English Appendix
The insurance broker’s fair analysis
A proposed model
The Insurance and Reinsurance Mediation
Act (Ley de Mediación de Seguros y
Reaseguros ) 26/2006 of 17 July calls for a
procedure to be drawn up for the fair analysis
by the insurance broker. In this study the
author develops an in-depth analysis he
presented in the INADE 2006 conference
and comments on those articles of the Act that
make direct reference to this need.
ENRIQUE ZÁRRAGA ARANCETA
Willis Iberia
Directive 2002/92/EC of the European Parliament laid down the bases for harmonisation of insurance mediation activity in the European Union.
The Private Insurance and Reinsurance Act (Ley de Mediación de Seguros y Reaseguros Privados) 26/2006 of 17 July was passed in Spain after a thorough debate both in the Congress and in the Senate.The Directorate General of Insurance and Pension Funds (Dirección General de Seguros y Fondos de Pensiones: DGSFP) also consulted many stakeholders in the sector to make sure the Act took their opinions into account.
The general perception of the Act, by brokers themselves, consumer organisations and the government, is generally favourable and positive as a whole.There is still need, however, of a regulation, not in theory envisaged, to develop some of the important aspects that have not been fully defined and to clear up some interpretative difficulties in the brokers’ day-to-day practice.
Some of the Act’s keynote ideas are the following:
- Obligation by the broker to give information to the client before the insurance policy is taken out.
- Principle of transparency as a sufficient guarantee of consumer protection.
- Need of giving the client objective advice on the products available on the market.
- Remuneration system guaranteeing the independence of brokers vis-à-vis the insurers.
All the abovementioned principles are extremely important. From my point of view, however, the one that without doubt captures the essence of clients’ expectations of the broker is the need of making a fair analysis.
I have had the chance of speaking to several brokers on this concept of fair analysis and we have all agreed on its importance. But I have also found that in general no procedure has been set up for unequivocally confirming that such a fair analysis has in fact been carried out in a professional manner.
On 14 December 2006, in a conference organised by INADE (Atlantic Insurance Institute) in Fundación MAPFRE, I presented a paper on a proposed fair-analysis model that brokers might find useful for complying with this obligation of our work. I now have the chance of fleshing out this initial paper and making some comments on the Act.These comments should be understood solely as my personal interpretation.
MAIN ARTICLES OF THE ACT DEALING WITH THE FAIR ANALYSIS
The most important articles of the Act in relation to the fair analysis are the following.
Article 26.1
«… the insurance broker offers independent, professional and impartial advice to those who demand coverage of the risks impinging on their personnel, assets, interests or liabilities. For these effects and purposes the concept of "independent, professional and impartial advice" is to be understood in terms of the obligation to carry out a fair analysis in keeping with the provisions laid down in article 42.4 hereof».
The broker’s independence from the insurer is guaranteed by the fact that the broker has no agency contract with the insurer and therefore does not represent the latter.The relations between them are governed only by a Letter of Terms and Conditions, laying down the rights and obligations of each one in the event of the broker mediating an insurance contract with the insurer in question.
The broker’s professional skills and expertise are vouched for by the DGSFP’s permit for exercising the profession.There is no doubt, however, that for some particularly complex risks some brokers would not be qualified for offering advice that might be satisfactory to the client.This is where the model we propose below could come into play, albeit with a very questionable degree of objectivity.This is because one of the kingpins of the fair analysis in the Act is missing: professional proficiency, meaning that the work should be carried out by an expert in the matter dealt with.
The premise of impartiality is based on the need of the broker to seek first and foremost the client’s interest over and above the broker’s own interest.A sine qua non is therefore the honesty with which the analysis is conducted.
Article 26.2
«Insurance brokers shall inform the would-be insured about the contract terms that in their judgment should be taken out and offer the coverage that, according to their professional criteria, would best suit the needs of said insured…»
The wording of this article makes no explicit mention of fair analysis but it is there between the lines in the recommendation for the broker to inform the client about the contract that, in the former’s judgment, should be taken out.
