Buying a freehold and then adding to the ground-rent income by loading the insurance is such a well known money-making opportunity it even appeared in the Sunday Times personal finance section as a “good thing to do”.
The absolutely brilliant bit about it is that leaseholders do not have to be told what the commission is.
Of course, those fig-leafs of respectability in this sector – ARMA, RICS, and ARHM – all say in their codes of practice that leaseholders “should” be told what the commissions are.
These aren’t enforceable and the key issue, of course, is that it is not managing agents who receive the commission anyway: it goes to the landlord.
FACT: leaked documents from Tchenguiz’s Estates and Management showed commissions on his freeholds of 42.5 per cent.
(The very rude term used by Baroness Greengross – the president of the Association of Retirement Housing Managers – in the Lords debate on leasehold to describe complaining pensioners in retirement term developments)
Most leaseholders know insurance commissions are taken by the freehold-owning landlord, but the amounts are only those that he chooses to declare.
When disputes go to the Leasehold Valuation Tribunal, it might decided to limit the declared commissions, as happened in November 2011 at Charter Quay, in Kingston.
Sometimes the OFT will wonder if it should do something, then it looks the other way and hopes the problem will go away. Despite many requests, both the LVT and the OFT seem unwilling to look at the hidden commissions.
The difficulties all start at the Financial Services Authority (FSA) which has a set of rules specifically preventing you from knowing how much money is made on your leasehold insurance. Under what are know as the FSA ICOBS rules, disclosure can only be made by the broker to his client, who is the landlord.
The leaseholder who ultimately pays the premium via the service charge, is not deemed to be a direct party to the contract and therefore not entitled to disclosure.
That leaseholders have no means of knowing about these commissions may be down to the fact that the FSA produced a report in 2005 that concluded there was no problem.
(The FSA get a little embarrassed if you ask them why someone faked some of the data in their “restricted” report on the matter know as document F0057).
However the FSA is not alone in stopping leaseholders from knowing about commissions. You have to thank the combined efforts of the FSA the OFT, RICS, the Department of Communities and Local Government, which drafts the relevant legislation and, of course, those “professional” industry self-regulators – ARMA and the ARHM.
They all do their bit in helping ensure you are kept in the dark.
The insurance industry has a long history of concealing details of commissions and payments with good reason as some of its practices are dubious.
For leasehold property insurance, we start with the headline commission where the landlord or his agent receive a percentage of the total payment.
Such commissions paid via the service change are not allowed under the legislation and so are obliquely redefined by the landlord as payment for their work in arranging the insurance.
However, the industry has a number of well known and perhaps murkier payment, bonus and credit schemes which may be linked to a buildings insurance. Set out below are some examples:
Scam 1: Contingent commissions.
Although these are sometimes frowned on by the FSA, they are legal and well known in the insurance industry.
A contingent commission is an additional payment/bonus paid back by insurers to the company taking the insurance at the end of the premium period when certain agreed criteria have been met. Fo example, if the claim level falls below level X over the year, it results in a credit of payment Y.
For some industries this is perfectly reasonable, but not the leasehold sector, where leaseholders receive none of the benefits of these bonuses and credits.
As the contingent payment would not be linked to individual policies but the overall portfolio, a leaseholder would never know if a contingent payment is made back to the landlord’s overall group.
In addition, to this simple example there are many more options for subtle contingent commissions/payments/bonuses. The following are three prime examples of the practice
- a) It is an easy for the landlord to arrange to slightly over insure a site(s) knowing this would give a lower claim level relative to the premium and therefore the insurance company/broker would be willing to agree a bigger contingent commission.
- b) It is possible to encourage the managing agent’s staff to make sure insurance claims are suppressed by placing costs through the service charge. How would you know if a problem on the site is charged to service charge rather than made as an insurance claim until years after the event? Just because a staff member says an insurance claim is being made, does that mean that is what happens?
- c) The company taking out the insurance may choose to omit certain items from the policy so that whilst the policy looks very comprehensive it actually excludes certain detailed matters on issues where a claim is more likely to arise. Perhaps that why many landlords choose a bespoke policy wording?
Scam 2: Soft commissions.
This is the system where the company taking out the insurance gets an indirect benefit for taking that insurance, again it is perfectly legal although not encouraged by the FSA. An example of this type of payment would be when a company insures a range of buildings and then has its own offices insured to a very low price.
There are few limits to the imagination on how these types of systems work. An apparently totally unrelated bill for something like electricity may be offset by the insurer/broker as part of a soft commission deal. As long as both companies declare it in their books there is not a problem and again you have no way of knowing if such commissions are linked to your site.
A slight variation on soft commissions is shown by the following example from the 2006 securitisation offer for Peverel Retirement interests for £352 million.
“The Properties are insured on a full reinstatement basis and rental value loss currently for three years (but not loss of Transfer Fees)”
We all know it is the leaseholders who pay the main buildings insurance. What we have no way of knowing is if those insurance payments also pays for the element that provides the landlord with three years insurance cover for his “rental value loss” if he is unable to recover those incomes for a particular site.
Rental incomes perhaps being the manager’s flat revenue?
Why all these potential extra commissions matter is that they would add yet further costs, which means you pay more.
While the FSA has specific rules to prevent you from finding out about these commissions, the Royal Institution of Chartered Surveyors (RICS) exacerbates the issue.
RICS supposedly looked in the transparency of insurance commissions which it dubs as “professional fees”.
It concluded that there was no real issue, but offered the platitude that it is important there should be transparency so that tenants do not become unduly concerned.
RICS, ARMA and ARHM like to pose as the champions of consumers, but are then repeatedly caught out suggesting the polar opposite.
Last year, CarlEX members were astonished when a senior member of RICS explained with helpful slides how a landlord could take that up 50 per cent of the total insurance premium paid for by leaseholders, without them knowing a thing about it.
This helpful performance occurred at the annual conference of LEASE, the costly and pointless government quango that is there to make leasehold tenure function equitably.
With 50 per cent commissions, and extra on contingent and soft commissions the potential profit from insurance is enormous.
Of course, we should point out that disclosure of commissions is required under the RICS “Service Charge and Residential Management Code” as approved by the Secretary of State under the Leasehold and Housing Reform, Housing and Urban Development Act of 1993. The Code has the whole of section 15 dedicated to insurance and your right to information about the policy wording and proof of payment, quoting relevant legislation, but the word commission is not mentioned once.
There is just one reference to commission in the Code appearing at item 2.6. This states:
“Insurance commissions and all other sources of income to the managing agent arising out of the management should be declared to the client and to tenants.”
This may appear to be unambiguous until you remember it is often not the managing agent who is making these commissions – it is the landlord and his agents. Like so many things in the RICS code perhaps this is yet another honest mistake?