The Leasehold Reform (Disclosure and Insurance Commissions) Bill – which would mandate compulsory commission disclosure by landlords – was presented as a private members bill to the House of Lords earlier this month (14 July 2022).
Introduced by Lord Kennedy of Southwark, the bill would also prevent landlords recovering service charges from their leaseholders if they failed to comply with their disclosure obligations.
While private member bills rarely make their way into law, the fact that members of Parliament have begun to agitate for this issue is further evidence of the way the wind is beginning to blow for the insurance sector.
In January this year ex-secretary for levelling up, housing and communities Michael Gove ordered an inquiry into the buildings insurance market because of concerns around “unfair service fees” being charged to leaseholders.
In May, the FCA announced that it was collecting data from the insurance industry to help inform “potential interventions” such as limiting commissions for multioccupancy buildings insurance, were it to identify fees paid to brokers as a “significant cause of harm”.
The financial regulator also said that it would consider amending rules to allow leaseholders to access information about insurance policies purchased by freeholders – which is what the Leasehold Reform Bill would also mandate in its current drafting.
Were the FCA to introduce these rules it would remove the need for government to intervene – the regulator could change rules to protect the public’s interest under its mandate to ensure that financial markets are “honest, competitive and fair”.
Earlier this week (27 July 2022) the FCA published the final rules for its landmark Consumer Duty regulation, which requires insurance firms to review their products and services against a new standard of fairness – one of the four standards forming the basis of this regulation was fair price and value.
The regulator explained that Consumer Duty was part of its intentional transformation into a “more assertive” regulator. It has also already expressed concerns over hidden remuneration elements and has ordered that fairness to leaseholders is taken into account in firms’ value reviews.
However, financial regulators have been aware of these issues since at least 2005.
In an unpublished Financial Services Authority (FSA) report seen by Insurance Times – dated 21 July 2005 – the regulator, which was replaced by the FCA and Prudential Regulation Authority in 2013, confirmed that it was aware of a market structure that created a “monopoly position” of freeholders over leaseholders in relation to buildings insurance service charges.
Michael Sicsic, managing director of specialist financial services risk and regulation consultancy Sicsic Advisory, said the recently introduced Leasehold Reform bill should act as “a big red flag and warning to the market to say Parliament seems to be keen to enforce, by law, commission disclosure”.
Leaseholders and renters in multioccupancy buildings – usually those living in flats – are beholden to their freeholders, who place buildings insurance themselves or via a property managing agent.
The problem, identified by the FCA, is that leaseholders have no ability to procure their own buildings cover or even view the policy by which they are being insured because they are not defined as the customer according to property laws.
This situation has meant that freeholders or their agents can then agree higher premiums for cover – benefitting an insurer and allowing brokers to take a larger service fee that can be used to pay the freeholder a commission.
All of this is ultimately funded by the leaseholder, who pays for the insurance premium via service fees imposed on them by the freeholder. Challenging these service fees is difficult and often involves litigation at a First-tier Tribunal of the Property Chamber.
As the freeholder does not have to pay for the cost of building insurance, they do not have a financial incentive to ensure that the cost of insurance is minimised.
Insurance Times has previously reported on disputes between leaseholders and freeholders, brokers and insurers at two Canary Wharf-based properties owned by billionaire property magnate, Yiannakis ‘John’ Christodoulou – One West India Quay and Canary Riverside.
Harry Scoffin, a reporter at leaseholder campaigning charity Leasehold Knowledge Partnership said that insurance premiums accounted for between £800m and £1.6bn of annual service charges paid out by flat leaseholders in England.
He added: “Leaseholders do not actually own their property – they only own the right to occupy their property in accordance with the terms and fees, including annual service charges [including insurance premiums] set by freeholders.
“In particular, leaseholders note that the entity that chooses the insurance policy is generally the recipient of a substantial commission from the insurance provider – this means the agents have a financial incentive not to pick the most cost-effective insurance policy for leaseholders, but rather to select the policy likely to pay the highest commission.
“This is one of the biggest scams in leasehold.”
Branko Bjelobaba, principal at financial compliance consultancy Branko, said that the market structure of the property insurance sector “smells really, really bad”, especially because “millions and millions of people are affected by this.”
He added: “Leaseholders should be entitled to know about commission arrangements, because the worrying thing is that the very largest brokers who have cornered this market are being paid or demanding extortionate rates of commission, which insurers are happy to pay to keep the business.
“Brokers are then able to split this commission with property managing agents as their cost of doing business. The fact is, leaseholders could be insured for a lot less.”
Bjelobaba added that insurers and brokers who specialised in this market should “ask themselves ‘is it right that we’re doing this?’ ”
“I would say, no,” he added. “It’s totally wrong.”
Part of the FCA’s governance of the insurance sector requires that insurers must conduct a value assessment on an annual basis. This examines how products are intermediated, how they are distributed, what each party does in the value chain for its fee and whether that fee is commensurate with the work each party carries out.
Governance rules require that insurers demonstrate that the payment of commission is appropriate for the work being done by a particular broker – but there is no formula that must be followed.
Branko explained: “Insurers need to think whether the amount of commission they’re paying is commensurate. With property managers, some insurers need to question whether they feel paying such ludicrous rates of commission is appropriate.”
Start of a solution
The recently introduced Leasehold Reform bill would represent the start of the solution to the issue of freeholders charging their leaseholders extortionate premiums.
Were leaseholders able to view the level of commissions their insurers, they could more easily demonstrate that they were not being provided with proper value for their property fees.
However, Scoffin believes that the ultimate solution involves leaseholders being able to procure their own insurance via resident associations.
“The majority of the problem is that leaseholders need to eventually be placing their own insurance policies,” he said. “The reality is that for as long as people don’t have control over their own services, freeholders and insurers will innovate into the next scam.”
Insurance Conduct of Business Sourcebook (Icob) rules define what information the customer of an insurance contract is entitled to receive – the application of these rules is dependent upon whether the leaseholder or the freeholder are determined as the customer in relation to the buildings insurance contract.
Under many contracts – such as the one for Christodoulou’s property at One West India Quay – leaseholders are not defined as policyholders and are not covered by Icob rules that would entitle them to information about their insurance policy.
Bjelobaba added: “The fact that leaseholders cannot arrange their own insurance is the issue. The one thing that would massively help is to allow the real person at the end of the chain who is paying for all of this – which Consumer Duty talks about all the time – to procure their own policy.”