Although the wording of this article is very similar to that of article 42.4,my impression is that this one goes further.Article 42.4 (to be looked at later) restricts itself to the strict analysis of insurance contracts regardless of who backs them up on behalf of the insurer.Article 26.2, on the other hand, introduces the concept of the broker’s judgment in making the recommendation.The broker therefore, who in practice is a person with a defined judgment and opinion, is bound to make a more overall assessment of the insurance company that might have to meet any claims, issue documentation and guarantee a reassuring financial solvency, etc.This will be over and above the evaluation of the specific contract terms.
As well as the above considerations, one of the mainstays, in my opinion, that should underpin the broker’s work is laid down in the paragraph referring to the coverage that «…would best suit the needs of said insured;…».
The insurance broker has to bear firmly in mind that the external financing of risks by means of insurance programmes is just one more part, and not always the most important part, of the client’s risk management process.
The diagram in the next page shows the different forms of dealing with a risk, whether or not it is transferable to the insurance market.The «Insurance Programme» is shown to be one component more of a general risk management philosophy.The criteria for taking out insurance should therefore fall perfectly into line with said philosophy.
RISK MANAGEMENT
Unless the client specifies the insurance programme it requires, the broker’s counselling and advice work in relation to the transferable risks has to focus on cataloguing said risks and drawing up a client risk map.The following figure shows a possible graphic representation of a risk map.The broker should in some way bear all these factors in mind when advising the client.
As a further step along the road clients are now beginning to ask brokers to help them manage the risks as part of the practices of good governance that each company has to implement in its management arrangements.
In the interests of really tailoring the counselling work to each particular client, the ideal situation –for all parties concerned– would be for brokers to find out beforehand the clients corporate risks management arrangements and their degree of development.
The next figure shows the principles of Enterprise Risk Management (ERM) as laid down in (COSO II, 29 September 2004), breaking down the actions into the following:
- Definition of the general risk philosophy and the steps to be taken.
- Internal control. Risk tolerance and degree of acceptable risk.
- Identification of risks, impact and probability.
- Controls set up.
- Monitoring of incidents and bringing them to wider notice.
- Dealing with incidents and agreements to improve internal control.
Once the risks have been identified and assessed, and after the client’s specific circumstances at the time of carrying out the analysis have been ascertained and the likely development thereof, the broker is then in a position to be able to evaluate, graduate and apply weights to the various risk-transfer aspects.
This whole process has to be adapted to each specific client «like a rubber glove fitting each hand», so that the insurance programme meets the client’s needs and expectations. It is then in this moment that the broker is really fulfilling its function in such a way as«would best suit the needs of said insured,…».
RISK MAP
RISK MANAGEMENT
«Enterprise risk management is a process, effected by an entity’s board of directors, management and other personnel, applied in strategy setting and across the enterprise, designed to identify potential events that may affect the entity, and manage risk to be within its risk appetite, to provide reasonable assurance regarding the achievement of entity objectives».
Source: COSO Enterprise Risk Management- Integrated Framework. 2004. COSO (Committee of Sponsoring Organizations of the Treadway Commission)
Article 42.2
«c) Insurance brokers shall inform the client that they are giving advice in due accordance with the obligation laid down in section 4 of this article to carry out a fair analysis».
The broker shall inform the client that it has carried out a fair analysis without it being necessary to present the fair analysis carried out.
To do so it shall analyse different contracts: examine their parties, characteristics, etc., and any aspect that may be of interest and furthermore it has to be fair, i.e., «applying» the aforementioned analysis to the client’s circumstances regardless of the circumstances of the person carrying out the process.
Article 42.4
«… the advice will be given on the basis of an analysis of
a sufficient number of insurance contracts offered on the
market in the risks being covered, so that it can then
make a recommendation on the basis of professional
criteria with regard to the insurance contract and in line
with the client’s needs.
In any case there will be assumed to have been a fair
analysis of a sufficient number of insurance contracts in
any of the following cases:
a) When the insurance broker has analysed in a
generalised way insurance contracts offered by at least
three insurance companies trading in the market of the
risks being covered.
b) When the insurance arrangement has been specifically
designed by the insurance broker and negotiated with at
least three insurance companies trading in the market in
the risks being covered to offer it exclusively to its client
in view of the latter’s general needs or characteristics, on
the basis of the professional criterion of the insurance
broker».
