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Insurers seeking greater control of their distribution channels are buying up brokers at an increasing rate. This raises the possibility for conflicts of interest. Breaches of duties by brokers to insured clients and Financial Services authority (FSA) interventions have risen proportionately. In Lloyd’s of London there are proposals to reform the divestment rules. This will allow Lloyd's brokers to present risks to Lloyd's underwriting agents under common ownership again raising questions about potential conflicts of interest.
The issue is clearly on the FSA’s radar. On 20 March the regulator published its latest consultation paper on transparency, disclosure and conflicts of interest.
Put simply, the danger is that brokers will lose independence if they are owned by insurers or consolidators with strong links to limited insurers, since the brokers will find themselves under pressure to promote the products of their owners. This has ramifications for the insured client, which may no longer feel assured that its broker is working on its behalf to obtain the best products at the best prices.
Clients are not completely without protection in these situations. It is a recognised principle of English insurance law that a broker owes its duty to the insured and not to the insurer. This is in spite of the fact that it is usually the insurer who pays the broker's commission a practice that the English courts have accepted. If a conflict arises, the brokers must put the interests of the insured first.
Second, the broker is bound by its common law fiduciary duties, including the duty not to make a secret profit. This means it can accept a brokerage in the ordinary course (as this is one that the client would expect it to receive), but it may not otherwise act for its own benefit. In real terms, a failure by a broker to disclose any secret fee or commission can amount to a breach of the broker’s contract of agency as well as a breach of its fiduciary duties, with a right for the client to claim any secret profit made.
Third, the practice of paying undisclosed commission to brokers by insurers has come under scrutiny. In 2004 former New York Attorney General Eliot Spitzer caused a storm when he alleged that the practice led to conflicts of interest that were neither adequately managed nor disclosed to the broker’s principals. Following investigations, a number of brokers refused to enter into such arrangements. Where brokers receive remuneration from insurers in excess of the normal brokerage they receive as the agents of the clients they will need to consider whether they are under an obligation to disclose and seek their clients’ consent to such remuneration.
Where a broker is allegedly in breach of a duty owed to its client (whether contractually or tortiously), and where the loss flowing from this breach and suffered by the client is foreseeable and not too remote, a claim for damages to compensate the client can be made, provided that the preconditions of the contractual or tortious cause of action can be satisfied and that the allegations can be proved.
FSA Principle 6 requires a broker to “pay due regard to the interests of its customers and treat them fairly”, which extends to an obligation to act reasonably and impartially towards customers and with competence and diligence to provide skilful advice and service. The FSA imposes rules in relation to fee disclosure, unfair inducements and conflicts of interest. Also, the FSA extends its rules to the scope of services provided by brokers impacting on the activities of consolidators, since it forces the broker either to advise the client of the market analysis it has undertaken, or for the client to request details of its relationship with its insurer owner.
The FSA's new discussion paper for the commercial insurance market sets out its belief in this area: namely that the broker should disclose remuneration to clients, that it must be clear what service it is providing to the client and on whose behalf that it is acting.
The FSA is also considering new proposals with regard to the transparency of information, both as to its clarity and general availability. Its aim is to ensure a more competitive and efficient market, where there is greater disclosure of remuneration, no conflict of interest and full transparency of process.
We can also expect a greater role going forward for the European Commission and the UK Competition Authority. The EU has already issued one report this year on the London subscription market. With insurers and others tying up supply chains, the potential for distorting the market could give rise to further investigations.
How these market forces will balance out is unclear at present, but it is clear that, if the customer is not treated fairly, then it does have remedies against the broker and it is certain that the FSA and the competition authorities will be watching.
David Coupe is a partner and Rowena Grundy is an assistant solicitor in corporate insurance at Clyde & Co