March 2025
Whenever a professional is engaged to act on behalf of another party, he serves as an agent of that other party, who in turn is his principal. In the eyes of the law, the agent becomes a fiduciary of the principal and must act in the principal’s best interests.
A conflict of interest arises where the agent’s duty to act in the best interests of his principal, conflicts with any duty the agent may owe to another person, or the agent’s own commercial interests. The risk of conflict is therefore inherent to any profession that is based an agency relationship, including both insurance agents and insurance brokers. This makes dealing with conflicts of interest a fact of commercial life for both types of insurance intermediaries. It is something that just comes with the job and a reason why the conduct requirements in section 90(f) and (g) of the Insurance Ordinance require a licensed insurance intermediary to use best endeavours to avoid conflicts arising with the interests of the policyholders for which they act, or to disclose them as a way of managing them.
Conflicts of interest can be injurious if not properly identified and addressed. A conflict can result in insurance intermediaries – whether consciously or subconsciously – acting in their own commercial interests ahead of the policyholders’ (whilst deluding themselves that this is not the case). In this way conflicts of interest can result in a ‘corruption of the soul’. Where a conflict situation is not properly addressed, the interests of policyholders may be subsumed and prejudiced without the insurance intermediary even appreciating this. Nevertheless, this would likely render the insurance intermediary guilty of misconduct under the insurance regulatory framework and not fit and proper to continue in their role.
Identifying, avoiding and (if they can’t be avoided) managing conflicts of interest is therefore a necessary part of the professional and ethical skillset of every insurance agent and insurance broker. In the following two articles we explore this skillset further, by providing an overview of where the main conflicts of interest inherent to the role of both an insurance agent and an insurance broker arise and how obligations under the insurance regulatory framework (not only of insurance agents and insurance brokers, but also insurers) seek to address these.
Section 90(a) of the Insurance Ordinance is the primary conduct obligation for all insurance intermediaries. It imposes a regulatory duty on every insurance intermediary to act fairly and in the best interests of the policyholder. At common law, however, an insurance agent serves as the agent of the principal insurers he represents. An insurance agent is remunerated (mainly in commission) by his principal insurers based on the insurance policies the agent sells on their behalf. Several potential conflicts of interest situations arise from this:-
An insurance agent’s own economic self-interest in selling the insurance policy which generates maximum remuneration for the agent, may conflict with his duty to the policyholder to recommend the most suitable insurance policy based on the client’s circumstances.
The Code of Conduct for Licensed Insurance Agents (“Agent’s Code”) addresses this potential conflict by imposing the following overriding duties on a licensed insurance agent:
The imposition of these duties by regulation, effectively forces an agent to override his economic self-interest and recommend the insurance policy most suitable for the policyholder’s circumstances (and to face disciplinary action if he fails to do this).
This potential conflict is particularly acute for long-term insurance policies (policies entered into for multiple years). Currently, for certain long term policies such as participating insurance policies, it is common for the insurer to pay the vast majority of commission to the insurance agent up front in the first year of the policy, in order to reward the agent for building the relationship with the client such that the client buys the policy. This ignores the fact, however, that the relationship is a long term one and needs to be cultivated and maintained by the agent over the duration of the policy period through ongoing servicing obligations (e.g. dealing with changes of policy ownership, requests to add beneficiaries, explaining the performance of the non-guaranteed benefits so the policyholder can assess whether the policy continues to meet their needs, and assisting the policyholder in making claims etc.).
By paying virtually all the commission the agent in the first year of the insurance policy term, the insurer essentially skews an insurance agent’s interest in favour of focusing on selling new insurance policies, in conflict with the ongoing duty to service existing policies sold. This risks creating poor servicing levels to the detriment of clients (a common cause of many complaints the IA receives).
The conduct requirements in section 90 of the IO aim to combat this by extending the requirements for the insurance agent to act fairly and in the best interests of the policyholder and with integrity and to exercise care, skill and diligence in respect of all regulated activities, including ongoing post-sales activities.
