Thursday, 26 July 2012
IMD2 plans explained as broker remuneration returns to spotlight–Analysis
Michel Barnier, EC Commissioner for Internal Market and Services, placed the thorny question of broker remuneration right back on the Brussels political agenda last month as he announced details about the revised Insurance Mediation Directive (IMD2) that calls for greater transparency and mandatory disclosure.
Guy Soussan, Partner with Brussels law firm Steptoe & Johnson LLP
But it seems that the new rules will not include brokers that place so-called large risks and reinsurance, as had been feared by some in the corporate insurance and reinsurance market, according to a leading Brussels insurance lawyer.
Brokers of large corporate business and reinsurance may breathe a sigh of relief because they will not be covered by IMD2’s new rules on transparency and disclosure.
But there will be nothing to stop national governments still toughening up their broker reporting requirements and even banning payments from insurers altogether as in some Nordic countries.
This is a minimum harmonisation directive and so leaves room for manoeuvre at the national level.
Mr Barnier revealed the legislative package in early July stating that it is designed to raise standards in the intermediation of insurance products and includes mandatory disclosure of remuneration for non-life brokers.
The prospects for action in this area were clearly flagged upped during Mr Barnier’s headline speech at the Insurance Europe (formerly CEA) conference in June.
During this event the commissioner revealed that he would submit a text to parliament and the council that would represent ‘real progress’ in terms of transparency, including remuneration, responsible risk management and the removal of conflicts of interest.
The IMD text is expected to be finalised and published in late 2013 or early 2014, with implementation no later than two years after.
Currently, only agents and brokers are covered by the existing IMD. But, in a move welcomed by the European broking federation BIPAR and national broker associations such as BIBA in the UK, the new proposal will widen the scope of the revised IMD to all sellers of insurance products, including insurance companies that sell direct to consumers.
Other market players that sell insurance products on an ancillary basis such as car rental companies will be included in a ‘proportionate manner’ in the scope of the revised directive, explained the EC.
The commission also confirmed that the rules ‘more effectively’ address the risk of conflicts of interest. Rules that mandate the disclosure of remuneration by intermediaries will be introduced, it added.
Improved requirements will apply to life insurance products that contain investment elements. These will cover sales standards, conflicts of interest and a ban on commission for independent advice, said the commission.
There will also be ‘mutual recognition’ of professional knowledge and ability that will be proven by registration and proof of professional qualifications acquired in another member state.
‘Special’ information requirements will apply where suppliers bundle products together by informing the customer that it is not possible to buy the two products separately.
And, ‘effective, proportionate, and dissuasive’ administrative sanctions and measures by ‘competent authorities’ will be introduced to cover breaches.
The IMD revision proposes several improvements to deal with conflicts of interest between the seller of the insurance product and the potential client.
The EC stated that customers need to understand the status of the person who sells the insurance product and so the salesperson will therefore have to ‘clearly demonstrate’ the role in which he or she acts–agent, broker, direct writer and so on. This will be done chiefly by the presentation of a business card when selling the product.
The seller will also need to disclose the nature (fee, commission or salary) and the structure (financed directly by the client or an undertaking) of his or her remuneration and what the premium encompasses in terms of services such as claims handlings, advice, administration and the like.
The EC said that rules will also be introduced to more effectively ‘address the risk of conflicts of interest,’ including disclosure of remuneration by intermediaries.
This will be a mandatory disclosure regime which means that the intermediary needs to disclose their remuneration to the customer as opposed to an ‘on request’ regime by which the intermediary needs only to disclose the remuneration if a customer requests that they do so.
The commission proposes a five-year transitional period. It explained that a mandatory 'full disclosure' regime is envisaged for the sale of life insurance products and an 'on-request' regime for the sale of non-life products with a transitional period of five years.
“After the expiry of this transitional period, the full disclosure regime will automatically apply for the sale of non-life products as well. This timeframe is long enough to allow SMEs to prepare and adjust their practices to the legislative change and to measure the impact of the suggested change in practice, whilst it is sufficiently short to put a full system in place in the foreseeable future. There is also a process for review and evaluation by the commission of the directive after its entry comes into force. This review shall in particular consider the impact of these disclosure rules on non-life insurance intermediaries that are small and medium-sized undertakings,” stated the EC.
The broking associations that responded quickly to the news from Brussels were not impressed with the mandatory disclosure proposals for the non-life market, even if there is a five-year transitional period.
