Business Economic Note 20

Table of contents

1. General Background

1. Who provides insurance?

2. The Financial Services Act 1986

1. The Central Register

2. Polarisation

3. The Intermediaries

1. Insurance Brokers

2. Insurance Advisers

3. The Financial Intermediaries, Managers and Brokers Regulatory Association (FIMBRA)

-FIMBRA Membership Categories

4. Tied Agents

4. The Insurace Directory and Yearbook ( Post Magazine Yearbook) & The FIMBRA Membership Directory

5. Payment Of Commission

6. Other Income

7. Record Maintained

8. Taxation Of Commission

Glossary

Appendix 1

Example of payment of commission on the indemnity basis

Appendix 2

Comparison of commission - LAUTRO commission surveys 1990/91

Appendix 3

Investment business requiring separate authorization of FIMBRA

Appendix 4

LAUTRO recommended rates of commission under the maximum commission agreement(abandoned in 1989)

Appendix 5

FIMBRA financial resources and reporting requirements

1. Who provides insurance?

The insurance industry comprises a wide range of organisations from large multi-national concerns, including proprietary companies with shareholders; Mutual companies, Friendly Societies and Provident Associations; and 'Industrial' life insurance companies. There are a number of other societies which provide insurance, notably Lloyds. Lloyds are a society of underwriters, all of whom accept insurance risks for their personal profit - or loss, since they are liable to the full extent of their private fortunes to meet their insurance commitments. Lloyds comprise some 20,000 members - 'names' - forming 400 syndicates, each managed by an underwriting agent.

The 'products' available from many insurance companies extend far beyond the generally perceived notion of 'insurance', with the wide range of investment policies or schemes that are on offer. As will be seen later in this note, the marketing of investment type policies became subject to regulation and control under the auspices initially of the Department of Trade and Industry, and subsequently of the Treasury via the Securities and Investments Board (SIB) as a result of the Financial Services Act 1986.

Hand in hand with the growth of the insurance industry has been the role of the broker. Originally the insurance industry had been the part-time occupation of a large and disorganised group of individuals with capital to speculate. Whilst they were prepared to put their signature to a list of people sharing a risk, none would gamble more than a fraction of their income. In these early days the broker's function was to assemble a list of names to provide cover for ships leaving port. Effectively brokers were 'the fixed point in a floating market'. Subsequently the broking industry has been characterised by growth, diversification, and amalgamation.

Nowadays the term 'broker' applies to a wide range of firms from the multinational organisations providing all classes of insurance and investments advice, to the smaller specialist brokers and what is popularly known as the 'High Street broker'.

The 'broker', however, is not the only means for the prospective customer to obtain the insurance cover he requires. The alternatives can be summarised as follows;-

• Direct from the insurance company, either at the offices of the company or via a 'free phone' link; or through a company representative.
• From an insurance agent or consultant.
• From a part-time agent, for example a solicitor, estate agent, travel agent, car salesman etc.

for the most part, this note focuses on the 'intermediaries', whether they be appointed representatives of the insurance company (but not employees), insurance brokers or independent advisers. It covers general insurance work, (i.e. motor insurance, home contents, building structure, etc.) as well as long-term and investment business which includes life assurance, pensions and the sale of personal equity plans, unit trusts, etc.

With effect from April 1988, and as a direct result of the Financial Services Act 1986, agents and brokers dealing with 'investments' became bound by law to register their business. This legislation has had a profound effect on the insurance world as a whole and on the role of the intermediaries in particular.

The Financial Services Act came about following a number of business failures in the early 1980s, which lead to a substantial number of personal losses incurred by investors. It was felt that measures were required which would offer protection to investors, and, as a result of the Financial Services Act, various Self-Regulating Organisations (SROs) were established under the direction of the Security of Investments Board (SIB). Among the aims of the Act was to ensure that potential investors should more readily be able to comprehend the product information, the legislative protection available, and the status of the person offering advice.

The SROs which most directly affect the insurance intermediaries are the Life Assurance & Unit Trust Regulatory Organisation (LAUTRO), and the Financial Intermediaries, Managers & Brokers Regulatory Association (FIMBRA), although currently there are moves afoot to draw the functions of these two bodies into one organisation, namely the Personal Investment Authority (PIA). It is envisaged that the PIA will regulate all investment business done with, or directly for, the private investor. Investment business within the terms of the Financial Services Act includes investment in:-

• company stocks and shares
• government and other public securities
• units in collective investment schemes
• long term life insurances
• options, futures etc.

The business activities governed by the Act include:-

• dealing in shares
• arranging investment deals
• providing investment advice
• establishing, operating or winding up a collective investment scheme.

Excluded from the definition of investment business are the following:-

• shares in Building Societies
• straight-forward banking instruments (cheques, bank accounts)
• leases and normal property dealings
• non-convertible level or reducing term insurance policies
• permanent health policies, unless they contain a profit element or surrender value.

