1 | Page The Future of Insurance Commissions & Insurance exposures for Strata Management Companies Introduction I have been asked to address the topic of insurance commissions. There has been a lot of noise around our industry about the practice of receiving insurance commissions, and I have been asked to give my views on this practice, and how I see the future of insurance commissions. Of course, the question proposed to me almost presumes that insurance commissions for strata management companies will disappear in the future, through some form of regulatory ban. I must say at the outset that I do not share that view, and will cover off a number of reasons in support of this. I do however see a shift in market practice, and will make a forecast of how I see this playing out over the medium to longer term. I have also been asked to comment on current distribution models under the financial services regime, and how commissions (whether they are in or out) may impact on such arrangements. I consider the issue of proper authorisation under the Financial Services Reform Act 2001 (Cth) (FSRA) to be an area that deserves far more attention by the sector than the issue of insurance commissions. 1 I have also been tasked to answer a number of specific questions, which I will do throughout this paper. What is the general practice that exists now? Current market practice includes the payment of commissions for the placement of Strata Insurance policies via certain Australian Financial Services (AFS) Licensees. The payment of such commissions have been made traditionally because of the number of administrative functions Strata Managers perform on behalf of these licensees, including undertaking training as a part of their authorisation process. In the appendix attached to this paper, I have collated a list of such tasks. This list is not exhaustive and clearly some tasks are more important than others, however it will give readers some ideas around the arguments for insurance related remuneration for strata managers (commission or fee). It is widely known within our industry (via benchmarking exercises) that insurance commission income levels represent about 12% of total income for Strata Management companies, and some 28% of income received from sources other than base “Management fees” 2 . Given this also represents around the profit margin level of Strata Management business, it is fair to say that the beneficiaries of insurance commissions are the Owners Corporations through lower base management fees. Competition amongst Strata Management companies has essentially arbitraged 1 The FSRA has been incorporated into the Corporations Act 2001 (Cth). 2 These statistic requoted at the 2012 SCA NSW Principal’s Retreat, Hamilton Island
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The Future of Insurance Commissions &
Insurance exposures for Strata Management Companies
Introduction
I have been asked to address the topic of insurance commissions. There has been a lot of noise
around our industry about the practice of receiving insurance commissions, and I have been asked to
give my views on this practice, and how I see the future of insurance commissions. Of course, the
question proposed to me almost presumes that insurance commissions for strata management
companies will disappear in the future, through some form of regulatory ban. I must say at the
outset that I do not share that view, and will cover off a number of reasons in support of this. I do
however see a shift in market practice, and will make a forecast of how I see this playing out over
the medium to longer term.
I have also been asked to comment on current distribution models under the financial services
regime, and how commissions (whether they are in or out) may impact on such arrangements. I
consider the issue of proper authorisation under the Financial Services Reform Act 2001 (Cth) (FSRA)
to be an area that deserves far more attention by the sector than the issue of insurance
commissions.1
I have also been tasked to answer a number of specific questions, which I will do throughout this
paper.
What is the general practice that exists now?
Current market practice includes the payment of commissions for the placement of Strata Insurance
policies via certain Australian Financial Services (AFS) Licensees. The payment of such commissions
have been made traditionally because of the number of administrative functions Strata Managers
perform on behalf of these licensees, including undertaking training as a part of their authorisation
process. In the appendix attached to this paper, I have collated a list of such tasks. This list is not
exhaustive and clearly some tasks are more important than others, however it will give readers
some ideas around the arguments for insurance related remuneration for strata managers
(commission or fee).
It is widely known within our industry (via benchmarking exercises) that insurance commission
income levels represent about 12% of total income for Strata Management companies, and some
28% of income received from sources other than base “Management fees”2. Given this also
represents around the profit margin level of Strata Management business, it is fair to say that the
beneficiaries of insurance commissions are the Owners Corporations through lower base
management fees. Competition amongst Strata Management companies has essentially arbitraged
1 The FSRA has been incorporated into the Corporations Act 2001 (Cth).
2 These statistic requoted at the 2012 SCA NSW Principal’s Retreat, Hamilton Island
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out any ‘fat’ that may have existed because of insurance commissions, if indeed such fat was ever
present.