BIPAR said that it welcomes the extension of the proposed revised directive to direct insurers and other operators and its intention to clarify rules regarding cross-border services.
It added, however, that it has serious concerns about the lack of level playing field of the proposed directive and about the proportionality of some measures imposed upon insurance intermediaries, which it said will be ‘injurious’ to consumers’ interests.
The federation said that, together with its national member associations, it will, in the coming months, continue to ‘actively promote’ its detailed views during the final stages towards the definitive adoption of the directive by the EU co-legislators, the European parliament and the Council of Ministers.
BIPAR said that it believes that ‘under the condition of a level playing field’ insurance intermediaries should inform insurance customers about the nature of their remuneration or compensation. They should also, upon request from their customers, disclose their remuneration related to the contract.
“We believe that such a system would ensure that there is a fair opportunity for dialogue between the client and the intermediary about price, quality, services and solutions and, at the same time, it would offer an adequate level of transparency without creating too much administrative burden for operators”, said Nic De Maesschalck, the director of BIPAR.
BIBA, the UK brokers’ association, said that it is pleased that the commission has ‘taken on board’ two of the main points made by itself and BIPAR during the development process of the directive.
The London-based association said that it had made ‘strong representations’ to the commission that the scope of the directive should remain wide and said that it is therefore pleased to see that both price comparison websites and travel agents are specifically listed within the scope of the new directive.
BIBA also said that it had made representations that both the disclosure and professional requirements articles should apply to all firms within the scope of the directive and is also therefore pleased that the commission reflected this within the new text.
However, BIBA said that it is ‘very disappointed’ that the commission had ‘ignored’ the views of EIOPA, HM Treasury, the Financial Services Authority and ‘all the leading insurance broking representative bodies in Europe’ by imposing a five year timetable to mandate the disclosure of commission in the general insurance sector.
BIBA also said that it is ‘extremely concerned’ that the commission has not fully reflected the level playing field that is needed to make sure insurers are equivalent on remuneration disclosure. “BIBA will be working with members to propose an alternative wording on this issue,” it said.
Steve White, BIBA Head of Compliance and Training, said: “We are pleased that the majority of points that we have made to the commission have been taken on board in this text, but we still have major concerns in some areas. Our primary concern is around mandatory disclosure and where it is imperative from a European perspective that a level playing field is established with insurers when selling direct.”
Eric Galbraith, BIBA Chief Executive, added: “BIBA, alongside BIPAR, will in the coming months, continue to actively promote its detailed views during the final stages towards the definitive adoption of the directive by the EU co-legislators, the European parliament and the Council of Ministers.”
The EC’s initial statement suggested that all brokers and sectors would be covered and that the so-called sophisticated large risks sector would not somehow escape the new rules as most in the market had hoped it would.
The EC said that it had introduced the package because the financial crisis had become a ‘crisis of consumer confidence’, thus confirming the assumption that this package is really aimed at the personal consumer and investment end of the market and not the business insurance and reinsurance sectors.
But some in these sectors feared that the EC’s determination to protect consumers would mean that they would be dragged into the new regime, despite the fact that the large risk and reinsurance markets were excluded from the original IMD.
There was little within the latest package announced by the commission in early July to dispel these fears.
But Guy Soussan, partner in the Brussels office of Steptoe and an expert in the field, told Commercial Risk Europe that the large risk and reinsurance sector will still be exempt from the IMD rules after all.
The lawyer pointed out that to work out how this exemption has been continued and what it actually means it is worth stepping back a little to the root of the whole question.
The broker remuneration question really arrived in Europe following the dramatic campaign against contingent commissions carried out by former New York Attorney General Eliot Spitzer in the early years of last decade.
The matter first surfaced in a serious way in Europe through the EC’s Business insurance sector inquiry carried out in 2007.
In its report that concluded the inquiry, the commission indicated it would either agree to self-regulation or reform through IMD2.
“The commission believes that this issue, although potentially leading to serious concerns of market distortion, has multiple dimensions which require careful consideration. It intends to look at the issue in the framework of the planned review of the Insurance Mediation Directive, without, however, at this stage prejudging whether this is the most appropriate way to address it,” stated the commission at the time.
Specifically on the topic of insurance brokerage, the commission said that it intended to ‘look at these issues anew’ in the framework of the review. But it also invited member states and industry participants to review the commission's findings and propose action themselves.
