Fees or Commission? The debate rages on

Flushed with success after regulating our bananas, the EU turned its hand to insurance distribution. From 1st October 2018 the EU Insurance Directive (IDD) was implemented in the UK by the snappily entitled Insurance Distribution (Regulated Activities and Miscellaneous Amendments) Order 2018.

The regulations remain in force despite Brexit. On Brexit day a technical update substituting the FCA (Financial Conduct Authority) sourcebook and rules was implemented by a short statutory instrument.

The intention of the regulations was to create a level playing field and fair competition amongst insurance intermediaries. The FCA also intended that insurance buyers should have better protection and better product information to give them greater confidence that the policies they bought properly met their needs.

Insurance buyers need to be clear what sort of intermediary they’re dealing with. “Know thine enemy” wrote Sun Tzu (no connection with Sun Alliance). Most insurance brokers are required to act in the best interests of their buying client. However, tied agents and aggregators act for the insurers whose products they offer. They owe no duty to the buyer.

Solicitors and accountants are often tied agents. They almost certainly won’t have access to a range of policies from a range of insurers, so that the chances of their cover being the best for your needs are reduced. They rely on the convenience of “one stop shopping” for their insurance business, in the same way that car showrooms push their own finance connection to car buyers. Solicitors and accountants are regulated by their own designated professional bodies.

The following deals only with broker intermediaries. It doesn’t cover life assurance, critical illness policies, pensions or other “protection” products, to which separate rules apply.

A rose by any other name would smell as sweet, and the same applies to broker remuneration. Fees and commissions achieve the same end of remunerating brokers for their expertise and work.

Brokers owe a duty of disclosure to their clients, as regards the nature and basis of remuneration received. The “nature” is the type of remuneration – commission, sales bonus or other incentives. The “basis” is essentially the source of the remuneration. Normally in insurance, the source will be the insurer, but it may be some other link in the distribution chain. As already mentioned, brokers act for the buying client, but standard practice is that the receiving insurer pays the broker’s commission out of the premium.

In addition to straightforward policy-linked commission, it is common for insurers to offer additional incentives, such as sales targets, or service agreements. These are called contingent commissions. Brokers may offer insurers additional remunerable services, such as consultancy or data analysis.

The FCA considered whether to make disclosure of the amount of remuneration compulsory, but, after consultation, decided instead to keep that aspect under review. Given the duty of care owed by brokers to clients, the work of investigating the client’s needs may be time-consuming and complex. The insurance requirements of a man-and-a-van are not the same as a business with staff, premises, stock and products.

For this reason brokers now commonly charge a fee for administration. For a small business, the fee may be an agreed flat sum, but in the realms or SMEs (small and medium enterprises) and larger, some form of menu pricing is more likely. Separate fees for policy set-up, amendments, renewals and reviews tailor the cost to the administration involved for the broker.

The fees, or the basis of calculating them, must be disclosed to and agreed with the client before the completion of the initial policy. The IDD requires that disclosure of the required information is made on paper or in a “durable medium”. The FCA handbook defines “durable medium” as “any instrument which enables the recipient to store information addressed personally to the recipient in a way accessible for future reference”, and includes email, or websites meeting certain requirements.

The client’s informed consent to receiving the information in this way must be obtained. If the client requests it, information provided in a durable medium must also be provided on paper, free of charge. Whilst the IDD and the FCA handbook don’t require the amount of remuneration to be disclosed, under the long-standing fiduciary duty owed by an agent to a principal the amount should be disclosed if requested.

The FCA handbook contains a set of principles, key of which is to act with integrity. Conflicts of interest may not always be avoidable, but if they arise, the principles require treating the customer fairly. A frequent conflict of interest is the tension between incentives on offer to the broker from the insurer and the broker’s duty to act in good faith and in the client’s best interests. Often full disclosure will resolve the conflict.

There are pros and cons for both a fee-based and commission-based remuneration structure in principle. However, it should be obvious by now that fees v commission isn’t a straight choice. In most cases, there probably won’t be a choice and the reality available is a hybrid model.

Brokers earn commission on policies they sell, but in a commercial context (as opposed to domestic policies) the commission is unlikely to fully remunerate them for the work involved in selling and administering the policy. Commission-only deals are likely to be rare. For commercial enterprises, the broker will expect a fee from the client in addition to the insurer’s commission.

If the fees v commission debate rages on, it’s likely only the Fast Show Self-Righteous Brothers down the pub.

What would Shakespeare have made of a shady intermediary demanding an unreasonable fee for default? It’s a shame he didn’t have experience of insurance. His most famous stage direction could have been “Exit, pursued by a broker.”