Striking a Balance

2nd July, 2008

It was four years ago that Eliot Spitzer began his investigations into the insurance market. The main focus of his concerns was the conflict of interest created by so-called contingent commissions, also known as placement service agreements or market service agreements which, in Spitzer’s view, were entirely at odds with the broker’s duty to make an objective judgement call regarding coverage, financial security and price. Instead, brokers would steer clients to those insurers with whom they stood to make the most money and the costs of contingent commissions were in turn passed directly to clients in the form of higher premiums. According to Spitzer, ordinary purchasers of insurance had no idea that brokers were receiving these hidden payments and brokers routinely misled their clients about the true nature of contingent commissions describing them, in one example, as “agreements that cover payment for the value brokers provide for insurance carriers”. In fact, they were nothing more than payments for steering business to preferred insurers. They were also big business. Marsh allegedly received $845 million in contingent commission payments in 2003.

Certainly, Spitzer was successful in extracting some large sums of money from brokers in settlement of complaints filed following the investigation – $850 million from Marsh, $190 million from Aon and $50 million from Willis North America – but has anything changed and does it need to change?

In the US, brokers agreed to reforms including, in the case of Marsh for example, acceptance of only specific fees to be paid by clients or specific percentage commissions on premium to be paid by insurers, disclosure of commission in plain unambiguous language and a prohibition on contingent compensation. There has been a knock-on effect in Europe. In September 2007 the European Commission published its final report on competition in business insurance. It found that contingent commissions that are not profit commissions had shown a notable decrease from 2004 to 2005 but very few companies had abandoned all of their contingent commissions and there had not been any major change in the incidence of commissions based on profitability of business placed. The Commission also found that the top five insurers accounted for the vast majority of intermediaries’ revenue from contingent commissions which highlighted the possible strong incentive for intermediaries to steer business to a few selected insurers. The Commission acknowledged that some large brokers had made efforts to disclose remuneration but others had not, raising concerns about distortion of competition. There was still very little spontaneous disclosure and, in the Commission’s view, customers want to see greater transparency. But do they?

The FSA has presently decided against mandatory disclosure of commissions. The current rules require brokers to disclose commission only to commercial customers and only if asked to do so. The FSA found that a mandatory disclosure regime would see a reduction in gross premiums as a result of reduced commissions arising from increased competition but not at a sufficiently high level to justify the cost to the industry of forced disclosure. Its work is, however, ongoing and one area on which it intends to focus is raising commercial customers’ awareness of the value of commission information disclosed by intermediaries. There is seemingly a perception that customers do not pay enough attention to commission rates, a concern echoed by the European Commission. Perhaps what they really care about is the bottom line figure and not how the cake is divided up.

The ABI recently commissioned CRA International to prepare a report assessing Customer Agreed Remuneration (CAR) in the consumer financial services market. In the CAR model, the cost of advice would be separated out from the cost of the product, explained by the advisor at the outset and agreed by the customer and paid for separately from the product. Providers would no longer pay commission to advisors (but could facilitate payment for advice on behalf of the customer). The report suggests that there would be many benefits of moving to CAR including increased trust in the financial services industry, greater shopping around and reduction in amount paid for products. At the same time, however, the report acknowledges that current levels of shopping around are very low and it is not at all clear whether that would improve. Nor is it at all clear that CAR would in fact end bias. Ways will always be found to offer incentives and differentiate from competitors. For example, in the CAR model, the report highlights “factoring rates” – where customers pay the cost of advice over time rather than in one up-front lump sum, providers could offer factoring services whereby they pay the advisor up-front and the consumer pays over time. Or providers could compete by raising the amount of remuneration advisors can ask for, known as “decency limits” – higher limits could attract advisors to promote a particular advisor’s products.

One thing that is clear is that brokers that have dropped contingent commissions are under pressure to increase revenues from elsewhere. Some brokers have introduced additional commissions ranging from 1.5 to 2.5%, amid claims that other brokers are continuing to rely on contingent commissions and there is no level playing field. But the FSA must tread carefully and ensure that any rules it puts in place do not disadvantage UK interests in the world market. So far it has resisted any temptation to go out on a limb in the absence of uniform codes of practice in other major insurance centres. It should continue to exercise caution and have regard to the “desirability of maintaining the competitive position of the United Kingdom” – as it is obliged to do by statute when discharging its functions