The scope of the PIA would include all the activities currently undertaken by FIMBRA and LAUTRO, as well as some of those which are now undertaken by the Investment Managers Regulatory Organisation and the Securities and Futures Association.

1. The Central Register

One important consequence of the Financial Services Act was the requirement of the SIB to maintain a public register of all firms who are authorised to carry on investment businesses, as well as some other information. Accordingly, a Central Register is available for public inspection.

• The Central Register can be used to check whether a firm is suitably authorised, and the entry for each firm gives:-
• its name, address and telephone number.
• a unique SIB number
• its authorisation status (i.e. whether authorisation has been surrendered by the firm or revoked by the regulator, or it is one of an interim authorised firm whose application has yet to be determined), together with starting dates and the applicable part of the Financial Services Act.
• the name of its regulatory body
• whether it can handle clients' money.
• a brief description of the type of investment business conducted by the firm.
• warning messages - for example. following suspension by a regulator, or other action taken.

The information is updated daily, and any significant changes that have arisen within the previous seven days will be shown as a list at the beginning of the register. These would include:-

• when a firm is no longer authorised
• when a firm has been publicly suspended from carrying on business by its regulator.
• when a firm is no longer able to hold clients' money.

Access to the Central Register can be gained by writing to SIB, or by telephoning SIB on a special number devoted solely to register enquiries, 071-929-3652.

2. Polarisation

A fundamental aspect of the Financial Services Act legislation is the concept of 'polarisation'. An investment adviser must be either:-

• A representative of only one life office (or marketing group) who can sell and advise on the products of only that company or (marketing group). The representative's activities are regulated indirectly by the body regulating the activities of his/her respective life office, which may be LAUTRO or IMRO.

  or

• An Independent Financial Adviser (I.F.A). 'Independent intermediary' and 'Broker' are alternative names for an I.F.A., and the distinction between these terms is drawn later in this note. Both the I.F.A. and the Broker must be a FIMBRA member - or, subject to conditions, a member of a recognised professional body.

Either category may alternatively be regulated directly by the SIB.

There were other consequences of the Financial Services Act which directly affected the agents and brokers, but the polarisation principle, together with the 'policing' of the industry by the SROs were the most far-reaching as far as the intermediaries were concerned. The protection afforded to the customer came, inter alia, via the requirement by the adviser to ensure, and keep detailed records to demonstrate, that the advice given to each client is unbiased, appropriate to the client's needs, and is based on a full understanding of the relevant investments available.

Whilst the Financial Services Act has brought about drastic changes in the marketing of life, pensions and investment business, the general insurance market has also undergone considerable upheaval. As a result of the general economic climate and heavy claims experiences, insurance companies have increased premium rates beyond the rate of inflation. Whilst at first sight increased premiums equate to increased commission income, in practice, the effect has been to increase the scope for the direct insurers at the expense of the traditional insurance brokers and agents.

'Insurance policies are sold - not bought'.

This maxim is fundamental to the insurance industry and puts into perspective the key role of the salesman as the contact point between the insurance company and the potential customer. In theory, at least, the 'broker' acts on behalf of the client, whereas the 'agent' is the representative of the insurance company. There is, however, much common ground between the two, not least of which is the means by which they are rewarded for their services.

1. Insurance Brokers

Any person, firm or company calling itself 'Insurance Broker' must be registered with the Insurance Brokers Registration Council in accordance with The Insurance Brokers (Registration) Act 1977. Insurance Brokers, by definition under this Act, are known as either practising insurance brokers, which are sole proprietors and partnerships, or enrolled bodies corporate, being limited liability companies. In order to be registered with the IBRC, firms must comply with the IBRC Code of Conduct; IBRC Accounts and Business Requirements Rules; and the IBRC Indemnity Insurance and Grants Scheme Rules. In addition, a minimum of 3 years experience in the industry, and/or appropriate qualifications are a prerequisite for acceptance as a broker.

Once they become insurance brokers, they must maintain the standards laid down by legislation, and if the requirements are breached in any way, charges of unfitness or unprofessional conduct may be dealt with by the Disciplinary Committee. The constitution and procedures of the Disciplinary Committee are established by statute, and its decisions may only be challenged in the High Court.

The code of conduct covers a number of guidelines on the standards to be maintained, principal among which is the requirement to provide advice objectively and independently. Each insurance broker must demonstrate annually that the number of insurance companies with which they place insurance business, and the amount of insurance business which they place with each insurance company, is such as to prevent their business becoming unduly dependent on any particular insurance company. The code of conduct specifically forbids any broker from becoming 'tied' to any insurance company.

The code of conduct also requires brokers to clearly identify any amount they propose to charge the client (i.e. in addition to the premium).

