FCA authorised firms that are coining more than 40% profits out of leasehold insurance, and here’s how:

£26.7m earned by FCA authorised firms owned by managing agents in years 2016-2021 with net profit margins hitting 73%

Managing agent owned firms appear to be far more profitable than large insurance brokers

Available data shows number of employees remaining stable, suggesting no significant increase in workload as a result of Grenfell

Easiest way of ensuring full disclosure is to produce certificates of insurance showing cost of the policy … and total of remuneration earned by all parties

By Liam Spender

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Liam Spender is a solicitor and trustee of the Leasehold Knowledge Partnership. He lives in a leasehold flat in London. The views in this article are personal and do not constitute legal advice. The emphasis in this article is for the benefit of general readers and provided by the editor.

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Response to the FCA Consultation on Multi‐Occupancy Building Insurance

Introduction

1) I am a leaseholder living in a block in London. By profession I am a solicitor. I qualified in March 2013. I practise in commercial litigation and arbitration. I am also a trustee of the Leasehold Knowledge Partnership, a charity campaigning for leaseholder rights and leasehold reform. I provide this response in my personal capacity.

2) The one overarching point about the FCA’s report is that it considers the problem is with unauthorised firms. That is not the case. The taproot of the issue is that regulated firms – insurers and brokers – have agreed to pay remuneration to both authorised and unauthorised firms over a number of years. As the report recognises, this has been to the detriment of end consumers.

3) As explained below, it is also the case that many of the largest residential freeholders and managing agents are receiving their share of remuneration via authorised firms they own, either in‐house insurance brokers or because agents are regulated for insurance distribution activities. The FCA should look carefully at the structure of the market before deciding it cannot do something material to address the situation.

4) Accompanying this submission is a spreadsheet giving details of the profit margins earned by authorised firms who receive insurance commission. The data is taken from Companies House and other public sources. Data is not available publicly for all of the authorised firms named on the front worksheet. The same spreadsheet also shows that insurance in relation to approximately 1 in 6 leasehold properties is administered by an FCA regulated firm owned by a managing agent or freeholder.

The FCA appears to have significantly more power over residential leasehold than it believes.

5) As can be seen from the accompanying spreadsheet, for the FCA authorised firms
owned by managing agents or freeholders, where data is available:

a. Excluding the captive insurer, a total of £26.7 million has been earned by authorised firms in commission between 2016 and 2021 (in some cases 2022);

b. Where net profit margin data are available, the range of net profit margin on that commission is between 48% and 73%, averaging at above 40%. The net profit margin data suggests that authorised firms receiving insurance remuneration incur relatively little cost in exchange for the remuneration
received;

c. The authorised firms operated by managing agents appear to have been significantly more profitable than large insurance and re‐insurance brokers over the same period. Over the period 2017 to 2022 (where data is available), large brokerages such as Arthur J. Gallagher, Lockton and Marsh have averaged net operating profit margins of between 15% and 31%. That compares to the net profit margins of between 48% and 73% for authorised firms owned by managing agents or freeholders. In other words, managing agent and freeholder owned authorised firms appear to be generating profits between 135% and 220% higher, on average, than authorised firms owned by third parties;

d. Authorised firms appear to pay away all (or virtually all) of their profits from insurance activity either in the form of intercompany loans, or as dividends. Again, this is not consistent with the idea that these firms are undertaking ongoing work in relation to insurance, such as handling claims;

e. In addition to paying away all of their profits from this work, the managing agent / freeholder owned authorised firms are also not carrying any accounting provisions for work they may be required to do in the future. Again, this is not consistent with a business with potential future liabilities in relation to claims; and

f. The publicly available financial statements show low numbers of employees remaining stable over time, suggesting there cannot have been any material increase in workload as a result of the Grenfell Tower fire. [Data is available for two authorised firms. FirstPort Insurance Services (which changed its name on 22 October 2022 to Knight Square Insurance Brokers) has employed 13 employees in every year between 2016 and 2021. Cox Braithwaite has employed 5 employees in every year between 2017 and 2021.]

6) There is only one captive insurer – that operated by Rendall & Rittner – for which public data are available. The captive in question appears to make profit margins sitting between those of the managing agent / freeholder owned firms and the independent authorised firms. It should be noted that Rendall & Rittner, in addition to operating a captive, also charges a placement fee for insurance. The profits earned via the captive are in addition to margins earned on the placement fees.

