How disclosure could shape the market

It’s summer, but rain clouds continue to dominate commercial lines profitability with downturn-driven expense rises, deteriorating loss levels and slow market growth. Insurer announcements suggest they are taking steps to better understand commission payments and the reciprocal business flows. The FSA is also focused on commission with recent reports suggesting it favours a move away from the current voluntary disclosure on request to one more akin to mandatory commission and broker status disclosure.

So why is the current focus on disclosure and status?

In recent years we have seen a marked income shift across the market from the insurers to the brokers. This has been driven by insurer panel consolidation or rationalisation, work transfer from insurers to brokers, higher commission levels and the emergence of the consolidators (integrated or networked) as a driving force for change in the industry. Broker remuneration is no longer clear or transparent.

The shift in profit has also been accompanied by a blurring of the old distinction between broker, insurer and reinsurer with each party potentially performing up to two or more roles for different segments of the market. The blurring has led to the creation of both real – and perceived – conflicts of interest for insurers and brokers which may be dealing with each other.

Consolidation, the use of managing general agents, delegated underwriting and the practice of preferred insurer panels have raised questions over the extent to which a broker is accessing the whole of market, or is in reality trading with a selection of pre-approved insurer ties. Whether such developments are in the customer interest is not for debate; regulator attention has focused on whether the client is aware of any preferred relationships the intermediary has and whether this impacts the status of the broker (tied, multi-tied or independent).

The combination of profit redistribution, consolidation and the emergence of a tied agency model has created regulator concern over whether customers are being potentially disadvantaged. The view is probably reinforced by some within the industry who feel commission disclosure will slow the rate of industry consolidation (despite the fact the credit crunch has done a far better job!) and help restore commercial lines profitability.

Will commission disclosure change anything? And will providing the customer with lots more information on intermediary commission and the status of the individual providing the information actually change anything? Well, it’s worth remembering that the UK insurance industry has been here before with the various changes brought about in the life industry in the 1990s.

Experience from the life industry, which in fairness is more focused on the end consumer than SME or corporate, suggests that commission disclosure at an individual product level did not necessarily change consumer behaviour in terms of channel choice.

You can debate whether this reflects the indifference of the consumer to commission disclosure per se or is a more accurate reflection of how effective the disclosure process by the adviser at point of sale through the key features and illustrations documentation.

The regulator’s view in support of the latter is substantiated by the changes proposed under the current Retail Distribution Review (RDR), which has introduced a further consultation called Customer Agreed Remuneration (CAR), to ensure clarify and transparency around who is paying what remuneration to whom.

Overall, looking at the life industry, you would be hard pushed to find definitive evidence that commission disclosure and related legislation significantly improved industry transparency, removed product or manufacture bias or promoted a more efficient market place. Treating Customers Fairly (TCF) was introduced to further protect consumer interests alongside greater information disclosure. Clearly, how you implement commission disclosure within the commercial lines market will be vitally important.

So what are the ‘get rights’ for commercial lines?

First, make it relevant to the customer. Having worked extensively with commercial insurance customers within the SME, mid corporate and large corporate segments, experience suggests a level of customer indifference around the different components of price. With regards to the broker, much depends on the nature of the relationship between client and advisor – the nature and manner of disclosed information must be carefully considered.

Second, recent years have seen a number of UK and EU regulatory changes impacting the insurance industry. It is important that any new commission disclosure regulation is consistent with the existing regulatory and fiscal framework. This may be stating the obvious but the impact of the recent CGT changes on the embattled IFA sector highlighted the importance of taking a holistic view.

Third, product specific commission is only one source of intermediary remuneration. All forms of commission and profit share need to be disclosed to ensure a level playing field. Broker remuneration in general insurance is more complex than headline product commission and could require more interpretation and disclosure than was experienced in the life market.

Finally, brokers perform a number of different roles on behalf of clients, for example, broking and claims support, and for the insurer – prospecting, administration and underwriting. Disclosure may lead to formalising these different roles and responsibilities and open up debate as to whether an administration fee should be charged for some services. Such a move will have implications for insurance premium tax and the application of other indirect taxes. There may well be knock on implications for current agency law.

It looks like we can expect some change in how broker commission and status is disclosed. At a personal level, I’m not sure what tangible shift or change in customer behaviour will actually take place as a result of this.

However, the UK commercial insurance industry has been operating a form of multi-tied distribution for many years and the alignment of the regulatory framework to this reality is probably no bad thing. In addition, we are in very difficult trading conditions and few businesses can easily absorb additional trading costs.

The timing and the nature of the implementation across the market will be important but it would be ironic if the new regulation triggers a further wave of broker consolidation just as the last one slows down. IT

Andy Baldwin is managing partner for accounts, industries and business development at Ernst & Young EMEIA Financial Services.