I can fee clearly now

Commission disclosure has never been a big thing for commercial brokers, however, in light of the Financial Services Authority's requirements, a wind of change blowing towards a fee-based model and a growing array of services that are provided over and above the basic placing of cover, brokers' remuneration is more diverse than ever before. In turn, firms need to better explain what they are charging clients for and exactly how much they are charging them.

The whole issue of transparency, fees and commission is an area the FSA is very hot on and it is trying to create an environment in which clients understand exactly what they are being charged for and how brokers earn their commission. There have been a number of global incidents in this area over recent years, and in relationships that can often be commercially complex the regulator is right to demand a level of clarity from those involved to allow customers to see exactly what is going on.

Clear

It was only at the end of last year that a missive was sent out from Canary Wharf to commercial insurance brokers reminding them of their obligations and highlighting areas where things could be done better. The good news for the industry is that the FSA did not find any widespread problems or deep-seated issues that were detrimental to customers (box one). The major point raised in the letter was that firms were failing to put adequate formal procedures in place to deal with client enquiries over commission and ensure that a consistent approach was taken in each and every case (box two). During this year and into next, the FSA is carrying out further work in this area and expects to complete an objective market failure analysis and corresponding cost benefit analysis, covering both transparency to the customer and to the market.

The regulator says it will use the findings of its study to decide whether or not to mandate commission disclosure, and this is something the industry should try to avoid at all costs.

There is absolutely nothing wrong with creating clarity, consistency and transparency when it comes to commission, however, in terms of the administration that would be involved in setting out the terms and conditions of commission agreements on the back of every deal, it seems such a move would create a lot of work for brokers and not be something the vast majority of clients are actually interested in. Even if brokers are not forced to disclose commission as a matter of course in the years to come, there is little doubt they will have to become better at understanding the services they provide and how they are remunerated for them.

This has already begun to happen to a large extent and any fees charged need to be disclosed in accordance with the rules set out by the FSA. This is becoming more relevant to a growing number of brokers that are no longer paid simply by the commission they earn on placing the business, but through fees that are charged for the services they offer.

Steve White, head of compliance and training at the British Insurance Brokers' Association explains: "Whenever a broker reverts from a commission to a fee arrangement there is an element of having to think through exactly what it is being offered and how much is being charged for it." White says BIBA is talking to members about this and promoting the idea that they send a 'terms of engagement' letter out to their customers spelling out exactly the services being provided. He adds: "I detect a greater willingness to look at a fees approach."

Certainly this is a point that Kevin Young, group chairman at broker Argyll Insurance Group, agrees with: "As brokers have become more professional the breakdown of fees has changed fairly dramatically. We cannot and should not be seen as a once-a-year service. Managing physical and financial risk is a complex business and it is right and fair that we, as brokers, are remunerated for the advice and service we provide."

Young feels that as brokers have become more professional and better at guiding clients through risk management assessments, health and safety issues, business recovery issues and alternative risk transfer possibilities, they have had a huge part to play in the improving combined operating ratios that most providers are now experiencing.

He says: "Only a few years ago CORs were running at over 100%, but today they have reduced significantly despite the soft market. Prudent risk management, health and safety advice and disaster recovery planning have reduced claims. Insurers have a role to play in this, but a lot of the work is conducted by brokers."

Providing these services is not only crucial to the better performance enjoyed by insurance providers, but also to the effective management of clients' risks. Young believes that working effectively with clients is more important than providing them with the cheapest cover available when it comes to long-term relationships and business retention.

He remarks: "Price is obviously very important to all clients, but retention rates are maintained at over 95% in our company due in no small part to the delivery of continuous after-sales services. A large proportion of these fall outside of the traditional broking model, and as such are charged out separately."

As brokers continue to offer services over and above the simple arrangement of insurance they will need to be able to charge for them if they want to receive fair remuneration for the work they are doing. This is perhaps easier for the larger firms that have separate divisions for the various services they provide whether it be risk assessment, health and safety consultancy or the viability of establishing a captive vehicle.

