Legal Update: The problem with delegated authorities

The recent London Matters 2017 report from the Boston Consulting Group and London Market Group shows that for the period 2013 to 2015, the London insurance market was strong in its historical core markets.

The report suggests one reason for such growth is the effectiveness of delegated authorities for underwriting and/or claims: agreements for intermediaries to act as insurers’ agents, or “giving the pen”.

Yet in respect of the 2013 to2015 period and since, the Financial Conduct Authority and the Prudential Regulation Authority have issued strong warnings as to the implications of DAs.

So, do DAs represent a long-term commercial solution experiencing some short-term regulatory problems, or a short-term solution that is creating long-term problems?

The report states that growth has been “where London is traditionally strong”. Premiums in the UK and Ireland grew by 1.8% a year and in the US and Canada by 3.7% a year. “These two regions between them represent more than two-thirds of market premiums.” A key factor was the strong growth in market managing general agent/coverholder premiums in the UK and North America.

Given the importance of DAs for its performance, the market wants “to make London capacity more attractive for coverholders”. And the report suggests: “Audit and compliance will be streamlined and standardised, and data collected only once.”

A different perspective

In commercial terms, the increasing reliance on DAs is a positive story. However, the FCA and PRA have a different perspective.

The FCA’s thematic review Delegated Authority: Outsourcing in the general insurance market from 2015 gave examples of material weaknesses in controls over DAs and over the intermediaries that hold them, including cases where the scope of requested audit was “unachievable” partly because of “the absence of due diligence or internal controls” and where “there was no clear framework or risk tolerance around the audit outputs and findings”.

As such, the reduction in audit processes set out in the report could easily lead to adverse regulator reaction. This will be even more likely if the FCA identifies that reduced audit processes may give rise to less effective management information on the fair treatment of customers, such as the categories of information expressly referred to in the thematic review: how and by whom products were sold, levels of cancellations, claims frequency, claims repudiations, claims service standards or complaints volumes.

Intermediary remuneration

A speech from September 2016 by David Rule, the executive director for insurance supervision at the PRA, highlighted that intermediary remuneration was increasing as a share of gross written premiums despite insurers’ desire to lower costs in line with lower premium rates.

The increased ‘take’ of intermediaries from gross premiums evidences an increase in their control over product distribution and other market operations. Examples of increasing intermediary control include both an expansion of classic DA arrangements and more recent ‘pay-to-play’ broker facilities. The report points out that the emergence of facilities aimed at reducing the market’s frictional costs can both reduce the costs of trading and allow packages of risks to be made more available.

The published views of various insurers are far more forthright than this. It may be that some market insurers aren’t just delegating their underwriting authority, they’re ceding control of their businesses.