure. That said, Marsh, Aon and Willis have recently reached an agreement with the New York attorney general over contingent commission arrangements of newly acquired brokers.
They had complained that they were at a competitive disadvantage, because while they have phased out contingent commissions, smaller brokers have not done so and when bidding to acquire other brokers would look to maintain the income stream from the target company's contingent commissions. Under the new arrangements, the big three brokers will also be able to take the benefit of the target company's contingent commissions for three years, giving the man opportunity to restructure remuneration arrangements.
The fact that the New York attorney general has agreed the deal seems an admission that contingent commissions are still rife throughout much of the US insurance industry, certainly below the top tier of brokers. This suggests that the FSA should tread warily in going down the path of forced disclosure or run the risk of putting UK brokers at a competitive disadvantage worldwide.
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