The IBRC accounts and business requirements rules stipulate that one (or more) separate bank account(s) with an approved bank must be maintained, into which all monies relating to insurance transactions of any kind in connection with their business, including brokerage must be paid. The account is to be designated 'Insurance Broking Account', and the title must contain the name of the practising insurance broker or enrolled body corporate or the names of the partners as applicable.

The rules also specify that practising insurance brokers must ensure that their accounting records are sufficient to show and explain the transactions of the business, and to disclose with reasonable accuracy the financial position of the business at the time. In particular, the records must contain entries from day to day of all sums received and expended in the course of the business, and the matters in respect of which the receipt and expenditure takes place. They must also record the assets and liabilities of the business. The records must enable compliance with the IBRC rules to be demonstrated at any time, and must be retained for a minimum of 3 years.

The annual accounts must comprise a balance sheet, a profit and loss account and notes to the accounts sufficient to show a true and fair view of the business as at the relevant date, and must be submitted to the IBRC within 6 months of the accounting period. The profit and loss account must:-

• show the total revenue of the business, dividing such revenue between that directly derived from insurance broking business and all other revenue. Where any 'other' revenue is reported, the nature of the business from which it derives must be disclosed.
• classify expenditure grouped under appropriate headings;
• show or disclose by way of note to the account the total brokerage contained in the account.

Additionally, a practising insurance broker must send a statement of particulars to the IBRC within 6 months of the end of the financial year to demonstrate compliance with the IBRC rules, which specify solvency margin requirements of :-

• insurance transactions assets at least equal to insurance transactions liabilities.
• working capital of at least £1,000.
• total assets to exceed total liabilities by at least £1,000.

The statement of particulars comprises 4 sections, as follows :-

• Summary of assets and liabilities.
• Questionnaire concerning undue dependence on particular insurance companies.
• Certificate of correct completion.
• An accountant's report of the statement of particulars.

The Indemnity Insurance and Grants Scheme Rules require each firm to maintain a policy of professional indemnity insurance against legal action by clients who have lost money as a result of the broker's advice or actions. The minimum cover required is £250,000 on an each and every claim basis, or £500,000 in the aggregate, or three times the annual brokerage of the firm, whichever is the greater.

For the purposes of the Financial Services Act, insurance brokers come in the main under the auspices of FIMBRA, although smaller brokers can satisfy the registration requirement merely by virtue of membership of IBRC, and additionally, some large firms, including some Lloyds brokers are authorised by IBRC for investment business.

Initially, a broker who did not handle client monies, and whose brokerage from investment business activities did not exceed 25% of the total income qualified for this exemption from FIMBRA, but subsequently this threshold was extended to 49% of total income.

At present, approximately 4,200 firms are registered with the IBRC, of which 1,500 are authorised to carry out investment business.

A broker will be an agent for a number of insurance companies, and may also be an agent for syndicates at Lloyds. In theory, at least a broker will have access to any insurance company. Whilst he naturally may be attracted to the companies that offer the higher rates of commission, nevertheless, to comply with the FIMBRA and IBRC regulations he has a duty to provide and to evidence the principal of 'best advice'. He is also obliged to disclose the rate of commission to his client if this is requested.

If a broker places insurance with a company for whom he will get no commission, he may ask for a fee instead. Generally his service in providing information and quotations is likely to be free, as the commission on the policy finally arranged is normally his reward. He may however levy a 'policy charge' for the arranging the policy, but any such charge may not, under the terms of his code of conduct, be disguised as part of the premium. The charge may alternatively be described as an 'initial charge' or an 'administrative charge'.

The services of the broker do not necessarily end at the point when the policy has been arranged. His services may well be called upon in connection with a claim on an insurance policy. His expertise and standing with the insurance company may be more effective in getting a satisfactory settlement than an individual could achieve on his own. The broker may well charge for this service.

Brokerage firms vary in size from single principals to organisations as large as some of the insurance companies. There are many firms within this range, some offering a comprehensive service covering all aspects of the insurance market, while others specialise in particular types of insurance cover.

2. Insurance Advisers

An insurance intermediary who is not a registered Insurance Broker may also describe himself as a 'consultant', 'specialist', 'adviser', 'agent', or any other description he sees fit other than 'Broker'. He may sell exactly the same products as a broker, for the same premium. Unless he is undertaking investment business, the insurance intermediary is not, however, required to register with any regulatory body. The insurance intermediary (or broker) who specialises in the general insurance field is not therefore directly affected by the Financial Services Act, 1986. Whilst a 'broker' is, in theory at least, bound by the rules and code of conduct of the IBRC, there is no equivalent statutory control governing the actions of other insurance intermediaries operating in the general insurance field.

