Failures of insurance brokers: selling the book of business

We review the regulatory issues that can arise on the insolvency of an insurance broker and consider how to avoid the pitfalls when selling its major asset, the book of business.

Insurance brokers carry out insurance mediation. Accordingly, they are typically required to hold client money in accordance with the provisions of CASS 5 in the Financial Conduct Authority (FCA) Handbook.

Client money must be held pursuant to a statutory trust under CASS 5.3 or a non-statutory trust under CASS 5.4. In either case, the effect is that the money is held for the purpose of the further rules contained in CASS 5.5 (segregation and operation of client money accounts) and CASS 5.6 (distribution of client money following a pooling event).

These rules are required to be followed by the broker as trustee while it is solvent. In the event the broker fails, the insolvency practitioner will need to ensure the rules are complied with.

Impact of failure

When a liquidator, receiver, administrator, trustee in bankruptcy or any equivalent is appointed over an insurance broker, this is defined as a ‘failure’ and triggers a ‘primary pooling event’ under CASS 5.6.

As a result of the detailed rules, all client money held by the broker is then immediately treated as pooled. It is to be distributed, after the deduction of costs properly attributable to the distribution, in the following order:

  1. To the clients of the broker, such that they receive a sum which is rateable to their respective interests.
  2. To insurers, according to their respective interests to the client money.
  3. Any surplus is retained by the broker.

It is, however, often the case that the insolvency of the insurance broker has been anticipated and the business of the broker (including the client money) is intended to be sold. This raises a number of difficulties.

Client consent

The transfer of client money (pursuant to a sale agreement) to a third party is only permitted under CASS 5.5.80R(2) when it is done “on the instruction of or with the specific consent of the client[s]”. Without client consent, no transfer can take place, even if the sale of the business has been contractually agreed.

Further complications arise if the sale takes place, or only takes effect, after the failure of the broker. As described above, the funds are treated as pooled and have to be distributed back to the clients. CASS 5 makes no exception to this requirement.

It is obvious why such a restriction exists. No doubt some clients might object to their money being transferred to a different, active, business, without their consent. No special distinction arises if the insurance broker is insolvent. Clients are likely to want to see this right to give consent preserved.

However, from the broker’s (or insolvency practitioner’s) point of view obtaining consent is likely to be costly and burdensome. In addition, if the client money has been pooled following failure, the refusal of just one client is likely to make it impossible to transfer the whole fund. If a sale agreement is agreed, it may be breached if the funds are not transferred, creating conflicting obligations.

The only other option is to apply to the FCA for a modification of the need to obtain consent. Waivers have been granted, but the FCA will need to be satisfied that the rules would be unduly burdensome or would not achieve the purpose for which they were made.

Potential solutions

It is open to the FCA to amend CASS 5 in line with CASS 7, which applies to investment firms. CASS 7 was recently amended to specifically introduce new rules to deal with what was a recognised problem of obtaining consent from all clients. The new rules provide a mechanism for an investment firm to obtain consent in its terms and conditions with its clients.

Another option is for insurance brokers to routinely obtain client consent in advance.

In the meantime, there is a risk that insurance brokers will find it costly, difficult or impossible to sell a book of business. These difficulties will only increase if the broker fails before any sale is completed.