Insurers also have a crucial role to play here. It is they, after all, who create this conflict through their remuneration structures. Insurers have an express regulatory duty to ensure that their remuneration structures for insurance intermediaries do not create misaligned incentives for their agents, putting them in conflict with the interests of clients. This regulatory duty (which is part of the broader treating customer’s fairly principle) applies across all long-term policies within the scope of Guidelines 15 and 162 issued by the IA. Whilst the notes to Guideline 15 fleshes this obligation out, by prescribing a spread of commission over a minimum of 5 years (or the premium payment term if shorter) for Class C long term policies, the broader principle also applies to non-Class C long term policies within the scope of Guideline 16. This is one of the reasons why the IA is considering to extend the specific spreading mechanism to participating insurance policies, as a natural and effective way of ameliorating this particular inherent conflict.
An apparent conflict also arises because insurance agents owe regulatory duties to policyholders to act in their best interests, whilst also owing duties at common law to their principal insurers (for whom they act as agent). This so-called ‘obvious’ observation was made continuously (by the legal profession, in particular) during the consultations leading up the IA’s creation, with the governmental response effectively being that the IA would sort it out in the Agent’s Code.
Anyone who has worked in an insurer and actually dealt with insurance agents, will know that in practice the mindset of many insurance agents (naturally) is to view themselves as representatives of policyholders and to represent their interests when dealing with their insurer principals. In discussions between an agent and the insurer, for example, the agent would usually refer to the prospective policyholder as “my customer” or “my client”, rather than seeing the insurer as the client (even though the insurer is the real principal). Insurers in turn often label their agents as ‘consultants’ (denoting their role as being consultants to clients, not the insurer). To this extent, therefore, the regulatory duty imposed on insurance agents to act in the best interest of policyholders, merely codifies an obligation which had already emerged from the nature of an insurance agent’s day-to-day practice.
Reconciling this conflict of interest in the Agent’s Code was not, therefore, as challenging as it first may have appeared. It simply involved codifying the requirement for a licensed insurance agent to recommend insurance policies which best meet the prospective policyholder’s interests, from the range of insurance policies offered by the agent’s appointing insurer. In doing so, an insurance agent serves the client’s best interests without creating a misalignment with his duties owed to his principal insurer(s).
The Agent’s Code further underpins the management of this potential conflict, by requiring licensed insurance agents to provide full transparency to clients about their role as insurance agents. Insurance agents need to expressly inform their clients that an agent’s role is to promote, advise on and arrange insurance policies offered only by their principal insurers3. The objective here is to leave the client in no doubt about the parameters of the service the insurance agent is providing. The client is going to be offered the insurance policy which best meets their needs, but the insurance agent is only going to be choosing from the insurance policies offered by the principal insurer(s) by which the agent is appointed, not other insurers (as would be the case with an insurance broker).
An insurance agent can be appointed by up to four principal insurers (of which no more than two can be long-term insurers). This raises the question of how an insurance agent can reconcile the different interests of his principal insurers, where these conflict.
Again, regulation intervenes through provisions in the Agent’s Code to address this:
Given the multiple potential conflicts that come with the territory of being an insurance agent, it is imperative that all insurance agents not only comply with the requirements in the Agent’s Code designed to address such matters (as identified above) but also develop an ongoing professional sensitivity to the risk of such conflicts so that they can identify them and deal with them as they arise.
Insurance agents are not on their own in this respect. Their principal insurers also have a crucial role to play. Section 68 of the IO effectively expands an insurer’s liability for its appointed insurance agents in their carrying of insurance activity, by attaching such liability to the insurer irrespective of whether or not the agent was acting within the scope of the authority granted to him by the insurer. In recognition of this, the Agent’s Code assists insurers by requiring insurance agents to comply with the policies, procedures and other applicable requirements of the appointing insurer in relation to carrying on regulated activities. Insurers – through their intermediary management functions and the key person they appoint to take charge of this – have a regulatory obligation to ensure adequate internal controls and processes are put in place on their insurance agents so that they comply with the requirements in the insurance regulatory framework, including those requirements designed to address conflicts of interest.