However, the Association of British Insurers (ABI), has formulated its own Code of Practice, which its members must undertake to enforce. The ABI's membership comprises the majority of UK. insurance companies, accounting for 97% of the world-wide long-term premium income and 90% of the general insurance premium income of UK. insurance companies. Its members are required to use their best endeavours to ensure that all those involved in selling their policies observe the provisions of the respective Codes of Practice. .

Separate, though broadly similar codes of practice apply to the selling of general insurance business and of life insurance (non-investment) business, neither of which were covered by the Financial Services Act 1986. A Code of Practice was originally introduced in 1981, but the codes in their current form took effect from 1989.

The current codes are directed towards those intermediaries who are not Registered Brokers. It is necessary for insurance companies to agree with intermediaries their precise status, and also, where an intermediary is the agent of more than one company, to ensure that he is classified in the same way for all the companies for which he is agent. To this end, the intermediary has a certificate showing his status. With effect from 1989, standard criteria were laid down by the ABI with regard to the appointment of agents, covering aspects such as detailed information on an applicants present and past businesses, professions and occupations; their qualifications and insurance experience; and references from bankers, accountants and auditors. In addition, the intermediaries are required to effect professional indemnity insurance providing much the same protection as that required by registered Insurance Brokers.

The Code of Practice set out general sales principles to be followed by the intermediary which are similar to those laid down by the IBRC. With regard to accounts and financial aspects, the intermediary must, if authorised to collect monies in accordance with the terms of the agency appointment, keep a proper account of all financial transactions with a prospective policyholder which involve the transmission of money in respect of insurance; acknowledge receipt of all money received in connection with an insurance policy and distinguish the premium from any other payment included in the money; and remit any such monies so collected in strict conformity with his agency appointment.

The Code has received wide acceptance and support from the Department of Trade Insurance Division, and its introduction and effective operation was regarded as a prerequisite to avoid statutory controls. As a consequence, the operation of the code is a requirement not only of ABI members, but is also commended by the DTI to non-member companies and Lloyds underwriting syndicates

Intermediaries who are engaged in investment business are required, under the terms of the Financial Services Act, to be regulated either by SIB or a self regulating organisation (principally FIMBRA or LAUTRO) or a Recognised Professional Body, or, alternatively, to be appointed as an 'appointed representative' by a firm regulated in one of these ways. FIMBRA regulates the independent sector whereas LAUTRO regulates the tied sector. Prior to the Financial Services Act, it was not unusual for an agent to switch allegiance from one insurance company to another. The new regulations now serve to restrict this freedom of movement, particularly where it is merely commission led, and the polarisation principle aims to enable the potential customer to appreciate the status and interests of the seller.

3. The Financial Intermediaries, Managers and Brokers Regulatory Association (FIMBRA)

In its capacity as the regulatory organisation concerned with the investment advice and services provided by independent firms to the general public, FIMBRA has a duty to ensure that its members are 'honest, competent and solvent', and that they remain so. In order to join FIMBRA, and applicant must satisfy the organisation that he has these attributes. The principle criteria by which an applicant firm is judged are:-

• The firm's principal(s) should have at least 3 years relevant experience in investment business:
• Other individuals to be registered should have at least 2 years experience.
• From September 1992, all individuals newly applying for registration will be required to have passed the Financial Advisers Competence Test, examined by the Chartered Insurance Institute, or possess an equivalent or higher qualification. Further training modules are being introduced, leading to a Financial Planning Certificate, which, with some exemptions, all individuals registered by FIMBRA as at January 1994 will be required to attain.

In addition, financial information is required to be submitted depending on the nature of the firm, and whether or not it has traded before. In either event, statements of personal assets and liabilities are required in respect of the proprietor in sole trader cases, and each partner in partnership cases. If a business has not traded previously, an opening balance sheet is required, together with a forecast profit and loss account for the first 12 months trading. If a business has previously traded, a set of accounts not more than 12 months old at the date of submission is to be provided. Such statements must reflect minimum financial resources according to the membership category for which application is being made.

FIMBRA Membership Categories

Depending on the scale of operation, and the nature of the investment work undertaken, FIMBRA members were originally categorised as follows;-

A revised FIMBRA rule book, aiming to simplify membership, and at the same time to tighten up on the statutory requirements, has recently come into force, which reduces the categories of membership from 8 to 3. These are as follows:-

• Category 1 - members may be involved in any investment business regulated by FIMBRA. They may handle client money or assets.
• Category 2 - members may be involved in any investment business regulated by FIMBRA except dealing as principal with clients. Any purchases or sales of ready realisable securities must be arranged through a stockbroker. They may handle client money or assets.
• Category 3 - members may be involved in the same area of business as those members in category 2. They may not, however, handle client money or assets.

Where members are authorised to handle clients' money, a separate 'client account' with an approved bank has to be opened.