Despite its reluctance to force the matter the commission’s report did point to the need for greater transparency on broker remuneration in several parts of the report.
For example it stated: “Insurers' profitability varies significantly across the EU-25 according to whether customers are SMEs or large corporations. In a few cases, certain member states seem to consistently display higher underwriting profitability in the SME segment. It has been suggested that this might, in some instances, be related to the mode of remuneration of intermediaries by insurers, the suggestion being that when brokers have market power, insurers may bid up broker commissions in order to capture business. However, this would need to be verified on a case-by-case basis.”
“Brokers act both as an adviser to their clients and as a distribution channel for the insurer, often with underwriting powers and binding authorities. This dual role is a potential source of conflict of interest between the objectivity of the advice they provide to their clients and their own commercial considerations. Such conflicts of interest can also arise from a number of sources linked to their remuneration, including contingent commissions,” added the report.
The commission said that market surveys and its public consultation had highlighted the fact that current market practices–in particular the ‘lack of spontaneous disclosure of remuneration received from insurers and other possible conflicts of interest’–created an environment in which business insurance clients, in many cases, were unable to make ‘fully informed’ choices.
It continued that practices aimed at ‘inciting’ brokers to place business with particular insurers have the potential to undermine fair competition in the insurance market around terms and conditions of cover, service and insurers' financial strength.
“Such practices might, instead, result in insurers' competing against each other on the level of remuneration afforded to brokers in an attempt to ‘buy’ distribution, or at the very least influence the broker's choice,” suggested the commission.
It therefore concluded that disclosure of relevant information by intermediaries, about the payments received from, and services provided to, insurers, may help mitigate conflicts of interest.
The commission added that, even where disclosure takes place, it did not always appear to be ‘complete, clear and understandable’ to the client.
“In the light of similar situations that arise in other financial sectors, notably in securities and banking, it is questionable, however, if disclosure alone is sufficient to mitigate conflicts of interest, in particular in relation to those types of remuneration that specifically aim at aligning the interest of brokers with that of insurers,” it stated.
The commission continued that the existing competitive market dynamics related to the price of mediation services appeared to be ‘limited, at best,’ as far as SME clients were concerned.
“The seemingly low concern of SME clients with the price of insurance mediation services may perhaps be due to a common misconception as to the amount of commission (and possibly other types of remuneration) actually paid to the intermediary included in their insurance premium, which is typically higher than is realised,” it concluded.
Mr Soussan pointed out that the industry was not ‘complacent’ in its response to the commission’s report.
Peter den Dekker announced when he took charge of the Federation of European Risk Management Associations at its Prague Forum, that he would make it a priority to come to a market agreement with BIPAR to obviate the need for unnecessary and badly aimed new rules.
Eventually a Protocol was signed in November 2010.
Its principles were summarised by Mr Soussan as:
- Intermediaries should identify, manage and mitigate any potential conflict of interest in an appropriate and transparent manner. They should provide clear and fair information on the nature of their services and the capacity in which they operate, including any underwriting powers and delegated authorities they may hold from insurers, so that business clients can make informed decisions on the purchase of insurance products;
- Intermediaries should voluntarily inform their clients about the nature of the remuneration directly related to the placing and servicing of the insurance contract, for example whether they are paid a fee or receive commission;
- They should disclose the amount of this direct remuneration on request from the client; and,
- Also on request from the client, intermediaries should give generic information about other types of payments they may receive from insurers if the business insurance contract of the client is part of the calculation of these payments.
Mr Soussan reminded CRE that Article 12 in the current directive explicitly exempts brokers from disclosure in the case of large risks and reinsurance.
It states: “The information referred to in paragraphs 1, 2 and 3 need not be given when the insurance intermediary mediates in the insurance of large risks, nor in the case of mediation by reinsurance intermediaries.”
The lawyer explained that, as part of its preparations for IMD2, the commission requested advice from CEIOPS (the European supervisory body now called EIOPA) and this advice was published in November 2010.
Recommendation 27 stated: “The majority of members agree that, in this context, the disclosure of information need not be given either when the insurance intermediary mediates in the insurance of large risks or in the case of intermediation by reinsurance intermediaries.”
Mr Soussan explained that CEIOPS’ rationale was that member states had neither implemented any such requirements in national law, nor reported any practical difficulties.
