This is part two of my review of the draft Code of Conduct for Insurance Brokers. In each part, I focus on a couple of issues and provide my comments and suggestions for revision. I am publishing these in the run-up to the deadline for providing feedback to the IA on 28 May 2019.
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Introduction
On 28 March 2019, in anticipation of it taking over the regulation of insurance intermediaries in mid-2019, the Insurance Authority of Hong Kong (IA) published a consultation paper on its draft code of conduct for licensed insurance brokers (Code of Conduct). The deadline for providing feedback is 28 May 2019.
Currently, Hong Kong insurance brokers are regulated under a long-standing self-regulatory regime by one of the self-regulatory organisations (principally, the Hong Kong Confederation of Insurance Brokers (HKCIB) and the Professional Insurance Brokers Association (PIBA)).
From mid-2019, licensed insurance brokers will be regulated by the IA under the amended Insurance Ordinance (Cap 41) (Ordinance). The rules and regulations promulgated by the HKCIB and PIBA will fall away, as will the current “Minimum Requirements for Insurance Brokers“. New statutory conduct requirements will be imposed by new sections 90 and 92 of the Ordinance. In addition, new section 95 will empower the IA to issues codes of conduct “for giving guidance relating to the practices and standards…ordinarily expected” from licensed insurance brokers. It is under this provision that the IA proposes to issue the Code of Conduct.
Issues discussed in this part
In this part, I separate my discussion into two sections. The first looks at broader themes and issues arising from the Code; the second looks at specific, practical issues:
Section 1 – Broader themes and issues
A. The appropriateness and usefulness of “fairness” as a guiding principle through the Code;
B. The emergence of a “disclosure” regime to address conduct issues
Section 2 – Practical issues
C. Written agreements
D. Insurance product due diligence
E. Gifts and rebating
A. Fairness
Paragraph 25 of chapter 1 of the consultation paper notes that a “core theme” running through the entire Code is that of treating clients fairly. Question 2 of the consultation paper asks if respondents agree that this is “fundamental to the regulated activities of the licensed insurance broker”.
Similarly, section 90(a) of the Ordinance provides that a broker “must act honestly, fairly and in the best interests of the policy holder…”
Before answering the IA’s question, it is probably necessary to understand what “acting fairly” actually means in practice for an insurance broker and how this relates to its existing duties to act in the best interests of clients.
The concept of “fairness” usually implies some form of balancing of competing, legitimate interests. For example, a sports referee or a judge would frequently be called upon to exercise a judgment in a fair manner. Where the fairness of the behaviour of one party to a transaction is considered, it would normally be assessed with reference to the manner in which it asserted its interests against the other. If one party, for example, were to use its bargaining power or knowledge to charge an excessive fee, that may be considered “unfair”, even though it constituted no legal wrong.
The SFC Code of Conduct for licensed persons, to which the Code has many similarities, makes numerous reference to persons being “fair” or acting “fairly”. These references are found, first, in relation to the requirements that clients charges are “fair and reasonable” and, secondly, in relation to conflicts of interest. In the latter case, conflicts of interest are addressed by way of appropriate disclosure and by taking all reasonable steps to ensure “fair treatment of the client”.
“Fairness” is also found in provisions where there are competing interests of multiple clients, such as the execution and allocation of trades. It is notable that each of these references to “fair” in the SFC Code do relate to those situations where is no clear obligation to act in the sole interests of the client i.e. they are consistent with the normal meaning of “fair”.
In the case of insurance brokers, they must, when performing their duties as insurance brokers, act in the best interests of their clients. In this respect, there are no interests to balance: only the client matters. “Fairness” in this context does not appear to add anything to the existing obligations. It does, however, have application when it comes to matters where the broker’s and the client’s interests are opposed, such as setting the commission levels or commission structures (as they will impact upon the price paid by the client, even if the insurer is paying the broker). It similarly would have application where it comes to competing demands on a broker of different clients – a broker should be fair when managing its resources. It is though difficult to envisage in what other broad areas of its work the need for a broker to be “fair” would arise.
It is interesting therefore that, in the context of remuneration, the Code takes a permissive approach. Under General Principle 7 (Conflicts of Interest), a broker is required to manage conflicts with “appropriate disclosure to ensure clients are treated fairly at all times”. Paragraph 7.1 fleshes out this principle out with regard to remuneration disclosure. There is no general obligation that remuneration should be “fair”, just that it is properly disclosed. The language of General Principle 7 assumes that appropriate disclosure is sufficient to ensure that clients are fairly treated. This can be contrasted with the SFC Code that provides that charges must “be fair and reasonable in the circumstances”.
In general, it appears therefore that the fundamental theme running through the Code is not (at least yet) “fairness”, but rather “disclosure”. I turn to this below.