Membership of FIMBRA is secured by means of an entrance fee and an annual subscription. With effect form April 1992, the initial application fee for membership was £1100. This figure includes three individual registration forms. For each additional registered individual is subject to a fee of £150. The annual subscription depends on the firm's size and the category of authorisation:

In addition, members of FIMBRA must contribute to The Investors' Compensation Scheme, which was set up under the Financial Services Act. The general principle is that if a failure occurs within the Self Regulating Organisation (SRO), the remaining members of that SRO share the cost of compensating private investors who lose money up to a maximum of £48,000 per investor. The levy is due from all investment businesses in full on 1st April of each year. The 1991/92 levy was as follows;-

Specific permission has to be obtained from FIMBRA by members wishing to engage in certain classes of investment business. This includes activities such as the operation of Managed Funds, acting as plan manager of a Personal Equity Plan and providing guarantees of investment performance. Additional fees and charges are payable in respect of these and other activities, and full details of these are to be found at Appendix 3 of this note.

Members of FIMBRA are required to maintain certain standards of accountancy and record keeping according to their membership category.

Category A members were required to maintain accounting records on a daily basis which were sufficiently detailed to explain each transaction and to reveal the member's financial position.

Category B and C members were required to maintain more detailed accounting records, and to reconcile their accounts every 5 weeks and their investment holdings for the clients every 6 months. All categories were required to prepare an annual financial statement, and category C1 and C2 members were required to prepare monthly financial statements. Category C3 members had to prepare monthly statements.

In addition, all firms were required to complete a questionnaire twice yearly, with the records to be kept for a minimum of 7 years. The records were to show separately commissions received in respect of each of the different types of transactions effected or arranged.

Appendix 5 provides a summary of the financial resources and reporting requirements under the simplified set-up.

FIMBRA monitors its members' activities through random checks at intervals determined by the type of business in which each firm is engaged, and by the regular reports from its members outlined above. Firms which handle client's money or are engaged in 'Special Activities' are visited by FIMBRA more frequently than those that do not. Failure to comply with FIMBRA's code of business rules may constitute prima facie negligence, which could result in action by FIMBRA, which can range from a fine to suspension of a member for indefinite period if serious breaches of the rules are found to have taken place. A suspension usually precedes further investigations, and prohibits a member from conducting any business authorised by FIMBRA.

Some 6200 firms are members of FIMBRA, and there are in excess of 21,000 registered individuals.

4. Tied Agents

It will be seen from the foregoing that the burdens imposed on the independent insurance adviser who wishes to undertake long term insurance or investment work are substantial, both in terms of financial commitment (membership fees and annual subscriptions) and the compliance cost entailed in maintaining records that can demonstrate the 'best advice' principle, as well as the standards of record keeping and accountancy that are demanded. In many respects the 'tied' agent's life is far simpler, with fewer overheads to sustain, and compliance costs greatly reduced.

This is not to suggest that a lower standard of regulation subsists in respect of tied agents in comparison with independent advisers. LAUTRO has strict requirements relating to the provision of 'best advice', and the maintenance of appropriate records, etc. These and the many other requirements which are laid down in order to protect investors are monitored by LAUTRO in regular inspection visits.

The tied agent benefits from the provision of training, offices, computers, telephones and stationery, and compliance assistance from his/her respective life company, and it is, therefore, perhaps not surprising that as a result of the Financial Services Act there has been a tendency for many insurance agents/consultants to become 'tied' to one of the major life companies.

Currently tied agents account for approximately 60% of all new business written by life companies. Appointed representatives (that is tied agents) of life offices include sole traders, partnerships and companies. they include, for example, building societies, estate agents as well as investment firms.. Indeed, a significant number of building societies constitute a tied agency under these terms, although this paper does not seek to cover that particular aspect of the insurance market.

It should be noted that the 'tie' can relate to a marketing group of companies as opposed to just a single entity. Many life companies divide their organisation into separate branches for the marketing of specific products or types of policy, and the tied agent's authority may extend across a range of products depending on the extent of training undertaken and experience gained.

An individual selling the company products who is either employed by the 'appointed representative' or is himself the appointed representative is usually referred to as a company representative or associate, but these terms are not particularly important in the context of the status of the salesman. Indeed, some employees are described as company representatives.

The 'polarisation' aspect of the Financial Services Act brings into focus the question of the appropriate status for tax purposes of the appointed representatives, who, as a direct consequence of the Act, have found their activities restricted to selling the policies of just one company. The correct schedule of charge cannot, however, be determined by this factor alone, and many salesmen in the industry are regarded by the Revenue as being 'in business on their own account' usually because of the financial consequences of the particular contract they enter into. Some insurance salesmen work under contracts of employment, whilst others work under contracts for services. The correct status can only be determined by examining the contractual arrangements in full.

