Season of change

Brokers have faced constant change in recent years and in view of a new climate of transparency and professionalism, should brokers also be considering the significant changes being made to commission structure and fee charging?

The question of professionalism provides one of the key areas for debate over the fee-charging issue, and in particular, whether or not the charging of a fee must go hand in hand with the customer's perception of a 'professional'. Certainly, accountants and solicitors, which have traditionally been viewed as professions, work on a fee rather than a commission basis.

For many, the answer hinges on what type of service you are providing and what type of client you are dealing with. John Thornton, chief executive officer, risk management services unit, Aon, comments: "Where we want to be perceived as professional and when we want to be perceived as a business partner or a professional adviser and we want to be paid for the value we add, then it is absolutely essential."

Another issue at stake is that brokers should feel they can be open about the money they earn for the services they provide, whatever the remuneration structure. As Cathie Bruce, head of customer proposition for Groupama emphasizes: "I have always felt brokers should be absolutely proud of the service they provide, and therefore should not shy away from acknowledging that they earn money for that service, regardless of whether they receive fees or commission."

Important aspects

For Eric Galbraith, CEO of the British Insurance Brokers' Association, the important aspect of fees/commission is that the client has the choice. "It takes more than just charging a fee for broking to be regarded as a profession," he observes. It is also worth considering that clients do not assume that they are getting a free service. As Galbraith emphasizes: "Clients don't regard the broker's services as being free so this is not an issue." Lyndon Wood, CEO of Moorhouse Group agrees: "Clients know a brokers' service is not free and that somewhere in the premium is the broker earnings."

So how important is the fee versus commission issue for customers themselves? Association of insurance and risk managers chairman Peter Berring explains that while 95% of Airmic members already remunerate their brokers by fees, the association does not insist on one model over another. "The factors that matter are value and transparency. Our members will be satisfied as long as these are achieved," Berring observes.

There is a widespread view among brokers that the practice of charging a fee is more suitable to some clients than others. Wood explains: "In our micro market - companies with fewer than 10 employees and with an average premium of £450 - we prefer commission. On our larger corporate business, with an average premium spend of £100,000, we prefer to charge a fee." Wood adds that for larger corporates it is the only way to do business. He comments: "The services that a broker can offer are wide and varied including insurance and managing risk or alternative methods and the client is paying for that expertise and contacts in a variety of marketplaces."

Stuart Reid, chief executive of Stuart Alexander, agrees: "Fees work very well for the large corporate clients. I believe and understand that there is no need or desire from the smaller businesses and retail customers to go to a fee basis."

Bruce observes that it would no doubt be easier to charge a fee where you are dealing with people who can understand the issues involved in running a business. "If you are talking to the finance director of a company about how you are going to charge for your time, then there would perhaps be a greater level of understanding than there would be in personal lines."

Charles Dupplin, who heads up the art and private client division at Hiscox, looks at the issues at stake for the high-net-worth customer: "Fees are much better for non-commodity business. My definition of HNW puts HNW firmly in this area. It is uncomfortable to be in a position of trust, knowing all about the safety and security of your client and their family and all of their belongings, and yet be secretive about your cut. Our most recent focus group findings on HNW clients show they would be surprised and shocked by the size of the brokerage. I say all this knowing that only a tiny minority of HNW clients today are fee based and very few of the rest have clear disclosure on broker remuneration."

Reid points out that the issue of changing to a fee-based system should not be underestimated, pointing out that it could cause 'tremendous difficulties'. Reid adds: "It is also very difficult to charge a fee for something that has got 12 months to run from the date you are actually charging the fee. For example, do you increase the fee if a claim occurs?"

Certainly, there are some significant challenges to meet for those contemplating the shift from a commission to a fee structure. "It is a huge undertaking," agrees Thornton, who points in particular to the cultural issues at stake. "While at the large end, it is now commonplace and therefore not ground breaking, this is still relatively recent. To get an individual to think in terms of time spent and value added and to be able to why that fee is appropriate, is a huge cultural shift."