Any prejudice to a policyholder caused by an insurance agent failing to avoid or manage a conflict of interest, therefore, will likely attach to the insurer (at common law and section 68 of the IO) and also raise questions as to the adequacy of the insurer’s controls and processes on its insurance agents to have prevented this. Insurers would do well, then, to support their agents through proper controls, training and channels through which they can obtain advice on dealing with conflicts of interest, as well as ensuring their remuneration structures do not serve as a cause of such conflicts.
Like insurance agents, insurance brokers are subject to the conduct requirements in section 90 of the IO, the primary requirement of which is to act with integrity and in the best interests of the policyholders they represent. Unlike insurance agents, at common law insurance brokers serve as agents for their clients to source insurance suitable for the client’s particular circumstances (and they have the advantage over insurance agents in being able to deal with any number of insurers for this purpose). The regulatory duties of insurance brokers under the IO are thereby in complete alignment with their common law role as agent of their clients.
Despite this, as is the case with insurance agents (and other professions that are based on agency relationships), there are conflicts of interest that are inherent to the insurance broking profession. The primary potential conflict arises from the main source of remuneration for insurance brokers in Hong Kong – commission.
Whilst there are different ways of remunerating insurance brokers for the work they do, by far the most common mechanism in the Hong Kong market is payment of commission7.
The legal basis for commission payments to insurance brokers is as follows. In consideration for sourcing and arranging an insurance policy from an insurer that suits the policyholder’s circumstances, the policyholder allows the insurance broker to agree with the insurer an amount that the insurer will pay the insurance broker for introducing the business to the insurer. This amount - payable to the insurance broker by the insurer - is a percentage of the premium paid by the policyholder to the insurer under the insurance policy which the broker arranges, and is termed ‘commission’.
Commission structures mean that whilst an insurance broker’s duties are owed to his clients to act in their best interest as their agent, the broker is paid by the insurer - a third party to the relationship between the insurance broker and his client. It is this which gives rise to a potential conflict of interest. Consciously or subconsciously, the insurance broker may be tempted to place his client’s business with the insurer paying the highest commission, rather than the insurer offering the insurance that best meets the policyholder’s circumstances.
In Hong Kong, agency law and regulation align to address this potential conflict in the same way - by requiring the insurance broker to disclose to the client, the fact that the insurer that issues the insurance policy, will pay remuneration to the insurance broker. Having been alerted to this through such disclosure, the policyholder can then readily ask the insurance broker for further and better particulars of the remuneration (for example the amount of commission) to be received and then decide whether to proceed with a transaction. These minimum disclosure requirements are set out in the Code of Conduct for Licensed Insurance Brokers in General Principle 7, Standard and Practice 7.1 and in the Practice Note issued by the IA supplementing this provision.
Where disclosure is insufficient to address the conflict
There are, however, certain types of commission mechanisms where even disclosure to the policyholder would be insufficient to manage the conflict and which should thereby be avoided. The insurance regulatory circular of 10 April 2006 – which stands the test of time and is referenced in the abovementioned Practice Note - best summarizes these as follows:
“prohibited practices include specifically (but not limited to) an insurer entering into a contract or agreement (exclusive or otherwise) with a view to inducing an insurance broker to place business with it by offering commission level based on volume or requiring an insurance broker to meet certain annual business target.”