Among the reasons for intermediaries tying are:-

• High commission paid compared with independent advisers. A comparison of commission rates paid to tied and to independent advisers can be seen at Appendix 1.
• Large loans made available to agents by the life companies. Three principal areas for which loans are given are repayment of debt, for business development, and most commonly against future commission earnings. Such loans can, however, 'tie' the agent in more senses than one, as LAUTRO rules place a duty on companies not to recruit as an agent a person who is in debt to another company by an amount over £1,000.

Many life companies set a minimum premium income that tied agents have to have written and able to write if they wish to tie to the particular company. Typically the average level is set at £50,000 expressed in terms of premium income.

The tied agency may comprise one individual working on his own, or it may comprise a structured sales force headed by an 'Area Manager', supervising a team of field representatives in a 'pyramid' type of organisation. Bonus systems operated by the life company are likely to apply to the agency as a whole, while the incentives for the individual sales representatives may be set by the area manager.

LAUTRO has recently laid down comprehensive training requirements for tied agents, which its members are in the process of implementing. These new requirements include initial training of 2 weeks minimum, followed by at least 6 weeks on the job training. Thereafter the agent must pass an assessment of competence within 6 months, before they are fully qualified to give financial advice. This is to be followed by an annual competence assessment for all representatives, including managers to ensure that competence is maintained. In practice, the training given by life companies of new agents has averaged a maximum of 2 weeks in total.

LAUTRO's rules on record keeping by company representatives place the onus on the member company to whom the agent is appointed to set appropriate standards. The rules specify that a company representative shall -

• keep a record in the form required by the Member of all transactions with investors which involve the transmission of money; and
• keep such other records as the Member may require of his dealings with investors;

and such records shall be kept for such a period as the Member may specify. The guidelines are amplified by the requirement that Members must ensure that appointed representatives must maintain sufficient records of the business it carries on to show and explain the representative's transactions, and to disclose with reasonable accuracy, at any time, the financial position of that business.

Additionally, LAUTRO'S rules insist that a company representative shall acknowledge in writing receipt of all money (other than cheques) received from an investor and shall forward promptly to the Member all money due from him to the Member.

The Central Registry has already been mentioned as a reference point for practitioners in investment advice. A further reference point covering a wider scope of insurance activity is The Insurance Directory and Yearbook (Post Magazine Green Book), which is issued annually and comprises 3 volumes :-

• Volume 1 - Insurance companies - Lloyds Syndicates - Unit Trusts;
• Volume 2 - Brokers and Intermediaries;
• Volume 3 - Statistics.

Volume 2 lists all firms of brokers and intermediaries belonging to one or more of FIMBRA, IBRC and ABI. The entries are listed in the towns in which they are located, and also, separately, in alphabetical order. Each entry provides the firm's name and address and telephone/fax number; the date the firm was established; and names of partners or directors as appropriate together with information on the classes of insurance dealt with. It also shows the location(s) of any sub-branches of the firm. The directory is likely to be found in the reference section of the public library.

A further reference point for information on intermediaries who are engaged in the provision of investment services that come within the sphere of the Financial Services Act and who are members of FIMBRA is the FIMBRA Membership Directory. This provides an alphabetical list of members together with their basic details and information on the specific types of activity in which they are engaged. The appendices include a post code order listing of firms within each county; an Activity Index showing which firms specialise in particular types of investment business; and a New Additions Index listing FIMBRA members not in the previous year's directory.

For the vast majority of insurance intermediaries, whether tied or independent, payment of commission represents the major element in their income. Rates of commission vary according to the type of the policy; the particular insurance company concerned; and the status of the adviser. For long term insurance, LAUTRO set out recommended rates of commission for specific types of policies under the 'maximum commission agreement' (the MCA), and following the Financial Services Act, LAUTRO members agreed to apply the maximum commission rate in respect of commission paid to the independent intermediaries.

The aim was to ensure that the differences in commission rates did not affect the advice given to their clients. However, no such restriction was imposed on the tied agent. In due course this factor was eliminated with the abandonment in 1989 of the maximum commission agreement. although the agreement does generally form the benchmark for rates now being paid. Many life offices still refer to the scale set by LAUTRO, quoting their rates of commission in terms of '100% LAUTRO' or '130% LAUTRO'. A report by LAUTRO in February 1992 revealed that tied agents are paid higher levels of commission than the independent financial advisers, on top of the assistance given to the tied agent by means of stationery, marketing aids etc.

The method of payment also varies from one insurance company to another according to each company's individual sales plan, and the terms of its specific agency contracts designed to best serve that plan. Essentially commission is calculated as a percentage of the premium paid by the client. Different types of policy, however, attract different schemes of commission payment. In particular long term policies are likely to offer the seller both 'initial' and 'renewal' commission.

Initial commission is calculated on the premiums payable during the 'initial earnings period' of the policy. This is determined by the particular type of policy and the number of years that the policy is due to run, but will not exceed 4 years. The following are examples of the maximum initial periods for certain types of policy:-

Renewal commission is normally payable annually from the conclusion of the initial period, and typically it is set at 2.5% of each premium. The table at Appendix 4 gives further details on the initial periods for different types of policies as well as the rates of commission set under the MCA.