The structure of the SCA NSW Strata Management Agency Agreement recognises the relationship
between base management fees and commission income, with the front page outlining such
relationship. The “agreed services fee” is set out with a “Plus commissions in schedule C1” (a
disclosure schedule) giving the Owners Corporation transparency to the arrangement and the option
to disallow commissions should they wish to do so. Assuming the Owners Corporation elected this
option, the Strata Manager would then have the opportunity to uplift the level of their agreed
services fee to compensate. It is important to note that if the Owners Corporation did elect this
option, they also agree for any commissions to be rebated to them direct, a factor that may be seen
as income for tax purposes. Specific accounting advice would need to be taken for a definitive
position, but it may be more efficient for an Owners Corporation to adopt a lower “agreed services
fee” and for the Strata Manager to retain commissions.
Regardless, if you look at the total cost of services from a higher level for a moment, whether the
Strata Manager gets the commissions and charges a lower services fee or the Owners Corporation
gets the commission and pays a higher services fees, the cost of the services ought to be a similar
level (save for tax implications).
It is important to reinforce that there is absolutely no legal impediment to Strata Management
Companies receiving insurance commissions, provided however that this remuneration is fully
disclosed. In the Alliance Strata Management3 case the issues of Strata Managers as fiduciaries and
their receipt of insurance commissions were tested. In that case Meagher JA reinforced that the law
at that time was clear, and:
“…if the fiduciary, before embarking on his fiduciary occupation, stipulates for the retention
of commissions as the price of his occupancy, the rules governing fiduciaries have got
nothing to do with the receipt of commissions.”
Whilst this case predated financial services reform (and to my knowledge the issues have not been
challenged since), the reforms embedded the principles of remuneration disclosure in connection
with general insurance products by introducing the requirement for a Financial Services Guide
(FSG)4. As I hope you all are acutely aware, an FSG must be given to all Owners Corporations by
those providing a financial service to it, and it must contain - amongst many prescribed items of
information - details on remuneration from AFS Licensees.5 Severe penalties may apply for failing to
provide an FSG – ranging up to $11,000 for an individual, or $55,000 for a corporation, and up to 2
years imprisonment.
The most concerning practice that exists in our market at present is not about insurance
commissions, but rather Strata Managers/Strata Management Companies not being properly
authorised by an AFS Licensee for arranging insurance with them and their Owners Corporations.
The range of activities outlined in Appendix A, whether some or all of these activities are performed,
in my view means that a Strata Manager is “arranging” a financial service and as such needs to be
3 Real Estate Service Council v Alliance Strata Management Ltd (1994 NSWCA)
4 Section 941B Corporations Act 2001 (Cth).
5 Section 942C Corporations Act 2001 (Cth).
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appointed by an AFS Licensee.6 This includes authorisation by professional insurance brokers under
their AFS Licence. The mere appointment of an insurance broker by the Owners Corporation, or by
the Strata Manager on their behalf, does not alleviate the need to have appropriate authorisations
from the relevant AFS Licensee/s. That includes circumstances where the Strata Manager may be
performing some activities of an arranger without the benefit of an insurance commission! That is,
the insurance commission does not in itself dictate the status or need for authorisation, the
collective view of level of activities performed is generally regarded as the measure. Severe penalties
may also apply to arranging or dealing in insurance without an appropriate authorisation - ranging
up to $22,000 for an individual, or $110,000 for a corporation, and up to 2 years imprisonment.7 If
you fall into this category, you are also unlikely to have professional indemnity insurance (PI)
protection from the AFS Licensee. Nor would you have provided an FSG, so the penalties mentioned
in the preceding paragraph may also apply.