7) I have also written a piece for the LKP website summarising the FCA insurance report. That piece also contains views that the FCA may wish to consider.

https://www.leaseholdknowledge.com/fca-report-on-insurance-in-leasehold-blocks-what-does-it-propose-and-why-does-it-matter/

Q1: What additional information do you think would most benefit leaseholders?

8) There should be much freer and fuller disclosure of the remuneration earned (howsoever described) from multi‐occupancy block insurance. This should include disclosure of amounts received by all parties in the chain. The disclosure should also give a brief explanation of what service was provided by each party in the chain in exchange for their share of the remuneration.

9) The definition of remuneration should be drafted broadly and with the expectation that regulated firms will try to continue to adopt measures to avoid giving disclosure.

For example, the definition of remuneration should include remuneration earned indirectly from a captive insurer and remuneration paid to both authorised and unauthorised parties.

10) There should be a route to redress for authorised firms who refuse to provide the information. By way of example, I have been trying to obtain commission disclosure in relation to my block since at least June 2021. All parties involved in the insurance arrangements are FCA‐regulated (FirstPort Insurance Services, Freehold Managers, Arthur J. Gallagher and the ARC Time Freehold Income Fund).

All of them refuse to seek or to provide ICOBS 4 disclosure. Instead, the best I have managed to achieve is partial remuneration data. The partial data obscure the total amount of remuneration in relation to the insurance because the bulk of the broker remuneration is being concealed.

I suspect that the reluctance to disclose the ICOBS data is because it will show either that the broker receives the same (or a higher) level of remuneration as the freeholder / managing agent and / or that there are undisclosed bonus arrangements in relation to the insurance, for example, a no‐claims bonus that is paid at year end.

 

Q2: Do you have views on how this information should be provided to leaseholders?

11) Information should be provided as freely and easily as possible. Leaseholders should have the right to direct disclosure from one or both of the insurer or the insurance broker, showing remuneration paid to all parties in the distribution chain.

12) The easiest way of ensuring full disclosure is to say that any authorised firm producing a certificate of insurance must state, on the face of the certificate, the cost of the policy and the total amount of remuneration earned by all parties in the insurance chain in relation to that policy. Leaseholders already have a right to a summary of insurance. That right could be extended to give a right to see the certificate itself. [See: paragraphs 2 and 3 of Schedule 1 to the Landlord and Tenant Act 1985.]

13) In terms of alternatives, it is already the case that certain prescribed information has to be provided with ground rent and service charge demands. [See: section 21B of the Landlord and Tenant Act 1985 and the Service Charges (Summary of Rights and Obligations, and Transitional Provision) (England) Regulations 2007/1257.]

The Landlord and Tenant Act 1985 could be amended to prescribe that any demand for a service charge including the costs of insurance must be accompanied with a declaration of the amount of remuneration earned by each party in the distribution chain, whether authorised or unauthorised. The statement could also offer a brief explanation of the work said to have been done in exchange for the remuneration.

14) It would be worthwhile if any type of disclosure could be collated into a central database so people could compare the mean, median and range of remuneration paid by different buildings. This would make it much easier for leaseholders to challenge unreasonable insurance costs. The data could perhaps be broken down into the number of units per block and the start of the post code of each block. Similar data has previously been made by the government in relation to weekly waking watch costs.

Q3: Do you have views on how our rules should be amended to include leaseholders as customers?

15) The report is unclear on why any unintended consequences would arise from amending the ICOBS rules to make them recognise the underlying leaseholders (who are both paying for the insurance and are the primary beneficiaries of the insurance) as customers. Indeed, the FCA has previously issued guidance saying that it is already the case that authorised firms have to consider leaseholders’ best interests under, for example, ICOBS 2.5.‐1R. [https://www.fca.org.uk/firms/buildings‐insurance‐leasehold‐properties (accessed 30 October 2022).] It is apparent that authorised firms have ignored his guidance over a sustained period of time.

16) For the avoidance of doubt, it is not the case that managing agents and freeholders can simply raise service charges to account for any fall insurance remuneration, although doubtless many will do so. Service charges must be reasonably incurred and paid in exchange for works or services of a reasonable standard. The reason these commissions have been hidden for so long is that managing agents and freeholders have not want their remuneration to be disclosed or tested in this way. [Section 27A, Landlord and Tenant Act 1985 and, with particular respect to insurance, see: COS Services Limited v. Nicholson [2017] UKUT 382 (LC).]

