Unrated insurers - the controversy rages

Frank Maher was taken aback when, while taking a detour from a summer holiday in Spain, he found the head office of the failed insurer Lemma Europe in Gibraltar.

Given that the building was called the Tower, the partner at Liverpool-based law firm Legal Risk had expected it to be one of the skyscrapers that dotted the British overseas territory’s skyline. Instead when he tracked down the address, he discovered the office on top of a pizza restaurant.

Lemma Europe was a subsidiary of Ukraine-based Lemma, which has had a particularly chequered history, capped by one of its directors reported to have been found murdered in the Ukraine. But the Gibraltar-based company is just one of a number of unrated insurers, often also thinly capitalised and based in similarly lightly-regulated jurisdictions, which have gone bust since the turn of the decade.

Gibraltar-based Lemma Europe had traded in the UK since 2008 until the Gibraltar reguator, the Financial Services Commission, removed its permissions in August 2012. Partners at Grant Thornton were appointed Lemma Europe’s liquidators.

At the turn of the decade, Irish insurer Quinn’s collapse into administration sent shockwaves through the industry. More recent failures include Enterprise and Gable, which both collapsed in 2016, resulting in an estimated £175m worth of claims to the Financial Services Compensation Scheme (FSCS).

The Financial Conduct Authority (FCA) announced last December, when carrying out its review of the FSCS levy, that it was considering charging brokers more if they have used insurers that do not have an insurer financial strength rating. It has said that it will be making a final decision this autumn on whether to press ahead with these proposals.

With the FCA limbering up to impose penalties on brokers which use unrated insurers, Insurance Times investigates whether the regulator is right to take this harsh line.

A dim view

Brokerbility chairman Ashwin Mistry takes a dim view of brokers that use unrated insurers, arguing that they run the risk of saddling the rest of the industry with compensation claims. “We take objection to brokers who take advantage of unrated markets at the expense of those who don’t.”

Charles Manchester, chief executive of Manchester Underwriting, agrees: “The vast majority of unrated insurers are competing with properly-rated insurers on the basis that they are not capitalised and are not rated, so are cheaper to run.

“The FCA doesn’t like authorised IFAs or brokers looking for trouble. They don’t want them in business any more than they want brokers selling unrated insurance to businesses.”

And Manchester wonders why brokers would take the risk of using an unrated insurer. “I can’t understand why smaller brokers in particular, who put their life into building their businesses, then risk it by placing long tail business with an unrated insurer.”

Sufficient capacity now

Mistry believes that there is little need to use unrated insurers now, because there is sufficient rated capacity in the market.

“The markets currently allow you to get a very good deal for your customers. Almost anything is insurable at the moment through recognised markets,” he says, arguing that the only reason for using an unrated insurer is to get a cheap deal.

Maher says this is the case in the solicitors’ professional indemnity market, which became a hotbed of unrated insurance in the wake of the financial crisis. Five years ago, around one in seven solicitors were covered by unrated insurers, according to a Law Society survey.

However, now, he says, unrated insurers have largely been driven out of the solicitors’ PI market partly because many mortgage lenders refuse to allow solicitors who take out such cover on to their panels.

“In the solicitors’ market, it’s not an option commercially. There are so many entrants into the PI market that nobody has trouble arranging cover at the moment.”

And the price differentials between rated and unrated insurers are now “marginal” compared to the period when the market was harder, when the gap was 20% to 30%, says Mistry: “The differences were great but they’re not so great now.”

He believes brokers should pay a penalty if they use unrated insurers, especially following the introduction of the Insurance Act last year.

“There has to be some penalty for short term advantage. Anybody trying to cut corners should be penalised accordingly,” says Mistry.

One option, he suggests, would be for brokers to pay a top-up fee to the FSCS in line with the share of the firm’s business that is channelled through unrated insurers. “If 16% of your business is unrated, the marginal fee should be increased in proportion,” he says.

Alternatively, he says, brokers that have placed business with unrated insurers should be called on to pay compensation before the FSCS if the carrier goes belly up.

However, Mike Hallam, head of technical services at Biba, points out that brokers are doing nothing wrong by using unrated insurers.

“There is no legal or other requirement for insurers to have a financial strength rating so there is no requirement for a broker to use an insurer with a rating.”

And, he argues, there could be sound reasons for using unrated insurers sometimes.

“In some markets or if you have an extremely chequered history, they may be the only option available.”

Litmus test

And while the recent spate of collapses has tarnished the reputation of such companies, he points out that the ranks of the unrated insurers contain some sound outfits.

“Just because they have not got a rating does not mean they are not a stable, good company,” he says. Amongst the unrated insurers listed on Biba’s Litmus Test tool, which helps brokers carry out due diligence on such companies, are motor specialist Sabre and Saga’s Gibraltar-based underwriting arm Acromas.

“Some are absolutely fine and may be in a better financial position than their rated colleagues,” says Hallam, adding the caveat that greater due diligence is needed when using unrated insurers.

For many smaller insurers, though, the sheer cost of being rated is a deterrent to getting involved in the process.

It’s not just the direct costs of being rated, which can work out at around £100,000, that insurers have to take into account.

“There is a lot of staffing time that goes into giving the information, which is ongoing because ratings are regularly reviewed,” says Hallam.

“It costs money to get a rating so if you can operate without it why would you pay for it,” says Manchester, who is also chairman of the Managing General Agents Association.

While he takes a generally dim view of unrated insurers, Manchester said it would be unfair to tar them all with the same brush: “One needs to be careful not to put them all in the same basket.”

It would mean less capacity in the market and less choice for customers, which at the end of the day isn’t in the best interest of the insurer, brokers or clients.

Biba, which has urged the FCA not to introduce penalties for brokers that use unrated insurers, said in its submission to the FSCS review consultation that the implementation of Solvency II should mitigate risk of defaults by forcing unrated insurers to demonstrate that they hold a sufficient capital.

Meanwhile Brexit could hinder UK brokers’ access to unrated insurers by potentially making it harder for insurers in light touch regulation territories, like Gibraltar, to passport their services into the UK market.

Manchester says: “If there are positives to come from Brexit this might be it. Once we are through any transition period, it will be back to the PRA to decide whether a company can trade here or not.”

But Mistry suspects that it may not be this easy to clear out the stables. “He who says money can’t buy you everything doesn’t know where to shop: irrespective of Brexit, people will find a way into the market.”