Client money rules: Cash concerns

The Financial Services Authority is devising new rules detailing the way brokers handle client money.

However, the changes have implications for the relationship between intermediaries and insurers, and could put smaller firms under pressure.

The proposals, set out in the consultation paper Review of the Client Money Rules for Insurance Intermediaries in August, will require all brokers to change the way they do business.

There will inevitably be an impact in terms of cost and technology for firms of all sizes, and it is important for the broking community to begin considering the consequences.

It is obvious that changes need to be made to the current arrangements. The collapse of Lehman Brothers in 2008, along with the subsequent litigation, underlined the fact that existing client money rules for brokers, which were based on the rules for banks, required review.

There is also an impatience with the system from the industry, and a feeling that it is failing adequately to protect clients' interests.

Target areas
The FSA's proposals aim to allay concerns over brokers and their operation of client money accounts. Inappropriate controls for non-statutory trust accounts, ineffective risk transfer and the problems reconciling legacy funds are just some of the areas where problems have arisen.

The proposals would tidy up brokers' client money accounts, but some might be tempted to write back funds rather than investigate them fully without due regard to contractual and fiduciary obligations, potentially prejudicing insurers and policyholders.

This would be unwise, as the FSA will want all brokers to show how they arrived at their decision to deal with the money.

The increase in frequency of performing client money calculations from at least every 25 business days to every seven, in most cases, will increase manpower requirements and may require smaller brokers to increase IT spending.

Meanwhile, the recommendation to impose time periods for which brokers can give credit to underwriters (90 days), and policyholders (45 days), may cause problems. Brokers would have to use their own funds to advance credit after the time limit has expired.

This will require intermediaries to review their own credit control processes and terms of business, as there may be a reluctance from bankers to increase loan facilities to fund these arrangements.

In addition, the FSA is proposing that brokers have a member of staff with oversight and specific responsibility for a firm's client money obligations.

This could lead to interesting boardroom discussion for some firms, as will the need to have sufficient funds so that business can be run off, if necessary, with no adverse impact on policyholders or their funds.

Changes to filings for brokers, and greater information on filings generally, should enable better monitoring by the FSA, assisting insolvency practitioners if they are ever needed.

Conditional risk transfer
A proposal to remove conditional risk transfer addresses an issue that has long troubled brokers. Some underwriters are reserving the right to withdraw risk transfer if the broker fails to meet certain conditions, putting the credit risk back on the client.

The FSA proposes to prohibit this practice, but some insurers may respond by declining to accept risk transfer at all and move to direct settlements.

Potential changes include allowing brokers to insert, into their terms of business agreements, pre-consents from clients to transfer their money between brokers when businesses are being sold, but require the broker to give the FSA seven days' notice prior to a transfer.

Other requirements, including the use of broker resolution packs, would help an insolvency practitioner understand quickly how client money has been handled.

But when, realistically, could the changes be brought into force? The FSA suggests that, in most cases, the new rules should be delayed for 12 months from final publication.

However, brokers should consider these issues at an early stage. No matter how they are viewed, brokers will need actively to reconsider their management and processes when holding client money as well as addressing legacy balances.

Tim Goodger, insurance group partner at Elborne Mitchell, and Philip Grant, chairman of Ambant.

Cleaning up your legacy accounts
The proposed FSA changes have particular implications for brokers dealing with run-off and other legacy business. Legacy money is often a risk to the integrity of the trust account, requires proper investigation and may become the subject of complex legal issues.

Brokers have two options when handling legacy accounts. The first is to implement their own legacy project. This can be done by using in-house skills, or bringing in a legacy specialist.

Brokers must establish the nature of balances, review all records (of firm and previous firms), interrogate computer systems and correspond with insurance undertakings, third parties or clients.

In addition, it is important to make proper adjustments and remove debit and credit balances, assess funds due to the broker and ascertain to whom funds should be paid.

The second is to transfer the legacy book. This can be done via a third-party sell-off.

Aims of the regulator's review

• To enhance the requirements on segregation and placement of client money to increase customer protection
• To improve the effectiveness of segregation and use of risk transfer
• To make the distribution on an insolvency and transfer of client money to another broker easier
• To improve firms' record keeping and reconciliations
• To improve governance and reporting to the Financial Services Authorty

One potentially controversial proposal would require brokers to address un-reconciled balances for legacy (pre-2005) business within a 13-month period.

The broker would have this limited period to return these funds to the rightful recipient, recoup monies due to it or make a write back to its profit and loss account.

Thereafter it would lose the opportunity to deal with the funds and may potentially be required to pay the balances to a charity.

Tales from the archive: 2012
Elborne Mitchell and Ambant are urging brokers to consider the FSA review of client money rules, a similar plea to that made by software firm Sequel in July this year.

Brokers that lack the necessary tools to handle compliance changes will struggle if proposed rules governing client monies are implemented by the Financial Services Authority, according to insurance software specialist Sequel.

Michael Graham, sales and marketing director, commented: "I estimate that a third of large and medium sized brokers will have great difficulties moving across to the client balance method, should the FSA call for market change.

Handling client monies shouldn't be one of the major distractions for so many firms. The prospect of such a rule change will keep significant numbers of brokers awake at night, typically firms with ageing and unfit systems.

"And their worries will quickly become nightmares if they have to implement the proposed accounting method, as they'll have to divert resources from their core business to cope. This is the last thing they need as the market becomes increasingly competitive."