The message here – don’t be bluffed into thinking you’re protected. Please take some time out to do
two things: (1) review which AFS Licensees you or your Owners Corporations use, and establish what
authorisation levels you have; and (2) insist on the level of authorisation you need, or stop trading.
It’s your responsibility, not necessarily the AFS Licensee’s, to ensure you have proper authorisation
(albeit both parties may be liable for resulting loss or damage by an Owners Corporation).
What is the difference between the “representative” models under the Financial Services Reform
Act?
I need to take a step back for a moment to cover off some fundamentals. To be able to provide a
financial service and arrange insurance, there is a requirement for financial services providers (such
as CHU) to be licensed in accordance with the FSRA. As an AFS Licensee, holders can distribute their
own products either:
a) Directly to customers;
b) By appointing intermediaries to distribute products as their authorised representatives; or
c) By appointing intermediaries as general insurance distributors.
Option c) was introduced as Class Order8 in 2005 by the Australian Securities and Investments
Commission (ASIC) as a relief for AFS Licensees.
The first point to appreciate here is that the authorised representative model and distributor model
are different from both a legal and practical perspective. This is contrary to what some in the strata
market believe; the incorrect assumption being that both models are essentially ‘the same’.
Strata Managers are appointed as agents of the Owners Corporation through the application a
Management Agreement and, as such, are in a fiduciary relationship for these contracted services.
Strata Managers can be tasked to carry out a wide range of duties on behalf of the Owners
Corporation, such as organising maintenance and repair works, arranging for quotations for services,
6 The definition of “arranging” is set out in section 766C Corporations Act 2001 (Cth).
7 Section 911B Corporations Act 2001 (Cth).
8 ASIC Class Order [CO 05/1070] General insurance distributors
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issuing levy notices, maintaining all accounting records, preparing budgets, organising and attending
meetings - to name just a few. In terms of insurance duties, this would normally include arranging
and paying for insurance in accordance with Owners Corporations’ instructions, assisting with the
preparation, lodgement and processing of claims, and obtaining insurance quotations and
valuations.
In my view, the proximity of the relationship between a Strata Manager and the Owners Corporation
(as a fiduciary or otherwise) attaches an inherent expectation for advice and guidance to protect the
interest of the Owners Corporation. This includes making available the relevant information and
providing guidance to allow Owners Corporations to make informed decisions about their insurance
requirements. Fulfilling this expectation is difficult at best without the ability to provide some form
of advice. As a fiduciary, it is almost essential the Strata Manager is seen to be doing so. Therefore it
is my contention that Strata Managers need to be appointed as authorised representatives, to be
trained and given authority to provide general advice.
In this capacity, a Strata Manager can give opinions and make recommendations to assist the
Owners Corporation in making appropriate decisions about insurance. In other words, authorised
representatives can provide proactive guidance based on their general advice authority and more
effectively fulfil their roles as a fiduciary- enhancing their reputation as the ‘trusted advisor’ to the
Owners Corporation.
Authorised Representatives v Distributors – a practical snapshot
Currently there are very few AFS Licensees who are prepared to appoint Strata Managers as
authorised representatives and give them general advice authority. I strongly recommend you get to
know who they are – a hint – in NSW I know of only one underwriting agency, and two brokers who
will do it (provide general advice authority) for all Strata Managers as a standard policy - subject to
training of course. Importantly, you should know all those AFS Licensees who will not provide
authorisation to this level.
In my view, these operators are ‘short changing’ Strata Managers and consumers, and creating
unnecessary risk within our sector. Why do they do it? My guess is because it is expensive to
operate, and they do not want to take the exposure themselves – remember that an AFS Licensee
who authorises Strata Managers to give general advice must provide PI protection for them whilst
acting in that capacity.
As a final observation, SCA (Vic) were so adamant that the authorised representative model was the
only model Strata Mangers should adopt, they made it a condition of membership (see also
Appendix B)9
Some key differences are summarised in the following table: