Timothy Goodger, Partner at City law firm Elborne Mitchell LLP, considers why CWBs are under so much scrutiny.
The way insurance and reinsurance intermediaries treat client money balances held for legacy insurance and reinsurance business remains a thorny and confusing issue.
This may well have been aggravated by the different views expressed by the FSA and the FCA over the years. They include the FSA’s comments in its 2008 paper entitled Credit write-backs: an articulation of the FSA’s position and subsequently in CP12/20, in which the FSA suggested draft CASS 5A rules to address aged balances. The latter considered payment of unreconciled balances to a charity.
Then, in 2023, the FCA proposed an expansion of the Dormant Assets Scheme as set out in CP23/12 with payment of balances to an authorised reclaim fund (ARF). More recently, it’s suggested the mechanism of so-called credit write-backs (CWBs), by which an intermediary writes back balances from client money trust accounts into its profit and loss account, is a breach of trust.
This step-change in approach has led to concern among intermediaries about how they can deal with unclaimed, unmatched and unreconciled balances. And particularly so since various intermediaries have aligned their processes with the 2008 Articulation and/or CP12/20. This alignment has resulted in intermediaries making CWBs, but equally making adequate provision in their accounts for potential claims to those balances.
The issue is further complicated by CASS 5 having neither a provision that prohibits CWBs nor a definition of them. That said, the FCA has sought to describe what they are, albeit in consultations.
Dealing with insurance transaction monies
The way an intermediary deals with insurance transaction monies, and specifically client money, is determined by the capacity in which it has received them and the basis on which it is obliged to hold them. That depends on the specific terms of business an intermediary has with its various counterparties and whether monies are received either on a non-risk transfer basis as agent for a policyholder, or on a risk transfer basis as agent for a re/insurer.
When an intermediary holds money pursuant to a statutory trust or a non-statutory trust (NST) per either CASS 5.3 or CASS 5.4 respectively, it does so as a trustee. This also applies if the money is held under an express trust account for re/insurers, such as a designated insurer trust account outside the CASS regime.
A NST, and potentially an express trust, is constituted by a deed and the intermediary is limited by the terms of that deed at the time it was executed. What’s more, when an intermediary is a trustee it has a fiduciary relationship with each beneficiary and must comply with additional duties and obligations.
But where a re/insurer has granted risk transfer to an intermediary and has stipulated the intermediary holds that money in an insurance broking account (outside CASS), this creates a debtor/creditor relationship between the intermediary and the re/insurer, rather than a trust. This means different obligations and considerations apply.
In any case, a UK intermediary, as a fiduciary, usually has an ongoing duty to account for money it receives from its clients and/or as agent for a counterparty.
Always a breach of trust?
It would be simplistic to say that any CWB is a breach of trust. It suggests any balances which cannot be reconciled or repatriated to a counterparty cannot be written to the intermediary’s profit and loss account in any circumstances. Clearly, writing back a balance without review or investigation might be open to criticism. But the approach to unmatched and unreconciled funds and any CWB ought to be considered in the wider context of the business written and the make-up of the balance. Also relevant is the relationship between the intermediary and its counterparties.
The vagaries of intermediary accounting mean that a ledger may well have unreconciled or unmatched balances due to the intermediary. These may be a result of netting off commission and fees, set-off between premiums and claims either by a policyholder or the re/insurance markets. On NST accounts there can be involuntary funding caused by market settlement systems or bureaux that debit premiums or additional premiums from an intermediary’s NST client account.
There can also be voluntary funding, by which an intermediary pays claims or return premiums from a NST before receipt from a re/insurer. In either case, the intermediary may need to make good a shortfall in the client money account, arising on a client money calculation.
Oversight or errors can lead to inaccuracies in ledgers. For example, not reflecting when a payment or recovery of a bad debt is received, which means the intermediary is not repaid the amount it funded.
There may also be incomplete accounting for settlement transactions, where there are foreign exchange differences, ancillary charges and immaterial settlement differences. Data transfers arising on the amalgamation or acquisition of businesses, and block transfers of balances combined with lost data and records also lead to anomalies.
The first step to removing mistaken entries in a transaction ledger is a proper review of balances and legacy business. It should include consideration as to how balances have arisen. This approach was mentioned in the 2008 Articulation and, in part, in CP12/20.
It’s important, too, to gather appropriate supporting evidence for senior management to review. The board (as governing body of the firm/trustee) can then make an informed decision to deal with balances.
Takeaways
So intermediaries should have properly documented and appropriate processes to consider legacy balances carefully on a case by case basis in the context of contracts and trusts. The right accounting and legal advice will help them stand up to scrutiny.
In light of the above, it is questionable whether the regulator ought to stipulate that every CWB is a breach of trust. Generally, the Courts have jurisdiction over trusts constituted in England & Wales and are best placed to deal with potential breaches of trust on a case by case basis. It is also questionable whether it is feasible in the context of NST deeds and intermediaries’ ongoing duty to account for monies, to direct intermediaries to pay away monies to a charity or an ARF when that was not addressed in a trust deeds or CASS at the time monies were received.
If you would like to know more about issues raised in this article, please contact Timothy Goodger of Elborne Mitchell LLP.