Many comments and reflections could be made on this article and we cite below the ones we consider most important:
- Even though a fair analysis has been made of a sufficient number of contracts, at least three, the broker could present the client with all the existing options, several of them or a single one, the one it considers to be most appropriate or the one requested by the client.
- The Act says in section a) of article 42.4 that insurance contracts have to be analysed, and I understand here that the concept of contract has to be likened to insurance products.A strict interpretation of this section, sufficient for abiding by the law, is that only contracts (products) have to be analysed, regardless of the characteristics and circumstances of the insurer who, in exchange for a premium, takes on the risks the broker’s client wishes to transfer.
- The wording «…in a generalised way insurance
contracts offered by at least three insurance companies…»
comes across as rather strange, inasmuch as it relates
the concept «in a generalised way», suggesting many,
with the number «three», which in principle would
seem to be few.
My interpretation here is that in mass risks, with «practically closed conditions and prices», such as automobile insurance, home insurance,multi-peril insurance, etc., the broker has to make a generalised analysis of these products, offering the product it considers to be most appropriate for each type of client without having to conduct a specific and differentiated analysis for each client, since in general these products usually give sufficient coverage of the transfer needs of risks of this type. In the interests of good professional practice the broker is bound to update this type of analysis. - The specific design of an insurance arrangement, section b), could refer to a general product for a specific segment with common types of risks. I also assume that this section would include the cases in which the broker asks the market for delimited insurance terms for a specific client, to suit its particular needs. In this case the product is understood to be the same, regardless of the insurer, so the only variable that the broker perforce has to analyse is the one of «economic terms».
- The broker will have to repeat the fair analysis whenever a contract runs its term and the client wants a new one. In the case of extendable-term policies, when the client’s risk transfer circumstances have not undergone any appreciable variation and neither has the insurance product been given new restrictions, in my opinion there is no need for another fair analysis.The broker will decide whether or not to make a new fair analysis in each particular case on the basis of such factors as prudence, circumstances, client’s behest and any other factor to take on board.
There are cases in which the coverage sought will not be provided even by three insurers. It is clear that in these cases the broker’s work will be limited to the options available on the market.
Article 42.6
«It will not be obligatory to furnish the information laid down in the above sections in the case of the mediation of a major risk».
Article 107 of the Spanish Insurance Contract Act (L.C.S. in Spanish initials) defines major risks, for which it is not obligatory to make a fair analysis.
- Railway, air, sea, river and waterway and river vehicles, transported goods, civil liability in air, sea,waterway and river vehicles.
- Credit and suretyship.
- Land (not railway) vehicles, damage to
property, civil liability, and diverse monetary
losses providing that the policyholder exceeds the limits of at least two of the three
following criteria:
- Total balance sheet: 6,200,000 euros
- Turnover: 12,800,000 euros
- Mean number of employees: 250
These figures have not been kept up to date.This outdatedness, together with the business development of recent years, means that many firms classifiable today as SMEs could be considered as major risk under article 107.
Although not obligatory, in my opinion there will be many cases in which the broker’s good professional practice would prompt it to carry out a fair analysis for these clients.
CHARACTERISTICS OF THE MODEL
In view of the circumstances in which brokers carry out their work, their management and administration responsibilities, I have tried to design a fair analysis model that can be universally applied to all types of contracts and also meets the following premises:
- Based on the professional proficiency of the broker.
- Trusting in the impartiality of the broker.
- Easy for the client to understand.
- Easy for the broker to apply.
- Measurable, quantifiable.
- Can be kept very simple or made as complex as is required.
THE MODEL
A model that meets all the abovementioned premises is the following:
R: is the final numerical score sought by the broker.The scale could be any one, but for reasons of familiarity I propose that the scale should run from nought (the worst) to ten (the best).
Vi: is the numerical score, from nought to ten, given by the broker to each variable analysed in each contract.This score is based on the professional proficiency of the person making the valuation.
Pi: is the weighted score given by the valuer to each variable.To construct this part of the model properly the valuer needs to «put himself in the client’s shoes».This calls for a sufficient level of knowledge of the client, to be able to give each variable the weight that the client itself would choose if it had the valuer’s experience.