17) Paragraphs 2.1 and 4.55 of the report are also incorrect. A freeholder is not the only party with an insurable interest in a multi‐occupancy building. It is not unusual to see current insurance policies arranged in the name of the “Freeholder and Lessees” of a particular block. Most leases will also require the interests of the leaseholder (and any mortgage lender) to be noted primo loco or secundo loco on the insurance policy, meaning they have a financial interest ranking ahead of the leaseholders’ and freeholder’s interests in any insurance money. As above, Section 30A and Schedule 1 to the Landlord and Tenant Act also give leaseholders the right to notify the insurer directly of any claims under the policy.

18) Any concern about unintended consequences, such as those outlined at paragraph 4.56 of the report are overblown. For example, where the interests of lessees and mortgagees are noted on current insurance policies, the terms of the policy already require the names of such persons to be provided in relation to any claim for damage affecting the noted parties’ interests. There is no reason why the same situation could not continue if leaseholders were to be made customers for the purposes of the FCA’s rules.

19) The FCA should be slow to believe the insurance industry, freeholders, managing agents and their surrogates when they say extra work will be involved in adding leaseholders as customers because the identity of leaseholders will change over the term of the insurance contract. That is for two reasons. Firstly, insurance contracts are typically no more than 12 months, which limits the rate of change.7 Secondly, freeholders (and their agents) already have the names of the people interested in leasehold flats. They use such information routinely to collect service charges and ground rent.

20) In relation to freeholder / agent knowledge of interests in leasehold property, in virtually all cases the terms of the lease require any assignment or mortgage of a lease to be notified within a short time of the transaction. Landlords already charge a fee for registering such transactions, sometimes several hundred pounds, so there is no additional cost implication of using the same data to keep track of who is a customer for the purposes of the building insurance.

[Insurance contracts longer than 12 months would most likely be Qualifying Long‐Term Agreements requiring consultation (or dispensation from consultation) under section 20 or 20ZA of the Landlord and Tenant Act 1985.]

21) Insurance for multi‐occupancy residential blocks is a large and special case. To the extent that there are any unintended consequences of changing the rules, the FCA should develop bespoke rules to mitigate the conflict of interest inherent in the arrangement. A bespoke set of rules could mitigate any unintended consequences by applying it only to insurance arranged for multi‐occupancy residential blocks.

Q4: Are there any potential unintended consequences we should consider if we include leaseholders as customers within our rules?

22) This appears to be a loaded question intended to solicit answers from authorised firms that suit their purposes, which is to be allowed to spend (and receive remuneration from) leaseholder money without being accountable, or with only minimal accountability.

23) As explained above, the FCA should focus on the interests of the end consumer and not the financial services industry and its surrogates. One way of doing this would be to make a bespoke set of rules for multi‐occupancy block insurance to protect the end consumer whilst avoiding the adverse consequences the FCA (and authorised firms) appear to fear.

24) Again, the FCA should be slow to believe the insurance industry and its surrogates when they claim that costs will rise if they can no longer receive commission, or other remuneration, from insurance. As explained above, and in the accompanying spreadsheet, where managing agents are receiving commissions they are generating large profit margins, averaging more than 40%. There is plainly very little cost involved in the current activity performed in exchange for remuneration. If remuneration is made more transparent, it is likely costs are going to be lower in future, not higher.

Q5: Do you have any views on whether we should prohibit authorised firms from paying remuneration to freeholders and unauthorised property managing agents?

25) Authorised firms should not be allowed to pay any remuneration to either authorised or unauthorised firms, unless this remuneration is disclosed in full to leaseholders and in exchange for services of fair value.

26) As explained above, some of the largest property managing agents are already FCA regulated firms, either because they are in‐house insurance brokers (FirstPort Insurance Services and Albanwise / Cox Braithwaite, for example) or because they regulated for insurance distribution activities (examples include E&M, Freehold Managers and E&J Estates).

27) Certain large residential freeholders receiving remuneration from insurance under existing arrangements (for example, the ARC Time Freehold Income Fund and the Ground Rents Investment Fund) are also FCA regulated investment vehicles. The ARC Time Fund appears to have received more than £5.2 million in building insurance commission in the period 2017 to 2022. The ARC Time Fund has provided no identifiable service in exchange for that commission. Indeed, in its most recent prospectus – issued 1 June 2022 – it has deleted reference to the fact that it receives 85% of the commission paid on its block insurance policy.