B. The emergence of a “disclosure regime”?
In this section, I refer to “disclosure” in the context of behaviour of a broker that that either is adverse to the interests of a policyholder (e.g. commission) or that is currently subject to a more restrictive regulatory regime.
Remuneration
In relation to disclosure of remuneration, it will be recalled that the question of the legality of a broker receiving commission from the insurer was considered in the case of Hobbins v Royal Skandia Life Assurance Ltd [2012] 1 HKLRD 977. The case held (correctly) that commission paid in the normal way at a normal market level was an established custom in the insurance market and that it was not unlawful. Whilst no disclosure is necessary, the court indicated that it would be good practice to do so. What was not necessarily appreciated widely is that the protection of that custom is strictly limited to its narrow terms. Any arrangement that falls outside of the “norm” would require a client’s informed consent in order for it not to constitute a secret profit and, possibly, to fall foul of section 9 of the Prevention of Bribery Ordinance (Cap. 201) (PBO).
The Code’s requirements for disclosure in paragraph 7.1 would likely address issues of legal risk relating to secret profits or potential breach of the PBO. However, as noted above, they do not constrain the ability of a broker to enter into an unusual remuneration arrangement, provided that it is adequately disclosed to the client. Whilst the Code does not actually change the current arrangements in these respects, setting it out in these terms may risk being seen as a validation of any model of remuneration. This does have potential to be abused by an unscrupulous broker.
It will be interesting to see if this is a regulatory policy or if the IA will eventually move to a more prescriptive approach to setting appropriate remuneration. The latter would be more consistent with the approach of other regulators in Hong Kong and overseas. I would advise brokers to prepare for a more prescriptive approach in due course.
Placing cover with overseas insurers
Under paragraph 4 (E)(b) of the current Minimum Requirements for Insurance Brokers issued by the IA, a broker should not place cover with an insurer that is not authorised in Hong Kong unless it is requested by the client, or there is an absence of suitable products available locally. In the Code (paragraph 5.2(c)), these caveats are no longer present. Instead, the broker is required to make certain disclosures regarding the identity, non-IA regulated status and financial standing of the insurer and the law/jurisdiction clauses of policy in question.
One risk of this approach is that a broker might place cover with insurers from poorly regulated jurisdictions and with poor practices on settlement of claims. Whilst the general duties of brokers should always preclude it placing cover with unsuitable security, regulatory experience tells us that a permissively worded provision does risk a careless or unscrupulous broker seeing it as a general permission to place cover with an overseas insurer. In this context, the process of disclosure would require a client to understand and critically evaluate the disclosures, something that it may not be competent to undertake. One possible approach the IA might take in a subsequent guidance note could be to identify jurisdictions with regulatory standards comparable to Hong Kong and to differentiate the requirements on brokers accordingly.
C. Written agreements
Paragraph 5.4 of the Code requires insurance broker companies to enter into written agreements with each client before arranging an insurance policy for the client. The agreement (a copy of which must be provided to the client) must state:
(a) the names of the parties;
(b) the appointment of the broker by the client;
(c) other terms of business that may have been agreed; and
(d) “other information” that may be required to be included by the IA from time to time.
On the face of it, this appears to be a sensible requirement. The existence of written agreements limits areas of potential dispute and generally protects the consumer. Of course, for the larger commercial brokers, this is something that is already routinely done. Detailed terms of business agreements are entered into. However, a similar process for a retail broker, dealing with one-off placements, would be onerous.
It is notable that the requirements for a “written agreement” do not require it to be signed, nor for it to be a single document (although it might be argued that this is implied). In practice, the requirements for a “written agreement” will likely be met by a broker appointment letter or, indeed, an exchange of emails that set out the basis upon which the broker is acting. What will not be acceptable, however, is for the arrangements to be arranged only in a telephone call.
D. Insurance product due diligence
Under paragraph 5.2 of the Code, a broker is required to provide information to the client about the insurance product it recommends, including the major terms, premium level and fees and charges. This requirement, in practice, does no more than state the normal duties that a broker must discharge in acting for a client.
What, however, is entirely new in the Code is the requirement in paragraph 2 of Part D (Controls and Procedures for Licensed Insurance Broker Companies) for a broker to undertake insurance product due diligence in respect of any insurance product about which it proposes to provide regulated advice to a client. Under this provision a broker must have in place proper controls and processes to assess “the nature and key features of insurance products“. It must be made prior to recommending the product and updated at regular intervals thereafter. Importantly, the broker must ensure that due diligence process is documented.