Administration and marketing

In addition to the obstacles represented by many years of accepted practice, the main challenges can be divided loosely into the headings 'administration' and 'marketing'. In terms of administration, issues include training staff and implementing systems which enable hours to be tracked and charged. Wood summarises some of the issues to consider: "This means software changes for many firms; trading terms; staff training and buy in; explanations to clients and document changing as well as costing out converting from commission to a fee that retains your historic profits." As far as the enormity of the task is concerned, Wood says it would come second to Financial Services Authority compliance back in January 2005.

The marketing side centres on the fact that brokers may need to become more proficient at demonstrating what it is they do to add value and therefore justify their fees. Bruce observes: "The customer would be able to see that there is a considerable amount of work involved." Thornton comments: "The broker has got to be able to explain the process. Many clients are still ignorant about what the broking transaction is and how long it takes to put the deal together, the research that goes in and so on."

Opinions are divided over whether the broker would need to involve insurers in any decision to move to fees. Thornton does not believe it can be done without insurer involvement. While he agrees that the broker is the agent of the client and not the insurer, he points out that the decision would have an impact on the insurer's business model, in terms of what they build into their price and in terms of their historic relationship with their broker partners. Wood points to system problems: "Insurers are happy to do it for larger businesses but their systems quite often do now allow this for smaller business." Of course, insurer involvement can only go so far. Bruce comments, for example, that in terms of fees brokers charge, "that has to be a discussion with the customer and not with the insurer."

Once the cultural, operational and strategic problems have been overcome for the broker looking to charge fees, there remain a number of pros and cons to consider. Wood highlights some of the primary concerns: "The benefits of moving to fees is that you are transparent to your customers which works very well in Moorhouse Corporate. Charging fees instead of commission also enables a firm to calculate and control its profit margin per case and standardises income across the board.

The disadvantage is that it does provide clients with the tool to negotiate you down on price, because they see what you earn from them for the service. Year one is OK. Year two can however be a problem if the client has had no reason to call upon you. You can then struggle to maintain the fee."

Berring, however, is keen to emphasise the benefits to insureds: "It means you know exactly what you will have to pay the broker, and it links their charges to the work they do rather than the amount of premium they place, which is a rather crude form of remuneration."

Daring to reveal

While the debate over fees continues, there has certainly been an increasing shift towards acceptance of transparency in broker remuneration, a fact that has been born out in some recent surveys (see box). In many ways, the fee debate must be seen in the context of these issues.

Bill Rendall, market liaison manager at Lloyd's Market Association, explains: "Fees should provide transparency for the client, something that the LMA is demonstrably in favour of and which promotes efficient markets when the insureds can see what they are getting for their money and make informed judgements.

"The LMA/IUA and Airmic surveys have clearly shown that this is something that insureds want."

Those brokers that are contemplating moving to a fee-based system are likely to face cultural and operational challenges. It is also worth considering that transparency of remuneration remains key and is likely to have more influence on consumer perception than whether or not the broker charges a fee.

TRANSPARENCY - TWO SURVEYS

Airmic survey shows big rise in broker transparency

Research published by Airmic this year has found a substantially greater willingness by brokers to reveal details of their remuneration, including payments from underwriters, and a widespread view among buyers that their fees represented reasonable value. Here are some of the highlights (figures from the previous survey in June 2005 are in brackets).

- Members whose brokers provide automatic disclosure of earnings: 64% (32%).

- Members satisfied with their brokers' information on earnings: 73% (44%).

- Members satisfied that their brokers' charges are reasonable: 78% (43%).

- Members paying broker fees rather than percentage commissions 95% (91%).

London Market Association/International Underwriting Association survey reveals buyers favour mandatory disclosure of all broker remuneration.

Corporate insurance buyers believe brokers should be made to disclose their commission earnings fully and automatically when arranging cover. The report also found a widespread lack of understanding about the level and breadth of broker remuneration. More than two thirds of clients believe they should know the total income their broker receives from placing and handling their company's insurance requirements, according to the survey. Currently their estimates of how much a broker might earn from commissions is only around half the true figure.

The survey was conducted by Insurance Research and Strategy on behalf of the International Underwriting Association and LMA. It reveals a strong groundswell of opinion favouring the introduction of mandatory disclosure of commissions by brokers. This would encompass recognised commission and fees from clients, as well as payments from underwriters, including commissions paid in the London Market.