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Proposed lease reform bill is ‘red flag’ for industry over property insurance commission disclosures

By on July 29, 2022 0

The Lease Reform (Disclosure and Insurance Commissions) Bill – which would make it compulsory for landlords to disclose commissions – was introduced as a private member’s bill in the House of Lords at the start of the month (July 14, 2022).

Introduced by Lord Kennedy of Southwark, the bill would also prevent landlords from recovering service charges from their tenants if they fail to meet their disclosure obligations.

While private members’ bills rarely make their way into law, the fact that MPs have begun to agitate over this issue is further evidence of how the winds are beginning to blow for the insurance industry. .

In January this year, former Levels, Housing and Communities Secretary Michael Gove ordered an investigation into the buildings insurance market over concerns about ‘unfair service charges’ being charged to tenants .

In May, the FCA announced it was collecting data from the insurance industry to help inform “potential interventions” such as limiting commissions for insuring multi-occupancy buildings, should it identify fees paid to brokers as a “significant cause of harm”.

The financial regulator also said it would consider changing the rules to allow tenants access to information about insurance policies purchased by freehold owners – something the Tenancy Reform Bill would also require in its current writing.

If the FCA were to introduce these rules, it would remove the need for government intervention – the regulator could change the rules to protect the public interest within its mandate to ensure financial markets are “honest , competitive and fair”.

Earlier this week (July 27, 2022), the FCA published the final rules for its landmark consumer bond settlement, which requires insurance companies to review their products and services against a new fairness standard. – one of the four standards forming the basis of this regulation was fair price and value.

The regulator explained that Consumer Duty was part of its intentional transformation into a “more assertive” regulator. He has also previously raised concerns about hidden compensation elements and ordered fairness to tenants factored into business value assessments.

However, financial regulators have been aware of these problems since at least 2005.

In an unpublished Financial Services Authority (FSA) report seen by insurance time – dated July 21, 2005 – the regulator, which was replaced by the FCA and the Prudential Regulatory Authority in 2013, confirmed that it was aware of a market structure that created a “monopoly position” of the free owners on the tenants with regard to the expenses of the insurance services of the buildings.

Michael Sicsic, chief executive of financial services risk and regulatory consultancy Sicsic Advisory, said the recently introduced lease reform bill should act as “a big red flag and warning to the market for to say that Parliament seems to want to enforce, by law, the disclosure commission”.

Unfair practices?

Tenants and tenants of apartment buildings – usually those who live in apartments – are indebted to their free owners, who take out insurance for the building themselves or through a condominium trustee.

The problem, identified by the FCA, is that tenants do not have the option of obtaining their own buildings cover or even seeing the policy they are insured under because they are not defined as the customer under the laws on the property.

This means that freeholders or their agents can then agree to higher cover premiums, which benefits an insurer and allows brokers to levy higher service charges which can be used to pay a commission to the freeholder.

All of this is ultimately funded by the tenant, who pays the insurance premium through service charges imposed on them by the landlord. Disputing these service charges is difficult and often involves litigation in a First Level Court of the Property Chamber.

Since the owner does not have to pay the cost of insuring the building, there is no financial incentive to ensure that the cost of insurance is minimized.

insurance time previously reported on disputes between tenants and freeholders, brokers and insurers at two Canary Wharf-based properties owned by billionaire property mogul, Yiannakis ‘John’ Christodoulou – One West India Quay and Canary Riverside.

Harry Scoffin, a journalist at the charity Leasehold Knowledge Partnership, said insurance premiums accounted for between £800million and £1.6billion in annual service charges paid by flat tenants in England.

He added: “Tenants don’t actually own their property – they only own the right to occupy their property in accordance with the terms and fees, including the annual service fee. [including insurance premiums] fixed by the freeholders.

“In particular, renters note that the entity choosing the insurance policy usually receives a substantial commission from the insurance provider – this means that agents have a financial incentive not to choose the insurance policy. the most profitable for tenants, but rather select the policy likely to pay the highest commission.

“It’s one of the biggest rental scams out there.”

Millions affected

Branko Bjelobaba, director of financial compliance consultancy Branko, said the market structure of the property insurance industry “smells really, really bad”, especially because “millions and millions of people are affected by this”.

He added: “Tenants should have the right to know about commission agreements because what is worrying is that the very large brokers who have cornered this market are being paid or demanding exorbitant commission rates, which insurers are happy to pay to keep the business.

“Brokers are then able to share this commission with property management agents as a cost of their business. The fact is that tenants could be insured for much less.

Bjelobaba added that insurers and brokers specializing in this market should ‘ask themselves ‘is it right that we do this?’ ”

“I would say no,” he added. “That’s totally wrong.”

Part of the FCA’s insurance industry governance requires insurers to carry out a value assessment on an annual basis. This examines how products are intermediated, how they are distributed, what each party does in the value chain for its compensation, and whether that compensation is commensurate with the work performed by each party.

Governance rules require insurers to demonstrate that the commission payment is appropriate for the work performed by a particular broker – but there is no formula to follow.

Branko explained: “Insurers need to consider whether the amount of commission they pay is proportionate. With property managers, some insurers have to wonder if they think it’s appropriate to pay such ridiculous commission rates.

Beginning of a solution

The recently introduced Tenancy Reform Bill would represent the beginning of the solution to the problem of freehold owners charging their tenants exorbitant premiums.

If tenants could see the level of commissions from their insurers, they could more easily demonstrate that they were not receiving appropriate value for their property costs.

However, Scoffin believes the ultimate solution involves tenants being able to purchase their own insurance through residents’ associations.

“Most of the problem is that tenants eventually have to purchase their own insurance policies,” he said. “The reality is that until people have control over their own services, property owners and insurers will be innovating the next scam.”

The rules of the Insurance Conduct of Business Sourcebook (Icob) define what information the customer of an insurance contract is entitled to receive – the application of these rules depends on whether the lessee or the free owner is determined as a customer in relation to the building insurance contract.

In many contracts – such as that of the Christodoulou property at One West India Quay – tenants are not defined as policyholders and are not covered by the ICOB rules which would entitle them to information about their insurance policy.

Bjelobaba added: “The fact that tenants cannot buy their own insurance is the problem. The only thing that would massively help would be to allow the real person at the end of the line who pays for all of this – which Consumer Duty talks about all the time – to get their own font.