This provision leaves open a number of questions:
(a) It is not entirely clear whether the requirement is to have in place “proper controls and procedures” to undertake the due diligence or actually to conduct the due diligence. It is a fine distinction, but it does potentially allow some leeway for failures to conduct the appropriate due diligence, providing that the controls and procedures are in place. It may, for example, excuse the lack of due diligence in circumstances where a new product was introduced for the purpose of a specific placement;
(b) The wording of the provision (particularly the requirement for periodic updating of the due diligence) does suggest that the IA envisages some form of centralised and documented due diligence on the range of products, rather than a broker relying upon the individual placement process and client disclosures required under paragraph 5.2 (and noted above). Indeed, if a broker were to rely only upon the day-to-day placement processes to comply with the requirements it would arguably not constitute having “proper controls and procedures” to ensure compliance. Smaller brokers with limited compliance resources will probably struggle to undertake systematic, centralised and documented insurance product due diligence, if that is what is envisaged;
(c) Commercial insurance policies, particularly for complex matters, will frequently be issued with numerous endorsements. Some of them may be standard form, some may be bespoke for the particular placement. For standard form endorsements (of which there may be many), it is open to question whether due diligence should be undertaken. Insofar that they amend a “key feature” of the policy (as per the Code), it seems that they would be included in the due diligence process. This, of course, would significantly increase the burden of undertaking and updating the due diligence.
(d) The requirement to keep the due diligence updated at regular intervals would appear to require a periodic dialogue with each of the relevant underwriters to obtain updated policy wordings (and possibly, endorsements). This would, again, add to the burden of undertaking the due diligence.
The rationale for introducing product due diligence requirements is easy to understand. It has, of course, an important and increasing role in the SFC Code. However, insurance products are (with some exceptions that could be addressed separately) significantly less complex and varied than many investment products. The need for a broking company undertaking a review to ensure that, as an institution, it understands a product it may recommend seems significantly less acute than in the investment space. This is particularly so given that a broker will always be required to advise on the major terms and suitability of the product in question in the course of a placement.
This seems to be an area where, in due course, a further guidance note from the IA could provide additional clarity of what, practically, is expected from brokers.
E. Advantages, gifts and rebating
Offering an advantage
Paragraph 1.2 of the Code addresses the offering by a broker of an “advantage” to an agent (director, partner, employee) of a client for whom a broker is appointed or seeking appointment. It provides that it may not be done unless (i) it does not breach any IA rules or the rules of any other relevant regulatory authority; and (ii) the client has given express prior written consent.
Although the Code does not refer to the PBO, the term “advantage” is used in that statute and it may be assumed that the IA (which has not attempted to define the term) has in mind a similar meaning in the Code. “Advantage” in the PBO includes any gift, loan, fee, reward, employment, contract, payment, release etc. Notably, the PBO definition excludes “entertainment”.
The question of what constitutes “consent” of the client may be difficult in some cases. It is possible, particularly in a smaller broker, that a director of the company to whom an advantage may be offered has full authority to act on behalf of the company on a day to day basis. The director may therefore have the power to provide the company’s consent for him to accept the advantage. If so, this would appear to satisfy the requirements in the Code.
It would not, however, provide adequate “permission” to constitute a defence under section 9 of the PBO (Corrupt transactions with agents). In this case, the director would need to obtain the consent from the board of directors. As such, in some circumstances the Code may provide a false sense of security to a broker that is seeking to offer an incentive to a client’s agent.
It may be sensible for the IA to clarify (if this is the intention) that the consent of the client should be provided by someone other than the recipient of the advantage (regardless of whether they have the legal authority to give such consent) and, in the case of a director, by the board of directors.
Gifts / Rebating
The Code is silent on the practice of discounting fees or rebating commission to clients. Currently, the membership regulations of both the HKCIB and PIBA regulate the practice.
The HKCIB regulations (paragraph 7.13) provide a broker shall not give a gift when promoting a specific insurance product, but may offer a discount on fees or a rebate on its commission. PIBA regulations (paragraph 5(d)) similarly preclude a gift or inducement to insure through a particular insurer, but permit discounts or rebating of fee and commission for non-long term products and provided they are not (only) for particular insurers.
The effect of the PIBA rules (and to a lesser extent, the HKCIB rules) is to preclude brokers from offering an incentive to a client towards a particular product or insurer (which could, for example, be because of preferential arrangements on commission, including volume based payments), which may conflict with the broker’s advice or the client’s best interests.
In the absence of similar guidance in the Code, it will be the requirements for disclosure under General Principle 7 and, in particular, paragraph 7.2 (relationships with insurers) that are relied upon to protect clients’ interests. For the reasons noted earlier in this article regarding the capacity of a consumer to understand and critically evaluate a technical disclosure, I believe that current PIBA rules on gifts and rebating have much to recommend them.
Will Harrison
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