28) As explained above, the accompanying spreadsheet gives details of the high profit margins enjoyed by the currently regulated FCA firms in relation to insurance broking and insurance distribution activities.

29) It is not disputed that placing a multi‐block insurance policy involves some work, usually on the part of a property managing agent. Common tasks will include providing information for the insurance proposal, arranging for valuation surveys, negotiating premiums and ensuring that all documentation is in place. The issue is why this work is currently being done in an opaque manner and apparently generating a net profit margin of more than 40% for the parties undertaking the work. It should be remembered that property managing agents already charge a per unit management fee for their work, which normally covers all of their head office costs plus a profit margin.

30) The report also seems to be predicated on misinformation spread by managing agents (and their surrogates) about their role in managing insurance claims. Most managing agents have no role in relation to claims beyond passing on the insurer’s telephone number.

31) The fact that managing agents have no role in handling claims is made explicit in some of their public filings. For example, note 1.6 to the financial statements of authorised firm FirstPort Insurance Services says as follows:

“Commissions earned on the placing of insurance products on behalf of third parties are recognised when the Company has completed its services under the arrangements which is the inception date of the underlying policy.”

[See note 1.6 to the FirstPort Insurance Services Limited accounts for the year ending 31 December 2021. The same note is repeated in all prior years going back to at least 31 December 2016, showing that the policy has been consistent over time.]

32) In other words, FirstPort Insurance Services considers its work is done at the moment the insurance policy term begins. It is notable that FirstPort still claims to perform activity in relation to insurance claims. That statement is not consistent with its approach to recognising revenue.

33) As explained above, leaseholders also have a statutory right to notify claims directly to an insurer, which negates any role for the managing agent. It is also common for the insurer under a policy to designate a broker to handle claims, meaning there is no role for the managing agent in handling the same work. See attached insurance certificate and policy wording showing how Zurich made Arthur J. Gallagher responsible for claims under its policies. At best, the current remuneration arrangements often mean leaseholders are paying two parties (the managing agent or freeholder and then the designated broker) to handle the same claim. The broker is then further remunerated by the insurer for claims handling activity.

34) It also the case that the work those receiving the commission are said to be performing is completely unregulated. For example, although managing insurance claims does require FCA authorisation, there is no means for leaseholders to enforce any quality of service standards on the provider.

Q6: Do you have other views on potential remedies concerning remuneration set out in the report?

35) As explained above, the FCA is not giving sufficient weight to the fact that authorised firms are also freeholders. Any rule changes must ensure that remuneration is not paid to either authorised or unauthorised firms without there being some service of fair value provided in return. If authorised firms are left out, expect that many more managing agents and freeholders will look to establish captive insurance structures, or make other arrangements, to continue to be able to receive remuneration.

Q7: Do you agree with the potential remedies we are not proposing to take forward?

36) If better information rights are given to leaseholders, such as the ability to demand information directly from authorised firms, there may be a role for the Financial Ombudsman to ensure disclosure is forthcoming from authorised firms who fail to comply. Giving leaseholders rights to complain to the Financial Ombudsman should be reconsidered when the final solution is proposed.

Q8: Are there any other potential remedies we should consider?

37) As above, the FCA already has power over some freeholders because they are FCA regulated funds (the two main examples are the ARC Time Freehold Income Fund and the Ground Rents Income Fund). There may be others. A fuller study of the market is required.

38) The FCA should consider adopting a specific rule requiring all authorised firms (including regulated investment funds) to publish within their annual statutory accounts a disclosure of all income earned from insurance on multi‐occupied residential blocks over the past 6 years.1039)

There also seems to be prima facie case for a full market investigation into the competitive aspects of multi‐occupancy block leasehold insurance. It appears that it is only possible to obtain cover from certain insurers if business for a portfolio of properties is offered. This is usually via a tied broker (for example, Zurich only offers insurance via Arthur J. Gallagher, who until 2022 were also given delegated claims handling authority). This may explain why single blocks, or smaller sites, struggle to obtain cover, particularly when affected by cladding issues.

Full wording of Zurich’s St David’s Square insurance policy is here