[co-author: Charis Chung]

FCA publishes its Final Report for Wholesale Insurance Broker Market Study

The FCA has published today its final Report in respect of its Market Study of the wholesale insurance broker market.

The Market Study was launched in November 2017 with a focus on evaluating the level of competition in the sector in light of how the sector is developing.  For discussion of the FCA’s Terms of Reference for the Market Study and further background, please see the previous blog post on this topic here.

Overview of the Report

The Report gives the level of competition in the sector an overall clean bill of health.  The Market Study has not generated evidence showing significant sector-wide competition concerns, and the FCA has accordingly concluded that intrusive regulatory intervention is not necessary.

The FCA did, however, identify some specific areas which it plans to address as a matter of its usual supervisory processes. These issues are discussed further below and include:

• certain restrictive conditions in contractual agreements between insurers and brokers; and
• inadequate management of conflicts of interest and inconsistent disclosure of broker remuneration to clients.

While the FCA noted that a number of stakeholders raised concerns about brokers requiring insurers to use them for facultative reinsurance of the same risks, the FCA concluded that there was no evidence of this currently occurring in any meaningful way in the market.

The Report also flagged for industry attention certain long term trends in the market and future changes to industry dynamics that could affect levels of competition for London market brokers going forward; in particular, growing competition from increasingly sophisticated local and international markets and the growing use of technology which could result in greater levels of disintermediation.

For a link to the Report, click here.

Highlights of the Report

A competitive market

In carrying out the Market Study, the FCA analysed a wide range of evidence to form a view of the competitive landscape of the market. The FCA concludes in the Report that the level of competition across the sector is, generally speaking, positive.

In particular, the FCA has found that large brokers are not able to exercise excessive market power.  While there are high concentration levels in niche markets relating to specific risk classes, concentration levels at an aggregate level remains acceptable.  The FCA’s review of brokers’ clients found that insurers are able to exercise effective demand-side pressure on brokers.

Additionally, there is no clear evidence of pay-to-play mechanisms in the sector, such as insurers being required to enter consultancy service agreements to obtain placement business or insurers having to enter placement facilities.  The FCA has also concluded that the presence of tacit coordination between brokers in the sector is unlikely, as evidence shows that coordination is likely to not be internally sustainable from the broker’s perspective.

The FCA will continue to monitor competition levels in the sector going forward.

Restrictive contractual clauses

The Report identifies certain examples of onerous conditions in contractual agreements between brokers and insurers that the FCA deems restrictive and which could have an adverse effect on competition.  These include:

• “Most-favoured-nation” clauses, which require insurers to cooperate with brokers to ensure that facility terms are market-leading, or restricting the insurer from offering better terms on the open market; and
• Client exclusivity clauses, which restricts insurers from providing quotes to other brokers for clients with which the broker has a facility set up, or to those clients directly.

These clauses only appeared in a small number of agreements reviewed by the FCA.  The FCA intends to follow up with the individual firms before considering whether any additional steps are necessary.

The upshot for brokers is to ensure that their agreements with underwriters do not contain clauses of these types.

Broker conflicts of interest and disclosure of remuneration

The Report noted that competition could be adversely affected if brokers failed to properly manage the types of incentives that are evident in the market to place business with certain insurers, for example due to higher remuneration received for placing risks via facilities or in-house managing general agents.

While the FCA recognised that such risks can be managed by brokers developing effective conflicts policies, the Market Study found that many brokers’ conflicts policies did not sufficiently identify a wide enough range of potential conflicts, articulated conflicts at an insufficiently granular level to be effective, or focused on personal conflicts rather than general firm-related conflicts.  Further, certain brokers’ conflicts policies did not include sufficient detail of internal procedures or controls for managing conflicts once discovered.

The FCA did not find evidence of significant market-wide issues but expressed a degree of concern that not all brokers were effectively managing conflicts of interest.  The FCA noted that a greater amount of work may be required from some brokers in order to meet the FCA’s conflicts management standards where brokers introduce new services or revenue streams.

Separately, the Market Study found inconsistent disclosure of broker remuneration across the sector.  The FCA did not state in the Report any requirement for firms to disclose remuneration, but explicitly reminded brokers of their obligation to communicate information to clients in a way that is clear, fair, and not misleading.

Choice of reinsurance broker by insurers

Some stakeholders had previously raised concerns to the FCA that brokers were requiring insurers to also use them for facultative reinsurance of the same risk.  The FCA did not find evidence of this occurring in the market, and recognised that there may be good reason for choosing the original broker to place facultative reinsurance, such as efficiency advantages and (in certain risk classes) a need for client confidentiality.

Still, the FCA explicitly states in the Report that harm may be caused if brokers “unduly promote their own reinsurance services” (paragraph 4.35 of the Report) and also noted other forms of unacceptable conflicts, such as where brokers might make the placement of business dependent on a guarantee of reinsurance brokerage for other risks.

The takeaway here is that while the FCA cannot find widespread evidence of these practices in the sector, it will take a negative view of any such practice that it does find in the future.

Changes to industry dynamics

The FCA dedicated one whole section of the Report to possible future changes in industry dynamics; a mixture of forewarning and commentary prompted by the evidence reviewed as part of the Market Study suggesting that the London insurance market is becoming less competitive globally.   This is due to other international and regional markets becoming increasingly more sophisticated, as well as other factors such as brokerage and infrastructure costs, the infrastructure costs associated with London’s subscription market, the need to pay for an extra party in the distribution chain (ie the London broker) and higher underwriting premiums in the London market.  The FCA predicts that London will face increasing competition from external markets for straightforward or less complex risks, which is likely to lead to a decrease in GWP and remuneration for affected brokers and to greater consolidation.  Larger, international brokers are likely to be less affected by this ongoing trend as they are less directly impacted by the dynamics of the London market.

Another factor that the FCA flags for industry attention is ongoing technological change and the resulting impact on revenue sources for brokers.  The FCA contends that the development of electronically-managed digital placing and underwriting solutions may decrease demand for insurance intermediaries and brokerage services in the market.  In the FCA’s view this may lead to brokers increasingly diversifying their revenue streams to include non-placement services such as consultancy-style services.

FCA next steps

Having not found any evidence of significant competition concerns in the sector, the FCA has decided to close the Market Study.  It will continue to work with the individual relevant firms identified in the Market Study and monitor changes in broker business models and competition across the sector.

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