Certainly this is something that broker Lucas Fettes and Partners is dealing with at the moment and David Lee, director at the brokerage, says: "How the fee breaks down is the big question and for firms at our level it is sometimes difficult. We do not have a separate division for health and safety, whereas the bigger national brokers all have separate divisions that charge independently." In the coming years it may be that smaller firms will have to get better at breaking down the services they offer and the fees charged for them to make sure they are being properly rewarded for the work they do.

New streams

As brokers improve their ability to classify the services they offer and how to charge a fee for them, the number of revenue streams they create will increase. At the moment, Argyll says something like 10% of its revenues come from services over and above the basic placing of cover and this is set to grow in the years to come. One of the potential areas of real growth is premium finance and Lloyd Hanks, director at Aascent, says brokers could be growing turnover by anything between 1% and 3% of their gross written premium through premium finance.

He says: "It adds value because it makes life easier for the client and is a service that the broker has put in place for them. This is an opportunity for brokers to add real value to their bottom line although many brokers do not appreciate that premium finance could be an integral part of the insurance sale." However, the real problem with this is that many brokers do not feel they should be making large amounts of revenue from the premium finance arrangements they have in place.

Lee says there is a vast difference between the attitudes held by firms regarding premium finance across the market, and, while many are making money from it, he is not convinced this is the best way forward: "If you were to do a comparison between the rates charged by brokers across the industry, (you could find that) some firms are charging double for their premium finance. However, you might not want to be greedy and clients may not know and perhaps they should be told. It's not very transparent is it?"

Young goes further and says Argyll is happy to add on enough to the basic premium finance rate simply to cover the administrative costs that are involved. It is not, however, an activity he believes insurance brokers should be looking to make significant revenue from. He says: "I do not really see that we are bringing anything in particular to the party when we say to the client that we can offer them a rate of x amount. Why should we make money out of this? If we were looking to make that a major revenue stream then I think we would probably be being a bit naughty."

It is not that Young does not appreciate the value that premium finance can bring, but simply that he does not feel brokers add anything themselves when offering the service and so should not be looking to make major revenue streams from it. Instead, he feels the focus should be on the services provided to clients on the assessment, elimination, mitigation and transferal of risk: after all, this is what they do best.

Commission may never go away as a part of the overall remuneration that brokers receive, but increasingly it seems the best firms in the market will be generating a much larger proportion of their income from surrounding services.

FSA 'Dear CEO' letter, 6 December 2006

"The majority of firms have adopted guidance issued by the London Market Brokers' Committee and the British Insurance Brokers' Association. To that extent, most firms we visited included a standard clause in their terms of business agreements, which reminds clients of their right to request information about any commission received in the placing of business prior to the conclusion of the contract.

Few commercial intermediary clients request commission disclosure, although some have sought a positive declaration from their intermediary that it is not being remunerated under a profit share arrangement or any other similar arrangement.

Few intermediaries have made consequential changes to their systems and controls to comply with the relevant Insurance Conduct of Business Rule (ICOB) rule - ICOB 4.6.1R, so we found a widespread lack of formal process among intermediaries as to what remuneration would be disclosed to a commercial client on request, with not all intermediaries including all forms of remuneration. Such a failure to disclose fully when asked by a commercial customer would be a breach of ICOB 4.6.1R."

FSA 'Dear CEO' letter, 6 December 2006

"Boards should establish and maintain procedures to ensure that the firm has the systems capacity and controls to respond to a commercial client's request for information about any commission received in connection with an insurance contract, including payments to associated firms, arrangements for sharing profits, for payments relating to the volume of sales, and for payments from premium finance companies when arranging finance.

Boards should ensure that proper records are maintained, sufficient to show and demonstrate that the firm has complied or has the capacity to comply with ICOB 4.6.1R."