We have set up the model so that the sum of all the weighted scores of the different variables analysed always adds up to one (1).
EXPLANATION OF THE MODEL
Article 42.4 of the Act says that «the broker’s advice will be given on the basis of an analysis of a sufficient number of insurance contracts offered on the market». As already pointed out, a strict interpretation of this article might conclude that the Act’s fair analysis stipulations can be met solely by analysing the contract terms and conditions (insurance product) in accordance with the client’s needs without going into the other aspects bound up with the insurer making the insurance offer.
- Valuation of the contracts’ insurance arrangement
(Vi).
An insurance contract comprises many aspects, so any valuer, on its own criterion, could take into consideration explicitly the aspects it desires in each case. My general proposal, for comparing different contracts, is that the valuer should give its professional opinion on the quality of the contract, rating it from nought to ten, in the following aspects:- Scope of the coverage: risks covered, applicable exclusions, property covered and excluded,…
- Technical terms: limits and sub-limits, excesses, clauses limiting and delimiting rights and obligations, other types of clauses in terms of coverage and administration of the contract, dealing with claims, regularisations, ...
- Economic terms: premium, form of payment, profit sharing, possible LTA,…
- Weighting of each aspect valued in the
contracts (Pi).
As previously mentioned, knowledge of the client will enable the valuer to give a «weighted score» to each aspect of the contract in terms of the characteristics of the specific client for whom the fair analysis is being made.
Example:
The table below shows an example of a fair analysis for a client, taking into account the abovementioned comments.
INSURERS
In this example the broker would recommend the client to take out insurance with insurer 1.
OTHER ASPECTS
Any professional of the insurance sector will be well aware that any insurance contract contains other aspects, also very important, that the broker has to take into account when making an insurance recommendation to the client.
It goes without saying, for example, that the efficiency of the contract will differ from insurer to insurer. Experience bears this out. Just as each client is different, so each insurer is different.
These differences, known only to the professional, could be of great importance in making a recommendation and the broker should bear them in mind to meet the remit laid down in article 26.2.
Here again, therefore, just as in the analysis of the contract, there will be a host of aspects to be taken into account by the broker.
The score will again be given from nought to ten. In the weighting the broker will again try to put itself in the client’s shoes, so as to give each factor the importance the client itself would choose if it had the broker’s knowledge and experience.
Some of the aspects to be taken into account could be the following:
- Solvency: although all the insurers that work in our country have to be approved by the DGSFP, it is none the less true that the valuation of the insurers differs from broker to broker.
- Management and payment of claims: some brokers make objective valuations like the one in the figure below, showing the six-monthly trend of each insurer’s claim management and payment record (the names have been removed).A tool of this type helps the valuer to come to a well-informed opinion on this crucial point.
- Administrative quality: it is unfortunately the case that the insurance market has not always shown itself to be very efficient in the issuing of policies, certificates and the rest of the documentation, often falling behindhand and making mistakes.This complicates the day-to-day business of the broker and therefore has an adverse knock-on effect on the client.
- Engineering: some insurers furnish their clients with recommendations on risk prevention and protection.This service is highly valued by clients.
- Bonuses, insurance training and risk management … and many other aspects that the broker will be able to take into account in each particular case.
RANKING OF INSURERS
Mean score of claim management
The model also serves for introducing these variables, each one with its valuation and weighting, up to the desired level of detail.
For example, the following table is a continuation of the fair analysis carried out beforehand, and the broker has thought fit to introduce the aspects of claims and engineering into the equation, giving a score and weighting to each one of them. It is therefore necessary to reshuffle the weighted scores of the aspects analysed beforehand.
INSURERS
Obviously, the above table’s breakdown could also be made to include the aspects making up the «contract analysis».There would then obviously have to be a reshuffling of the weightings to ensure that the sum of all the weighted scores still adds up to one.
SOME FINAL COMMENTS
Although at first sight the model might not appear as simple as we might wish, especially for people with no mathematical training, I would urge them to give it a second look, whereupon they will see that it is in fact easy to apply.
Although it is very easy to apply, the general conclusion still has to be drawn that all fair analyses depend in the end of the subjectivity of the valuer.