“At the commission’s public hearing in December 2010, stakeholders were invited to comment on whether to adjust or clarify the regime for large risks. BIPAR noted its above-mentioned protocol and stated there was no reason to change the status quo,” said Mr Soussan.
Furthermore, the proposal for IMD2 retains the exemption for large risks, said the lawyer.
He explained that the application of the exemption means that a number of risks, as defined in relation to their nature and/or the size of the policyholder, will not be subject to minimum disclosure requirements, other than those which the member states may impose at national level.
Mr Soussan added that the definition of large risks has not changed. It is still defined with reference to Article 5(d) of Directive 88/357/EEC and its thresholds have never been updated.
The lawyer pointed out that the proposed directive also introduces a professional customer category of policyholder that is exempt from mandatory disclosure.
The professional customer is defined in the Annex as: “A customer who possesses the experience, knowledge and expertise to make his own decisions and properly assess the risks that he incurs.”
The Annex also provides a list of persons that will be regarded as professionals in all insurance services and activities and insurance products for the purposes of the Directive. They include entities that are authorised to operate in the financial markets such as credit institutions, national and regional governments and other institutional investors.
Mr Soussan added that the directive also introduces a final category, based on the 2004 Markets in Financial Instruments Directive (MiFID), which it defined as ‘large undertakings’ that meet two of the following size requirements on a company basis:
- Balance sheet total of €20m;
- Net turnover of €40m; and,
- Own funds of €2m.
There are two caveats to the above exemption.
First, that professional customers may request a higher level of protection by written agreement.
The IMD2 annex states that the circumstances in which such an agreement may apply would be ‘when it deems it is unable to properly assess or manage the risks involved’.
“At first sight, this wording suggests that a professional customer can elect to be treated as a consumer in relation to the information on the risk to be insured. This election for consumer status does not appear to extend to any right to disclosure of remuneration,” said Mr Soussan.
Second, member states may also adopt stricter requirements, within the limits of EU law and provided that this is notified to EIOPA and the commission.
Mr Soussan pointed out that the European Commission’s impact assessment on IMD2 also stated: “Which buyers of insurance fall outside the scope of IMD1? Business clients have been excluded from the specific protection rules designed for consumers in all financial services legislation (including MiFID), except in insurance. In insurance, size criteria are used, and in the case of ‘large risks’, ie. risks above a certain threshold (normally business risks), insurance intermediaries do not need to apply the information requirements.”
The impact assessment continued: “Some respondents to the public consultation, notably the consumer organisations, state that the disclosure requirements for IMD2 should be aligned with the approach in other areas of financial services. Most stakeholders therefore argued that the scope of IMD1 should be any natural person plus SMEs, but professional clients should be excluded. The vast majority of stakeholders also believe that the current exemption for insurance intermediaries from requirements to provide information in the ‘large risks’ area (eg. a person who buys insurance cover for his private airplane) is useful and should be maintained.”
So what does all this really mean for the business insurance and reinsurance market in Europe and brokers in particular?
Mr Soussan pointed out that, with the introduction of the professional customer category, a potentially larger group of policyholders will not receive automatic information disclosure requirements.
But he added that, as ever it seems with commission rules, there is still a degree of ambiguity. “There is currently a lack of clarity over how the two exemptions will interact with one another. The commission may provide further clarification, on its own initiative, or on request from the other EU institutions. Both are based on similar criteria: the same turnover and balance sheet, but the thresholds are different. The Annex specifies that ‘professional customer’ is a wider definition as it applies to ‘all insurance services, activities and insurance products’.
“It is not clear whether the exemptions cover a set of policyholders that genuinely do not require disclosure. We have noted that a significant proportion of the exempted policyholders will be SMEs. We note that the commission is going to review the SME definition this year but both the IMD2 and the MiFID seem to contradict a general EU policy principle to treat SMEs similarly to individual, retail consumers,” explained Mr Soussan.
“In the absence of EU standards for large risks and professional customers, some member states may well continue to fully exempt them, whereas other member states (such as France) could decide to maintain their existing national disclosure requirements. Yet other member states may introduce certain disclosure requirements, which may be provided either to all customers or at least upon request. IMD2, like its predecessor, will then remain a minimum harmonisation directive for the corporate insurance market,” he concluded.
So it’s all neatly clarified but open to change at any moment then.