Firms must become our first line of defence

Since the FSA took on the regulation of general insurance in 2005 a considerable number of cases of fraud involving insurance brokers have come to our attention.

As one of the FSA's statutory objectives is to reduce financial crime we are concerned about the extent of the problem and keen to emphasise that we always take strong action against those that use the general insurance sector to commit fraud.

We are seeing examples of fraud occurring in both large and small intermediaries, although different patterns of behaviour are emerging. In general, it is taking place where inadequate systems and controls are allowing employees to abuse positions of responsibility undetected.

But we are seeing examples of fraud being deliberately perpetrated by firms' senior management, sometimes resulting in significant risk to consumers.

Our starting point is that for all firms, responsibility for managing financial crime risk rests with senior management and ultimately, where relevant, boards of directors. Firms should be looking at their processes and identifying any weaknesses that could be exploited for fraudulent gain.

There are a number of key questions that senior management need to be addressing:

Controls and checks are, however, only as good as the staff that are responsible for them. It isn't just about having an adequate number of staff to ensure an appropriate

segregation of duties, but also making sure that those members of staff have the necessary skills and experience for the job they are asked to do. This is particularly important in smaller firms where an ideal level of segregation may simply not be possible.

Organised gangs
We are also alert to the risk of coercion of employees by organised crime gangs, or indeed collusion between employees and external parties. Again, this is an area where good systems and controls have an important part to play in reducing risks.

We are not, however, only seeing instances of fraud by employees. Particularly disturbing is the number of cases of fraud at senior management or director level, where systems and controls are effectively bypassed altogether.

Motives appear to be wide ranging but have included: the maintenance of personal lifestyle; disguising insolvency by falsifying capital adequacy; funding other businesses; and seeking to maximise bonuses from incentive schemes by falsifying new business.

Over the past year we have seen an unacceptably high number of cases, primarily involving smaller brokers, as a result of which customers are directly being placed at risk. Brokers have been taking premium from customers and not placing the risk with an insurer, leaving customers to believe that their risks are underwritten when this is not the case.

Policyholders know only that they have paid a premium and often will not closely examine a cover note, which should identify the ultimate insurer. Or they will not worry if a period of time goes by without a policy document being provided.

In some cases, brokers have no intention of placing the risk with an insurer. In others, firms accept business and issue policy documentation under the names of insurance companies with which they have no binding agreement on the basis that they hope to enter into such an agreement on a retrospective basis.

Indeed, some insurers may well have felt coerced into agreeing to underwrite business, rather than risk having their reputations damaged in the event of claims arising and their names being associated with a failure to honour policies.

There is, nevertheless, still a significant risk to customers in the period between their believing their risk has been underwritten and the actual underwriting agreement coming into effect.

Some brokers quite clearly believe that the law of averages is on their side and that they can pocket premiums and keep their fingers crossed that any claims that arise will be small enough for them to pay out of their own pockets.

We have seen instances where policyholders have been paid minor claims with personal cheques from a broker's own private bank account rather than from a client account or an insurance company. When a large claim appears, however, such as the loss of a business premises through fire, the claim will almost certainly go unpaid as the broker will lack sufficient funds to pay, and may be unwilling to relinquish money acquired by fraudulent means.

In some cases the scale of this type of fraud has been considerable. One such case involved a broker specialising in holiday travel insurance. It underwrote tens of thousands of policies without placing any of them on cover. All such practices expose customers to risk. In most cases the amount of business conducted may be small, but for the individual claimant the impact can be disastrous.

Even in cases of fraud where consumers are not directly placed at risk, it is fair to say that ultimately the consumer picks up the tab for fraud in the form of increased charges for services.

It is vital that brokers and insurance providers help in the fight against financial crime. We know that many firms are aware of others with poor reputations and we understand that in the absence of hard evidence of a firm defrauding its customers, one firm may feel uncomfortable about reporting another to the authorities.

But whistleblowing is proving to be very effective in the identification of fraud within the sector. We do stress that we are not about to break down doors on the strength of a rumour that may simply result from bad feeling between two firms. We are aware that some reports received may be exaggerated and we therefore conduct our investigations accordingly.

Combating fraud in the general insurance industry requires an effective partnership and shared responsibility between the regulator and firms.

Firms need to recognise their responsibility to manage and mitigate the risks of fraud through effective systems and controls and through passing on information about fraud in other firms to the appropriate authorities.

At the same time, we will continue to alert the industry to the risks that we identify and to take firm action against those that use the general insurance sector for the purposes of committing fraud. IT

' Stephen Bland is retail intermediaries sector leader at the FSA