Commissions which are in excess of what is normally paid in the insurance market, would also be problematic, not only from the regulatory viewpoint, but also from the perspective of compliance with section 9 of the Prevention of Bribery Ordinance (Cap. 201) (“PBO”), which criminalizes agents making secret profits from their role as agent without the lawful authority of their principal. In Hobbins v Royal Skandia Life Assurance Limited and Clearwater International Limited [2012] HKCFI 10, the court of first instance summarized the position for insurance brokers as follows:-
“In my view, there is “lawful authority” (consisting of a long line of judicial pronouncements stretching from the 19th century to the present) for the commercial practice that an insurance broker acts as an agent of the insured and not of the insurance company. As a result of that the line of judicial pronouncements, it has long been settled at common law that commission paid to an insurance broker by an insurer does not constitute an illegal secret profit unless it is in excess of what is normally paid within the insurance market.” [Emphasis added].
Excessive commission levels, therefore, do not bring with them the “lawful authority” that customary levels of commission paid within the insurance market would and would thereby place the insurance broker (and the insurer paying such excessive levels) in difficulties when it comes to compliance with section 9 of the PBO.
This, of course, raises the issue of where the line lies between customary and excessive commission levels. In recent years this issue has threatened to become a live one for commission paid on participating insurance policies, where the levels of commission offered by insurers to certain broker companies in the first year of the policy, have resulted in such commissions being given away by the broker company as excessive referral fees that drive unlicensed business (triggering necessary enforcement action).
Insurers are mistaken, if they believe that in paying these commissions, they are fire-walled from any regulatory liability arising from the insurance broker’s use of such referral fees because the broker is not their agent. The duty of the insurer – under Guideline 16 – is to ensure that their remuneration structures do not create misalignment between the insurance intermediaries’ own interests and their duty to act in the policyholder’s best interests (part of the wider ‘treating customers fairly’ principle). This duty of insurers applies to the remuneration they pay to insurance brokers that place business with them, as much as it does to the remuneration they pay their appointed insurance agents.
The IA’s circular of 22 May 2024 sought to address these matters. As indicated in the article on insurance agents, however, this issue is still ripe for being further addressed by the proposed introduction of a smoothing mechanism for payment of commission for participating insurance policies, similar to that which applies to ILAS policies.
In the same way that insurance agents may need to deal with situations where the interests of their different principal insurers’ conflict, so an insurance broker needs to be sensitive to addressing situations where the interests between their clients (the broker’s principals) may place the broker in a position of conflict. These situations would be rare, but they are ones to which major insurance brokers should be (and based on our inspections, are) alive. Such situations could arise, for example, where an insurance broker has handled placements for two different clients simultaneously and a claim incident happens involving them both, with each client seeking to apportion liability to the other. It might also arise where clients are tendering (and competing), say, for the same construction contract and have engaged to the insurance broker to secure insurance to demonstrate they meet the tender requirements. Addressing such conflicts either through disclosure and consent, handling through separated teams, or ceasing to act, may be solutions an insurance broker in this situation may find itself having to adopt. Major insurance brokers therefore do (and should) have policies and processes in place to address this.
To sum up both these articles, then, the insurance intermediary who buries his head in the sand about potential conflicts is one who will not be long in the insurance market, given the potential conflicts that come with the nature of the profession (based as it is on agency relationships). For professional insurance intermediaries, being sensitive to, recognizing and dealing with potential conflicts of interest is a fact of commercial life and part of the ethical skill-set they must continually cultivate to build both trust and success in their careers.
Notes:
1 Agent’s Code General Principle 2, Standards and Practices 2.1(b) and 2.2(b).
2 Guideline on Underwriting Class C Business (GL 15) and Guideline on Underwriting Long Term Insurance Business (other than Class C Business) (GL 16).
3 Agent’s Code, General Principle 7, Standard and Practice 7.1
4 Agent’s Code, General Principle 1, Standard and Practice 1.2(c)
5 Agent’s Code, General Principle 5, Standard and Practice 5.1(b)
6 Agent’s Code, General Principle 7, Standard and Practice 7.2
7 The other form of remuneration comes in the form of a fee paid directly to the insurance broker by the policyholder for advice and the representation provided in sourcing and placing an insurance. This is relatively rare – albeit not unknown – form of broker remuneration in the Hong Kong insurance market.