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Broking changes highlights tensions
By Tim Goodger and Alex Booth of Elborne Mitchell
First published: Insurance Day [14th July 2005]

THE new rules imposed by the UK's Financial Services Authority (FSA) have brought into
the open tensions that have always existed between brokers and underwriters which they have
not necessarily addressed up to now. These questions concern the who in an insurance
transaction bears the credit risk of a broker's default or insolvency.

At any one time brokers hold hundreds of millions of pounds on behalf of clients or
underwriters. While the risk of default may be remote, it does happen and the consequences
can                                         be                                    far-reaching.
As of today, an agreement that credit risk will be borne by the insurer rather than the
policyholder (so-called "risk transfer") must be recorded in writing and, generally, the easiest
place to record it is in a terms of business agreement (Toba).

Brokers and underwriters alike have been generating a raft of different agreements for
particular types of business, resulting in numerous variations in terms and requirements. This
is where the potential for conflict lies. What happens if the two parties cannot agree?

As the July 14 deadline has approached, people have been working ever more urgently to
comply with the FSA's rules. The resulting Tobas could prove, in some cases, to be awkward
or impractical.

Alternatively, if either party feels a Toba has put them at a disadvantage, they might try to
reopen the issue. In that sense these agreements may become a tug of war, with brokers
gaining the upper hand as the market softens and underwriters benefiting as it hardens. In
some cases Tobas have been used to advance more burdensome business terms than those
that might otherwise have been imposed had underwriters not agreed to risk transfer. Whose
terms are accepted is sometimes a question of who has the greater commercial muscle.

In this article we consider some of the practical issues, especially those facing brokers and

When drafting or reviewing a Toba, it is helpful to do so from the standpoint of whether the
obligations are appropriate to the broker and the relevant class of business to see whether the
broker is realistically able to comply with them, and if they fit existing procedures.

Particular terms might be better for one party's cashflow or give more or better protection
than that party might otherwise enjoy, or may impose an administrative burden on the other
party. If there has been a prior trading relationship, governed perhaps by other terms, the
parties should ascertain if there is an intention to change those.
Brokers generally should make sure the terms in their different Tobas (client to broker and
broker to insurer) dovetail and ensure consistency. Every broker should consider whether it is
able to account to the underwriter and draw on the commission payable to it in a timely
manner          to        allow        for        its       business       to       operate.
Brokers and insurers or at least those with less sophisticated back-office functions will be
presented with an increasing administrative burden of monitoring a multitude of terms and

The LMBC (London Market Brokers' Committee) model Toba provides the potential for
consistency but already many terms are being tweaked so that policing the terms of the Tobas
becomes an issue.

There can be unwitting credit risk, and therefore uncertainty and ambiguity should be
addressed. Parties should consider if the Toba has a prospective effect only or whether they
expressly acknowledge risk transfer where it did not exist previously in a trading relationship.
Tobas may affect the terms of agency agreements or binding authorities between the parties
and attention should be given to whether those terms are superseded or there is friction
between the two.

For insurers there is the additional question of whether to permit co-mingling of money held
on their behalf with policyholder money in the broker's statutory or non-statutory trust
account. The rules allow brokers to keep both in the same account as long as they have the
insurer's written consent.

Nothing new in that, but there is one important difference. In the event of failure of the
broker, insurer creditors now come behind policyholders when it comes to payment of
creditors. In the past with old-style IBA accounts, parties would have been treated equally.
But crucially, the statutory or non-statutory trust account is protected from general creditors.

CASHFLOW                                                                     CONSTRAINTS
Tobas may affect cashflow by placing additional time constraints on brokers to process
premium payments and because insurers insert premium payment warranties in policies such
that receipt of premium by the insurer, rather than the broker, satisfies the obligation to pay
premiums within a particular time period. Although the LMBC model states brokers should
use reasonable endeavours to settle premium, other Tobas may seek to charge interest
payments at semi-penal rates on the late settlement of premium to incentivise the broker.

Some insurers may not agree to risk transfer simply because the trading relationship with a
broker is not established or security is inadequate. This may lead to consideration of whether
additional security, such as guarantees, is required from the broker or, at the very least, some
due diligence exercise on the broker is undertaken prior to doing business.

These changes should mean greater clarity and force the market to confront issues that have
been there all along for example, where monies have been placed in an IBA they were not
necessarily protected from the firm's general creditors. Winners will include those with the
clout and negotiating skills to make their agreements stick. Buyers of insurance will find their
interests better protected due to the prevalence of risk transfer or the operation of trust
accounts where money is held on their behalf.

Losers will include anyone who ends up taking a disproportionate share of the credit risk.
Finance directors may want an active part in negotiating Tobas because of the impact on
cashflow. Brokers will no longer have the same opportunity to hang on to large balances.
There is potential for a cashflow crunch for some smaller broking firms in four or five
months time.

   •   A Terms of Business Agreement (Toba) is an agreement setting out the basis on
       which two parties do business
   •   In the insurance industry, Tobas are generally between broker and insurer or between
       broker and client
   •   Tobas should clarify at whose risk a broker holds premium and claims money and
       where/how it is held


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