It is more than three months since the Financial Conduct Authority (FCA) published its terms of reference ("Terms") for a market study into the wholesale insurance broker market – in effect, the London Market.
An earlier article addressed the market study's likely focus on brokers' conduct rather than competition law issues, and raised the issue of whether a competition law solution might achieve little more than protection for market participants that are "inefficient" from a competition law perspective.
This article, however, explores how recent regulatory publications highlight the market study's line of enquiry that:
- certain practices that engender competitive efficiency in the insurance market might equate to breaches of conduct rules; and
- such breaches work to the disadvantage of insureds; so
- from the perspective established by the FCA's particular statutory duties, the structure of competition within the London Market is inefficient and requires corrective measures.
These points were addressed in paragraph 4.29 of the Terms, which said: "We emphasise that the purpose of this market study is not primarily to investigate infringements of competition law … Instead, we intend to look at whether lawful activity is nonetheless harming the competitive process (and we may intervene to address this)."
Recent regulatory communications raise the question of whether certain features of the London Market – in particular,
- "facilities" (i.e. contracts for the delegation of underwriting authority or decision-making to brokers or others),
- "data services", and
- the role of managing general agents (MGAs) –
are, or will continue to be, fully within the confines of "lawful activity".
It seems that what is exercising the mind of the FCA and the Prudential Regulation Authority (PRA) is the rights or interests of insureds as the customers that ultimately sustain the UK insurance market. This was emphasised in a February 2018 speech by Sam Woods, chief executive officer of the PRA and deputy governor for prudential regulation at the Bank of England, entitled: "Looking out for the policyholder".
As is often the case with PRA speeches on the insurance market, Woods reminded his audience of the justification of the historical expansion of prudential regulation, by referring to "… high-profile [general insurer] failures in the 1960s and 1970s … and … a couple of decades later … in the Lloyd's Market …" and the view that these failures "result[ed] in part from poor regulation …".
Woods developed the last point further, implicitly emphasising that insurance business is not only about market professionals (e.g. insurers and brokers), but also about insureds: "Without minimum [prudential] standards, policyholders would be much more exposed to the risks presented by imprudently run firms … less scrupulous firms [would] drive out better-managed firms by engaging in unsustainable pricing practices in order to gain a greater market share. This perversion of competition could lead to the failure of insurers to pay out claims and reputational damage to the wider UK insurance market."
In effect, the PRA is propounding a version of Gresham's law: unsustainable (i.e. bad) insurers drive out sustainable (i.e. good) insurers. Woods' speech also refers, however, to the idea or perception of power imbalances across the insurance market that are the subject of the FCA's study, suggesting that, "measures designed primarily to make one part of the market more competitive than another, through measures that favour one group of firms over another, will reduce innovation and productivity and be damaging in the long run".
That point chimes with the statement at paragraph 4.20 of the Terms that the FCA, "would be concerned if the exit [from the market] of certain firms harms the competitive process [in the London Market]. It could be harmful if the use of facilities raises barriers to expansion or entry in the sector, by denying smaller players and potential entrants sufficient scale to compete effectively."
What concerns the FCA and PRA is that they are, or become able to, "facilitat[e] competition" in the UK, and in particular London, insurance market to bring (in Woods' words) "the right type of competitiveness". The FCA has recently indicated what this is, and is not.
On January 26, 2018 the FCA published a decision notice with respect to One Call Insurance Services Ltd. One headline issue in the decision notice was a breach of client money rules by One Call's receipt of monies under premium finance arrangements for the renewal of certain motor insurance policies, and its disbursement of those monies for purposes other than the payment of the premium due at such renewals, including "to finance its own working capital requirements".
An important ramification of that issue for the FCA was that: "Use of these [monies] may have provided [One Call] with a competitive advantage because it did not have to raise [working capital] funds itself and this may have enabled [One Call] to offer customers lower insurance prices than its competitors which did comply with the Client Money Rules."
The One Call decision notice sets out an explicit connection between regulatory non-compliance and (accordingly) unfair competitive advantage. The final notice in respect of Bluefin Insurance Services Ltd, dated December 5, 2017, provides examples of implicit connections in this regard.
The headline issue was Bluefin's failure to communicate clearly, fairly and in a non-misleading way with customers as to Bluefin's strategy of introducing risks to, and placing risks with, its parent company insurer, AXA UK Plc (AXA). Such introductions and placements were made in preference to, or without, any interaction with the wider market of potential underwriters. Bluefin marketed itself as a "truly independent broker" but benefited, or sought to benefit, financially from placements with AXA, in particular under the terms of "facilities".
In one example, a Bluefin employee "requested a quote [for a customer] from only AXA, [which] had been identified by Bluefin as the 'target insurer'. The customer took matters into his own hands and obtained a quote from an alternative insurer for almost half of the AXA quote. [Bluefin] subsequently obtained a matched quote from AXA. Had the customer not obtained his own quotes (despite having engaged [AXA as] an independent broker) he would have paid almost double for his insurance."
The final notice spelt out the basis of the £4 million sanction against Bluefin as the principle "… that … brokers will always act in the best interests of their customers and provide them with sufficient information to allow … informed decisions, [which] is central to the relationship of trust between [brokers] and … customers [especially] where the … broker is party to information to which the customer does not have access …".
The concept that a broker might achieve financial gain, and therefore competitive advantage, by misconduct in the form of failure to communicate, or manage conflicts of interest, properly with its clients is a vital aspect of the market study, which aims to look into "lack of transparency and asymmetric information between the client and broker regarding [the broker's] remuneration" (paragraph 4.12 of the Terms). In this regard, the Terms highlight:
- "[brokers] withhold[ing] information and opportunities from insurers which do not pay for their services",
- "tied reinsurance" and "
- broker-owned … MGAs".
If the market study finds evidence of misconduct vis-à-vis customers, and links that misconduct with advantage among risk-carriers and/or brokers, then certain well-known and widespread London Market practices become unsustainable.
This article was written for Thomson Reuters Accelus Regulatory Intelligence.