Blog: Unrated insurers - the risks for UK brokers

The inflow of new capacity, often through unrated providers, may seem to some like the answer to a broker’s prayer. The argument is that it allows brokers to offer cheaper premiums for their hard-pressed clients. In many instances, it also helps them to continue to offer classes of business that mainstream insurers have abandoned. And it usually results in better margins too. But at what cost?

Historically, unrated insurers can undercut the market because they have a lower cost base. But, since they haven’t got the financial standing to get a rating, almost by definition they are more likely to go bust. The collapse of Alpha and Lamp in recent months underlines the problem. It also raises the question of whether, in trading through unrated insurers, brokers are properly exercising their duty of care to their clients. They may even be laying themselves open to potentially disastrous law suits, if a client sues because the collapse of an insurer results in no cover for a claim. Yet, in spite of the repeated warnings issued by industry bodies, there has been virtually no regulation in this area.

The industry needs to take urgent action to safeguard the reputation of the broking sector. First, brokers, that continue to place business with unrated insurers, should not only be required to inform their clients that their insurance comes from an unrated provider and precisely what that means, but their clients should also acknowledge in writing that they fully understand the risk and consequences of an insurer going bust.

Then the industry needs to examine the disproportionate use of the Financial Services Compensation Scheme. Is it fair for all brokers to pay the same constantly rising contribution when some are prepared to take dangerous risks with their carriers? Should those who opt to use unrated insurers automatically pay a higher levy proportionate to the increased risk?

Mainstream insurers also need to take some of the blame for this free-for-all, because of the way in recent years they have retreated from key markets such as construction professional indemnity, black-cab drivers and a great number of new and emerging risks. It’s fair to say that insurers, like the rest of us, are being caught on the hop by the speed of change. But now is the time for them to return to the fray through pooled arrangements, involving perhaps half a dozen or more other carriers. In this way they would be able to offer capacity for more difficult risks by spreading the exposure. But first there should be extensive consultation with brokers to identify the risks that are under duress.

For brokers clients come first, second and third. From that perspective it’s obvious that they must do due diligence on insurers and be open and honest with clients at all times. If the client wants a cheaper deal it’s the broker’s responsibility to spell out the risks entailed in going down that route.

The regulator needs to intervene with tighter controls over capital funds or, at the very least, proper scrutiny of the capitalisation of unrated insurers. But until that happens the onus is on brokers to protect our clients from the consequences. If broker’s don’t, if they carry on blithely with the same unrated regime, more and more of their policyholders are going to get badly burnt.