With most of the longer term policies, intermediaries can opt to receive their commission on what is known as the 'indemnity' basis. A wide variety of different indemnity schemes are operated by the life companies, but generally, under such a scheme the salesman may receive all or most of the initial commission immediately following payment of the first premium due on the policy. The seller is required to indemnify the insurance company in the event of payments of premiums lapsing during the initial period. If payments do lapse during this period, he (or she) will be called upon to repay the relevant proportion of the initial commission received. A claim of this nature by the insurance company is termed 'clawback'.

The payment of the initial commission under these terms may well be subject to a discount, and certainly interest would be charged on late repayment of a clawback. In practice, the amount of the sum clawed back would simply be debited to the agent's ongoing account with the insurancecompany. An example of commission paid on indemnity terms illustrating the potential clawback is shown at Appendix 1.

For general insurance the commission is a straight-forward percentage of the premium paid. For certain types of insurance the rate may be higher for the first year than for subsequent renewals. A case in point here is very often house contents policies. Commission structures are very much determined by market forces and therefore vary according to companies and types of products. As such, there is no central source of information on general insurance commission rates. However, research has indicated that the prevailing commission rates for general insurance are fairly consistent, with motor insurance typically around 10% (fleet insurances 7.5%), and fire, home owners, general liability, work accidents and other risks - individual or industrial averaging around 15%. Certain types of insurance attract higher rates of commission. For example travel insurance commonly attracts rates in excess of 30%.

In addition to the standard commission received, the tied agent may also receive 'bonuses' which may take the form of 'volume overriders' - increased rates if the agent has placed a particular level of business with the respective insurance company; prizes for attaining certain targets, which may be in monetary or gift form; and 'promotional expenses' made to reimburse the agent on occasions where the company's budget for a particular promotion has been exceeded. Some insurance companies operate a points system to reward agents attaining targets which typically may be in relation to premium levels or numbers of policies sold. As points mount up, they can be 'cashed in' for prizes of various kinds.

Incentives such as volume overriders are forbidden to the independent intermediaries, who must ensure that their 'best advice' duty is not compromised in seeking to acquire requisite level of business with one particular insurance company. FIMBRA are likely to require an explanation or justification if more than 20% of an independent adviser's business is placed with one company.

A frequent feature of agents' or brokers' income is 'shared' commission. This is likely to arise where the intermediary has an arrangement with, typically, a solicitor, accountant or estate agent, who, in the course of their business, has a client in need of insurance advice. Whilst many such businesses may have expertise in the insurance world within the firm, others will have an arrangement to introduce the potential client to an insurance broker or agent. The commission arising from such introductions is normally shared, either on a 50/50 basis, or according to the amount of work undertaken by the respective parties in obtaining it.

Commission may also be shared with a client. This aspect of commission sharing is discussed in the next section of this note.

As indicated earlier, an agent or broker may well earn fees, which may be in addition to the commission receivable in arranging a policy; instead of the commission; or for services not directly related to securing business for an insurance company - e.g. assisting the client in a claim arising out of a policy. The principal legal consideration is that the agent is obliged to make it clear to his client that such fees are not part of the commission that may be due.

Fees are commonly charged to larger clients or businesses as an alternative to commission where the clients require a number of different sorts of insurance. Often the commission (or part of the commission) is 'rebated' or 'sacrificed' to the client to either provide further benefits to the policy or policies being arranged, or as a direct incentive to the client proprietor or director concerned. Either way, the object is to achieve a competitive advantage over rival intermediaries in order to secure or retain business.

Increasingly, there has been a trend towards fees as a basis for charging as opposed to commission, often with a flat rate charge to the client, with the commission - or most of it - passed on to the client by means of a rebate or policy enhancement. In cases where the commission has been paid on indemnity terms, and in the event of the policy lapsing during the initial period, the adviser may well be liable for commission clawback on money that he has effectively 'given away' or rebated.

The retention of client monies pending the requirement to forward the net premium to the insurance company clearly affords the agent the opportunity to accrue building society or bank interest on funds held, and such interest may represent a significant element of his income. This aspect, of course, relates only to those intermediaries who are permitted to handle client monies.

The nature of the broker's or agent's business largely determines the extent of the records that are maintained. As previously indicated, a bona fide 'broker' is obliged, by virtue of his affiliation to the IBRC to adhere to certain standards of record keeping. Membership of FIMBRA confers similar obligations. The records may well, however comprise quite different procedures with regard to the separate facets of general insurance and investment business within the scope of the Financial Services Act. Indeed, it is not uncommon for a broker company dealing across the range of the various types of insurance products to divide his business up into quite separate entities, each dealing with a particular aspect of the overall business.

