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            2018, the London Market's 'Year One'?

            The FCA has published its terms of reference (ToR) for a market study into the wholesale insurance broker market to assess how effectively competition is working in the wholesale insurance broker sector, as well as how brokers influence competition in the underwriting sector. This article was written for Thomson Reuters Accelus Regulatory Intelligence.

            Date: 04/12/2017

            "Year One" was the period beginning in September 1792 that the French revolutionaries deemed to be the start of an era of profound change. Drastic action was seen as necessary to change circumstances pertaining before "Year One".

            On November 8, 2017, the Financial Conduct Authority (FCA) published its terms of reference (ToR) for a market study into the wholesale insurance broker market to: "assess how effectively competition is working in the wholesale insurance broker sector, as well as how brokers influence competition in the underwriting sector".

            The ToR indicate that the wholesale insurance broker market could face profound change. In the coming months, Thomson Reuters Regulatory Intelligence will be publishing a series of articles looking at the circumstances — identifiable from media articles and other public material —the FCA is likely to encounter in conducting its market study, and which the FCA may or may not decide merit action and change in one form or another.

            There is a range of possibilities for the form such action may take:

            • One possibility is that the FCA will amend existing guidance to clarify or explain the application of current rules, thus "nudging" the market toward slight or gradual change.
            • At the other extreme, the FCA may find breaches of current rules or competition law, which could result in enforcement activity.

            The scope of the market study

            As the ToR explain, the study will in essence look at the "London Market" as a whole, being: "risk business, from overseas and the UK, placed by brokers with Lloyd's syndicates and insurance companies operating in … London … [for] cover purchased by large corporate clients … and … portfolios [of SME risks] pooled together and placed in blocks …".

             The study will focus on three main topics:

            • "Market power", i.e., brokers' "ability to raise the prices of their services beyond normal competitive levels", and "how easy it is for firms to enter the industry or expand their businesses, as the threat of new rival firms offering lower prices may constrain existing players from exercising the market power they might have".
            • "Conflicts of interest", in relation in particular to the selection of products and providers for insureds.
            • "Conduct" that may or may not facilitate competition among market participants so as to benefit insureds.

            The basis and potential effects of the market study

            The ToR say at several points that stakeholders have raised concerns , although it is unclear if these concerns were raised in the normal course of reporting or as part of whistle-blowing. This advance information means that the FCA is already able to focus on particular interactions between brokers and insurers. Concerns about the London Market's ecology highlighted by the ToR include:

            • the increasing number, size and significance of underwriting agent businesses known as managing general agents (MGAs), and the increased influence in the market they potentially afford to brokers through ownership and exclusive service arrangements;
            • the rise of "facilities" (i.e., contracts for the delegation of underwriting authority or decision-making to brokers or others) and "data services" that could make insurers into brokers' "captive buyers" of risk and information;
            • whether insurers are in effect being coerced by brokers into entering into arrangements with brokers or others;
            • whether insureds are seeing, and have the ability to see, the benefit of insurance placement, data and distribution methodologies that are more efficient for brokers' purposes; and
            • whether brokers are meeting any legal fiduciary, and separate regulatory, obligations to insureds.

            The FCA has stated its intention to take enforcement steps against entities engaged in anti-competitive practices. Ominously, it uses the term "tacit coordination", implying that the market may not be working effectively because brokers are acting in alignment rather than competing at arm's length. Such conduct could ultimately lead to civil, and even criminal cartel investigations. The ToR explicitly "remind brokers" that the "Principle 11 [obligation] to … disclose anything relating to the firm of which the regulator would reasonably expect notice … includes … a [potential] infringement of … competition law."

            Moreover, any failure on the part of an entity to act with integrity and/or treat its customers fairly will equate to conduct rule breaches which will result in enforcement action. Insurers as well as brokers could face liability if they are party to anti-competitive arrangements, or knowingly fail to protect insureds from the effects of brokers' breaches of legal or regulatory obligations.

            In this regard, the ToR refer to an investigation by Eliot Spitzer, the-then New York attorney general, in 2004. "This investigation had a global impact, and stopped some brokers from receiving contingent commissions [from underwriters] — where revenue depends on the volume or profitability of the business placed — [with those] underwriters."

            Court documents filed in connection with that investigation included the allegation that: "A cast of the world's largest insurance companies … paid hundreds of millions of dollars … to steer business their way … colluding … to rig bids and submit false quotes to unwitting clients …". The investigation resulted in a fine of more than $800 million, and in changes among the most senior management at insurers and brokers, in some cases as a result of criminal convictions.

            If the FCA were to proceed against individuals, it would not need to meet the criminal burden of proof, and could pursue enforcement by reference to the Approved Persons Regime (APR) for intermediaries' personnel and the Senior Insurance Managers Regime for insurers' personnel.

            Context and the way forward for the market study

            The timing of and context for the market study is potentially significant. In April 2017, the FCA announced an inquiry into the conduct of leading brokers in the aviation insurance market, being part of the London Market; last month that inquiry was taken over by the European Commission. 2018 is expected to see the replacement of the APR with the Senior Managers and Certification Regime (SMCR), and the implementation of the Insurance Distribution Directive (IDD).

            The IDD is formally due for implementation in February, although this may be delayed until the autumn. The IDD has potentially major ramifications for insurance brokers' business and remuneration models. The ToR addresses commissions and fees that brokers charge to insurers, including:

            • "where:
              •  risks are routed through [MGAs] or;
              • the broker has a greater level of involvement in the design and/or delivery of the insurance product.
            • [for insurers] to participate in … facilities;
            • [in relation to] the volume of business placed or its profitability;
            • other agreements – e.g., for:
              • a "strategic agreement" [between an insurer and a] broker …" or;
              • data analytics and associated consultancy services …".

            The ToR note the analysis from Lloyd's of London that between 2004 and 2016 the proportion of premium received by intermediaries in relation to the sale of insurance products increased from 18 percent to 22 percent. The FCA is considering the implications of this for customers; the Prudential Regulation Authority has been considering the implications for insurers.

            The FCA said it would soon start gathering data and other information from brokers, insurers and insureds, including via individual meetings and a roundtable event, and has asked for feedback on the ToR by January 19, 2018. An interim report is due next autumn, possibly coinciding with implementation of the IDD and the SMCR.

            This article was written for Thomson Reuters Accelus Regulatory Intelligence.

            Related people

            Howard Cartlidge

            • Head of EU Competition (London)

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