UAE. It doesn't make sense." This was what Lloyd's CEO, Richard Ward, had to say last year on the topic of how, in the UK, brokers are generally remunerated by underwriters rather than their clients.
Ward's comments sparked some debate in the industry on best practice for broker remuneration. In this article we explore recent developments in both the UK and UAE surrounding remuneration issues and broking practices.
New Lloyd's bulletin on broker remuneration
On 1 March 2012, Lloyd's Market Bulletin Y4567 in respect of distribution costs, broker remuneration and additional charges came into effect, aimed at Lloyd's Managing Agents and affecting the brokers with whom they deal.
Interestingly, despite Ward's comments on broker remuneration practices, the bulletin stresses that "Lloyd's does not seek to interfere with the agreement of commercial arrangements in the market…", but acknowledges that as remuneration arrangements are constantly evolving, then so too must the methods to reduce the associated legal and regulatory risks.
This bulletin is aimed at ensuring that high standards are maintained when it comes to broker remuneration arrangements, particularly in light of the UK Bribery Act 2010, which came into force on 1 July 2011.
According to the bulletin, there is a concern that additional payments by insurers (for example, contingent commissions) might be seen as inducing or influencing the broker to place business with the insurer contrary to the broker's client's best interests, or which might otherwise cause improper performance by the broker of its duties.
Such concerns are elevated where the additional payments are calculated by reference to the amount of business underwritten by the insurer or the profitability of the business.
Consequently, Lloyd's now expects Managing Agents to consider a series of questions in order to determine whether an additional payment should be approved, or whether the commercial motivation behind the additional payment is not appropriate in the circumstances. The bulletin also stresses the need for full records to be kept by Managing Agents, and also outlines the reporting requirements where additional payments are approved.
Although Lloyd's-centric, the new guidance will, no doubt, be of interest to brokers operating in the local market, particularly given the UK Bribery Act connotations and the lead taken by Lloyd's in driving international best practice.
Changes to premium collection regime in the UAE
In the past 18 months, the UAE insurance market has been the victim of a number of scandals, the most high profile of which concerned a brokerage firm in Dubai being found to have used premiums collected from its clients as working capital of the business (and even for investment in property) rather than keeping it in a segregated client account.
This left a number of Insurers without payment and important consequences for the insured customers whose premiums had not been passed on.
The UAE Insurance Authority's initial response was to issue a Circular in April 2011, requiring premiums collected by brokers to be deposited in a separate account to the one used for their day-to-day working capital needs. For many brokers in the UAE, particularly those set up in accordance with international best practice, this requirement was nothing new and was already in place.
However, for some it presented more of a challenge. Historically, premiums collected in the UAE were often used for the brokers' own short-term working capital requirements, with arrangements in place whereby the broker would make payments to Insurers at the end of a specified period.
The Insurance Authority continued its reforms with the issuance of Circular No. 3 of 2012. This Circular requires that, from 1 March 2012 onwards, cheques issued by the Insured customer for the payment of insurance premiums must be issued directly in the name of the Insurer.
However, Insurers often do not have the systems in place to process broker commissions in a timely manner upon receiving these payments, resulting in delays in brokers receiving their remuneration. This also causes problems where premiums are paid in instalments rather than one up front lump sum.
This sudden change to existing practice caused some consternation within the local market, resulting in the broking community approaching the Insurance Authority to ask them to reconsider their position. We shall have to wait and see whether the Insurance Authority bows to pressure, or whether it stands firm on this issue.
Other areas for reform
There are a number of areas which will require greater scrutiny by regulators in the UAE in due course, including the practice of "grossing up" of premiums. Grossing up occurs where the Insurer obtains reinsurance terms from Reinsurers, but passes on a significant increase in price (even on a proportional placement) to the customer.
It is not unknown for premiums to be grossed up by as much as 80% or more in some cases. Such practices are typically not transparent and do not serve the customer's best interests.
The future for broker remuneration
It is arguable that the controversy surrounding existing broker remuneration practices could largely be avoided by moving to a fee-based structure whereby brokers are paid for services provided to their clients, rather than underwriters accounting for acquisition costs. This is in line with most other professional services providers who charge their clients for time spent on a particular matter, according to set hourly (or fixed) rates.
The FSA in the UK has signalled its intention to require the financial adviser community to move towards fee-based remuneration and it is seemingly a matter of time before it turns its attention to the broking community to require similar changes.
Moving away from the commission-based approach (which lacks transparency and can lead to conflicts of interest) to a time-spent basis should ensure that brokers are properly remunerated for the value that they add. At present there is a danger that brokers either charge too little, resulting in a request for extra fees to cover the shortfall (e.g. when providing a claims service), or take a hit in the hope of obtaining commissions on future placements. Such an approach may give clients a distorted view of the value that brokers provide, since underwriters are left to pick up the tab.
Whether there is an appetite for such a shift is another matter, particularly so in the UAE, where the Insurance Authority has to date focussed more on the handling of premiums, rather than tackling underlying issues such as broker remuneration practices and grossing up. We understand that a new law for brokers is in the pipeline and so it remains to be seen what regulatory requirements this will introduce.
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Disclaimer: The views set out in this article do not constitute legal advice and readers are urged to seek specific legal advice in relation to any particular issues which arise from the subject-matter of the article.
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