With regard to general insurance, it is common for clients to pay a deposit or the whole premium for a policy direct to the agent who may well pay it into a designated client account. The client is then legally covered for insurance purposes, but there may be an administrative delay of up to 4 weeks whilst the insurance company produces the policy documentation to the agent. At this stage the insurance company invoices the agent for payment of the premium, normally allowing 30 days credit, although some companies allow a longer period of credit of 60 or even 90 days. The agent in turn pays the net amount due to the insurance company, having, where applicable, obtained any balance due from the client, and after deducting his commission. In practice, this may well be about 2 months after receipt of the initial premium, or later where a longer credit period is allowed.

In addition, it is quite common for brokers and agents to allow clients credit, with the result that the policy may well be arranged before the premium has in fact been paid. In these circumstances, the agent will withhold the policy pending receipt of the premium (or balance thereof) from the client. In the event of the client changing his mind and deciding not to proceed with the purchase of the policy, the agent will have a credit entry on his commission statement, equivalent to a 'credit note'. Such entries are sometimes termed 'reversed premiums'. Similar arrangements can apply where the agent is authorised to handle client monies in transacting business covered by the Financial Services Act.

The larger insurance companies issue monthly statements to all agents who deal with them regularly, setting out details of policies taken out - or cancelled - and the resulting commission due to the agent. The commission statements will normally also include details of any bonuses earned, as well as information concerning commissions paid on indemnity terms, and the position with regard to any loan arrangements entered into with the agent.

With long-term/investment type insurance, unless the agent is authorised to handle clients' money, it is normal for the client to make payment direct to the insurance company, and for the insurance company to remunerate the agent with his commissions on a monthly basis accompanied by the monthly commission statement. Payment by the insurance company will normally be either by cheque, or by crediting the agent's bank account.

In cases where the agent or broker is involved in investment business within the scope of the Financial Services Act, and is authorised to handle client monies, it is not uncommon for separate accounts to be opened for individual clients or for specific groups of clients, especially where large sums of money are involved.

The sole trader tied agent, without the administrative constraints imposed on the independent agent, and without any complication by way of fee income, should be able to produce a precise account of his earnings simply by reference to his commission statements, and commonly, this, together with a record of business expenses, hopefully appropriately vouched, is the extent of the records required for the preparation of his accounts. LAUTRO rules additionally require the maintenance of client details by tied agents.

Detailed client files are likely to be an important element of the agent's or broker's records. In particular the independent intermediary dealing with long-term insurance is required to maintain detailed client records to satisfy the regulations of FIMBRA and/or the IBRC. Detailed notes of advice given and business secured not only provide a reference point for possible future business, but also provide documentary evidence which may be called upon in the event of a claim by a client alleging inappropriate advice.

In common with most concerns, increasing use is made of computer systems for a wide variety of business applications. In particular, computerised fee and commission management systems are now available to agents which analyse and reconcile commissions earned and premiums paid.

The appropriate taxation treatment of payments made to their agents by insurance companies is a regular topic of debate between Inspectors and the recipients. The overriding advice where a dispute of this nature arises is that the correct treatment of any item of payment can only be established from studying the precise terms of the relevant agency agreement.

Tax Bulletin issue number 5 published in November 1992 offers an insight into the thinking of the Inland Revenue's technical specialists on this subject, and the relevant section is reproduced below.

As the note suggests, there are numerous variations in the precise terms of agency agreements. Only one - albeit the most common - is addressed here, and other variations will need to be considered by reference to their own particular facts. Where for example commission is only paid as regular premiums reach the insurance company, and the right to that commission lapses with the termination of the agency, the Revenue would accept that the commission should be recognised only as it becomes receivable.

Initials and abbreviations used.

Example of payment of commission on the indemnity basis.

Mortgage endowment policy arranged - premium payments of £100 per month/£1200 per annum.

• Initial earnings period - 38 months.
• Initial commission rate - 25%;
• Renewal commission rate - 2.5%.
• Discount - 1% per month compound.

Initial commission = (£1200 x 25% x 38%)/12 = £950

Discounted initial commission - £794.76

Under the indemnity terms, the agent receives the initial commission of £794.76 immediately on receipt of the first premium by the insurance company.

In month 39 renewal commission of £30 is receivable annually for the duration of the policy. (i.e. £1200 X 2.5%)

If, however the policy lapses after, say, 12 months premiums have been paid, then £575.64 would be reclaimed, or 'clawed back' by the insurance company, calculated as follows:

(£950 x 26)/38 = £650 - (less discount) = £575.64.

Comparison of commission - LAUTRO commission surveys 1990/91

Investment business requiring separate authorisation of FIMBRA

LAUTRO recommended rates of commission under the Maximum Commission Agreement (abandoned in 1989

FIMBRA financial resources and reporting requirements