Insurance mediation does not sound like the kind of thing solicitors do, but in fact many are involved in it and their knowledge of the rules around it are often sketchy. Alan Bannister of Vizards Wyeth outlines the main issues. Vizards Wyeth is a Legal Futures Associate.
Insurance mediation is defined by legislation as comprising six activities. The SRA’s rules – designed to allow solicitors to claim the professional firms’ exemption from direct Financial Services Authority (FSA) regulation – contain restrictions and impose a much tighter regime than many solicitors are aware.
In this article we shall examine to what extent solicitors are permitted to undertake insurance mediation activities if they choose this route in favour of full authorisation by the FSA.
What is it?
Insurance mediation became a regulated activity in January 2005, following the UK’s implementation of the EU Insurance Mediation Directive. The only way now to avoid direct regulation by the FSA is to qualify for exemption and there are two routes to achieving this: firms must either become an appointed representative of a firm that is itself regulated by the FSA or take advantage of what is known as the ‘exempt professional firms’ provision.
For solicitors, the former option is not available because of rule 19(1)(a) of the Code of Conduct, which prohibits firms from becoming an appointed representative. The latter brings with it stringent conditions that are tougher than would be the case if the exemption were not claimed.
The Law Societies of England and Wales, Scotland, and Northern Ireland are classified as ‘designated professional bodies’ by virtue of sections 326 and 327 of the Financial Services and Markets Act 2000. This means, that subject to certain restrictions, solicitors working for firms regulated by the SRA may conduct regulated activity without the need for direct authorisation and regulation by the Financial Services Authority. (Note however, that the exemption does NOT apply to authorised non-SRA firms even if they are managed by a solicitor.)
The SRA rules and restrictions
The restrictions imposed by the SRA on solicitors who wish to claim exemption under the professional firms’ exclusion largely reflect guidance issued by the FSA itself.
They are that a firm:
- carry on or agree to carry on effecting and carrying out contracts of insurance as principal; and
- the activities arise out of, or are complementary to, the provision of a particular professional service to a particular client;
- the activities are incidental to the provision by the firm of professional services;
- the firm accounts to the client for any pecuniary reward or other advantage which the firm receives from a third party; and
- that their firm appears in the FSA Register as an exempt firm and that they appoint a compliance officer.
So what does this mean in practice in relation to each of the six regulated insurance mediation activities?
Insurance mediation – the regulated activities
Activity 1 – Dealing in contracts as agent
Solicitors who have authority to bind insurance on behalf of insurers are likely to fall in this category. It does not matter whether advice is given or a recommendation is made. The very act of binding cover is sufficient.
Activity 2 – Arranging (bringing about) deals in insurance contracts
A solicitor would bring about a contract of insurance if his involvement in the chain of events leading to the contract of insurance were important enough that, without it, there would be no policy. Examples of this type of activity could
include negotiating the terms of the contract of insurance on behalf of the customer with the insurance undertaking and vice versa, or assisting in the completion of a proposal form and sending it to the insurance undertaking.
Activity 3 – Making arrangements with a view to transactions in insurance contracts.
In this case, there is no limitation by way of the requirement that the arrangements would bring about the transaction to which they relate, as in the previous activity. So this activity includes helping potential policyholders fill in or check application forms in the context of ongoing arrangements between these persons and insurance undertakings.
Another example would be a person introducing customers to an intermediary either for advice or to help arrange an insurance policy. The introduction might be oral or written.
Activity 4 – Assisting in the administration and performance of a contract of insurance
This relates, in broad terms, to activities carried on after the conclusion of a contract of insurance and for or on behalf of policyholders, in particular in the event of a claim. It might also involve the processing of premiums, issuing policy documentation or dealing with endorsements to the policy mid-term.
Activity 5 – Advising on contracts of insurance
The advice must:
- relate to a particular contract of insurance (that is, one that a person may enter into and be specific);
- be given to a person in his capacity as policyholder or potential policyholder;
- be advice (that is, not just information); and
- relate to the merits of a person buying a contract of insurance.
Activity 6 – Agreeing to carry on a regulated activity
Agreeing to do any of Activities 1 – 5 inclusive is itself a regulated activity. In the FSA’s opinion, this activity concerns entering into a legally binding agreement to provide the services to which the agreement relates. However, merely making an offer to do so is not a regulated activity.
What does this mean in practice?
A general insurance contract in which solicitors commonly get involved is that which provides cover for reimbursement of after-the-event (ATE) legal expenses. We shall use this as our working example of what is and what is not permitted under the professional firms exemption operated by the Law Societies of England and Wales, Scotland, and Northern Ireland.
1. The rules require that the insurance MUST relate to the provision of a specific professional service to a particular client and be incidental to the professional service – in this case, representing the policy holder in a claim against a third party.
2. It is permitted for a solicitor to operate a binding authority granted by the underwriters of the ATE cover. In other words they can go on cover on behalf of underwriters.
3. Premiums collected for the cover MUST be on behalf of the underwriter granting the binding authority. Whilst this is usually the case when operating a binder as agent for the underwriter, for the avoidance of doubt, terms of business between the solicitor and the underwriter should grant risk transfer to the solicitor and premiums kept in an account separate from the firm’s own monies.
4. Helping prospective policyholders complete any required proposal forms is permitted but solicitors’ firms must ensure that the inherent conflict of interest involved – the firm acting as agent of the prospective policyholder at the same time as agent of the underwriter – is adequately explained and understood and accepted by the prospective policyholder. Segregation of duties may be required as a conflicts management technique.
5. Representing the policyholder in the claims process against underwriters is permitted even though the firm is being paid by underwriters to conduct proceedings against the third party. The same inherent conflict of interest mentioned above must be properly managed.
6. Solicitors’ firms may advise on the merits of cover but must be scrupulous about the likelihood of a successful outcome to merit the expenditure by the client.
7. Solicitors’ firms must ensure they appear on the relevant FSA Register page and appoint a compliance officer.
Final points for thought
Traditionally, commissions payable for ATE policies are of the order of 40% and the SRA rules require that firms account to their clients for the receipt of such commissions. This may prove difficult to justify in itself, without the further complication of additional commissions available under certain schemes.
ATE legal expenses insurance, whilst technically underwritten by an underwriter, in practice often is not. It is in some cases effectively underwritten by a wholesale intermediary who is required to indemnify the underwriter issuing the paper. The intermediary is indemnifying the underwriter that premiums will exceed claims and therefore the underwriter is effectively only underwriting the credit risk of the intermediary. The intermediary often offers enhanced commissions – up to 70% in some cases – to a solicitors’ firm if it provides a counter-indemnity to the intermediary.
One might ask whether there is anything inherently wrong with such an arrangement. If the solicitor firm takes the risk (of the case being unsuccessful and costs not being recovered from the third party), then why shouldn’t they receive a higher reward in the process?
Well, rule 1 of the Code of Conduct – the core duties – springs to mind, as does the requirement of rule 3(f) of the Solicitors’ Financial Scope Rules 2001 (not to act as principal in the contract). Smoke and mirrors arrangements such as apply in the circumstances described may be seen as compromising a firm’s integrity and independence.