AILA 2013 – Sydney September 2013 WP Distribution of Insurance Products Intermediaries and Conflicts of Interest – The Paradigm of Fronting Insurance Dr. Kyriaki Noussia

Introductory Thoughts - Setting the Scene Fronting  special cases of risks  large risks Fronting risk occurs  fee owed to local insurer. Local insurer intermediary  acts for insurer and places risk entirely with reinsurer

Introductory Thoughts - Setting the Scene Insurance intermediary  acts in dual capacity Broker towards insurer (first insurer’s broker /intermediary eg. bank) Serves interests of reinsurer towards first insurer = > Apparent conflict of interest broker serving both first insurer and reinsurer Clear cut case - direct conflict of interest

Introductory Thoughts - Setting the Scene Representing dual interests  not good practice  should be prohibited - high risk entailed In addition  double intermediary fee  fee from the first insured (materialized and collected via the premium owed by the first insured to the first insurer)  commission/ fee owed by the reinsurer

The Problem In essence  real insurer is the reinsurer Reinsurer  bears the risk Direct conflict of interest  reinsurer is in fact the real insurer

Understanding Whom The Broker Represents Issue  whose agent broker or intermediary is. General rule  intermediary is agent of ceding company but facts may show otherwise Houston Cas. Co. v. Certain Underwriters at Lloyd’s London, 51 F. Supp. 2d 789, (S.D. Tex. 1999) Banco Ficohsa v. Aseguradora Hondurena, S.A., 937 So. 2d 161, 165 (Fla. Dist. Ct. App. 2006)

Understanding Whom The Broker Represents USA  specific conduct and relationship of parties determines nature and extent of agency status most critical factor is control St. Paul Fire and Marine Ins. Co. v. Eliahu Ins. Co., 1997 U.S. Dist. LEXIS 8916, at *18-19 (S.D.N.Y. 1997)

Understanding Whom The Broker Represents Where intermediary is agent of cedent  cedent may be responsible for agent’s actions, including misrepresentations Houston Cas. Co. v. Certain Underwriters at Lloyd’s London, 51 F. Supp. 2d 789, (S.D. Tex. 1999) Reliance Ins. Co. v. Certain Member Companies, 886 F. Supp. 1147, (S.D.N.Y. 1995) Calvert Fire Ins. Co. v. Unigard Mut. Ins. Co., 526 F. Supp. 623, (D. Neb. 1980)

Understanding Whom The Broker Represents Reinsurance intermediary  integral role in reinsurance transactions placing risk on behalf of ceding company participating in negotiation of reinsurance contract serving as a conduit between cedent and reinsurer

Understanding Whom The Broker Represents Depending upon relationship of reinsurer and intermediary possible that intermediary is deemed a dual agent this entails conflicts of interest

Understanding Whom The Broker Represents Conflicts of interest circumstances where some / all of interests of persons to which reinsurance broker provides a service are inconsistent with, or diverge from, some or all of the reinsurance broker's interests. In cases of dual agency  intermediary bound by principles of agency

Understanding Whom The Broker Represents Agency status determined by factual enquiry may be governed by statute, regulation or contract absent statute, regulation or express contract, the question is a question of fact

Understanding Whom The Broker Represents In Re Pritchards & Baird Inc. 8 B.R. 265 (D. N.J. 1980) aff’d 673 F2d 1299 (3d Cir. 1981) Pritchard and Baird (P&B)  intermediaries prior to filing for bankruptcy acted regularly for a group of companies named the Hartford

Understanding Whom The Broker Represents In Re Pritchards & Baird Inc. 8 B.R. 265 (D. N.J. 1980) aff’d 673 F2d 1299 (3d Cir. 1981) Issue - whether P&B served as Hartford’s agent or as agents of the reinsurers Court  agency relationship existed between P&B and Hartford ( insurer) only

Understanding Whom The Broker Represents Since In Re Pritchards & Baird Inc. intermediary clause of reinsurance contracts expanded to stipulate that reinsurance intermediary (for payment and receipt of premium) acts as agent of reinsurer.

Understanding Whom The Broker Represents Still  no good solution We argue  no permission for dual representation Direct conflict of interest  unsurpassable and insurmountable

The European Response – IMD I & Proposal for IMD II European Commission began review of IMD I so that  insurance intermediaries  comply with new rules (disclosure, conflicts of interest)

The European Response – IMD I & Proposal for IMD II Article 12 of IMD I touches on conflict of interest issues intermediary has to provide information but no specific rules about managing conflicts of interest CEIOPS advice to Commission on IMD2 both intermediaries and insurers comply with high level principles on conflicts of interest

The Law in Australia In Australia  Conflicts of interest depend on precise circumstances affected by: - agreement of parties - relevant legislation - general law obligations - relevant circumstances of parties & transaction

The Law in Australia No legislation specifically governing the conduct of reinsurance brokers There is general consumer protection legislation In Australia  nothing prevents broker from entering agreement which allows the relevant conflicted entity to act in conflict with obligations otherwise owed to principal. Great care  needs be taken in drafting contract and obtaining such agreement

Leeways – The Way Forward Choices  once a conflict of interest is identified avoid it OR seek to manage it Most reinsurance brokers would seek to manage it by way of disclosure to the client.

Leeways – The Way Forward Above solution  doubtful Since real insurer = the reinsurer he bears the risk hence direct conflict of interest exists as the reinsurer is in fact the real insurer

Intermediaries and Conflicts of Interest – The Paradigm of Fronting Insurance THANK YOU FOR YOUR ATTENTION ! Dr. Kyriaki Noussia