Medical schemes commission: "There are no brokers-only service providers..."

01 August 2009 Robert W Vivian, University of the Witwatersrand

The case of Afrisure CC and another v Watson NO and another 2009 2 SA 127 SCA, which was discussed in the previous edition of FAnews, comes under closer scrutiny with regard to the role of the broker and the issue of commissions.

In the last edition of FAnews, the case of Afrisure CC and another v Watson NO and another 2009 2 SA 127 SCA, in which the liquidator, Watson NO, successfully sued Afrisure CC, a medical schemes broker and Etienne De Villiers, its owner and sole member of the Close Corporation, was discussed. In this article, the importance of this case with regard to the role of the broker and the issue of commission are examined in greater detail.

Why is commission paid?

A very simple question that needs to be answered is: 'why are brokers paid commissions by risk carriers?'. The answer is equally simple: because they introduce business to the risk carrier. Risk carriers wish to acquire additional business. The additional business is valuable and, quite rightly, the carrier is and should be prepared to pay for it. For this reason, broker commissions are classified as acquisition costs for accounting purposes.

To be entitled to the commission, the broker need do no more than introduce the insured and insurer. In this regard the broker is in no different position than any other broker who is responsible for introducing two different parties. Take for example the estate agent, more correctly referred to by the Americans as a real estate broker. Why does the real estate broker get paid a commission? It is for the same reason: introducing the buyer and seller.

Nothing is simple

Unfortunately the simple answer to the simple question is more often than not completely forgotten when it comes to insurance. Increasingly the answer which is given to this simple question is that the broker is paid because of the services he/she renders to the insured. This is, of course, completely incorrect. It is in the interest of the broker to render services to the insured, since there is very little which stops the insured from going directly to the risk carrier or changing brokers.

Indeed, most brokers render a wide range of services to the insured. An analysis of these services may indicate that in many cases these are unnecessary and, in fact, a duplication of services provided by others. For example, a broker may keep detailed claims histories, which the risk carrier also keeps in order to deal with claims.

The valuable service which brokers provide in placing business with risk carriers can be explained in terms of the economic theory of intermediation, but it is not necessary to go into this theory for purposes of this article. Oddly, the fact that brokers get paid a commission for introducing business, as with the other benefits of intermediation, seems to have been completely forgotten, in particular by 'regulators', 'legislators' and now judges. 'Commission for the acquisition of business' has been substituted by 'value for services to the insured'.

A private sector in SA?

A while back I attended a seminar where a leading economist pointed out that very few African countries have what can be described as a private sector. Very few mean less than five. Of course, South Africa is listed as one of the few. There are, however, many aspects of South Africa's so-called 'private sector' which do not clearly qualify as being part of a private sector. When the state prescribes in such great detail what so-called private sector institutions may or may not do, what products they may or may not sell, who may or may not own the institution, what may or may not be charged, and so on, then it is not clear that an institution subject to these prescriptions is still a private sector institution. Where this happens, the so-called 'regulations' are in fact not regulations - they begin to look more like a company's operations manual.

This is quite evident in the regulation of medical schemes. The question then arises: is the medical scheme industry really subject to regulation or is the government attempting to run the industry as if it is a government department via so-called 'regulations'? It seems as if the latter is indeed the case.

Doing more for less

The fact that brokers are paid for acquiring business is forgotten in the 'regulations'. These are predicated on the basis that brokers are paid for services provided. What is called a commission is not a commission, but a fee for service. Now a 'fee for service' is in no way the same thing as a commission. Yet, the 'regulations' define what 'services' the broker must provide.

In addition, the 'regulations' limit the 'commissions' to 3%. It is not clear that the acquisition activities and these services can be funded out of 3%. Increasingly, not only is the state attempting to run the 'private sector' via 'regulations', but in doing so, the state is imposing positive duties on people to do things, but it does not make any provision to pay for these duties. There is no guarantee that existing income can pay for these additional activities. In the case of the medical schemes broker, not only are additional services laid down, the income is severely reduced!

SCA ruling

In the Afrisure CC case, the fact that a broker is paid for acquisition of business is forgotten. It is accepted that brokers are paid only for services rendered. In fact, the defence told the courts, but the significance of what was said by the defence does not seem to have been understood by the Supreme Court of Appeal (SCA). The SCA responded to the point that brokers are paid for placing business as follows:

"The flaw in the picture presented by De Villiers is, in my view, ... [that] all the obligations listed in Annexure A would in any event be part of Afrisure's duties as a broker. Fundamental to De Villiers' denial that this is so was his thesis that, in principle, once a broker had successfully introduced a client to a medical scheme, he or she has no further obligations, qua broker, to either the client or the scheme. Departing from this premise, his proposition was that every obligation referred to in Annexure A which came after the introduction of the client to the scheme, should be classified as an additional service for which Afrisure was entitled to additional remuneration, over and above the three per cent brokerage."

Far reaching consequences

Thus, the court failed to understand the simple answer to the simple question - brokers are paid for introducing business and not for services they provide. In essence, the SCA decided that brokers are not entitled to any commission but only fee for service. In terms of this new understanding of brokers, there are no brokers - only service providers, with the state free to continue by 'regulation' to add to the list of things these service providers must provide, without any income for services provided.

Even more disturbing is the fact that brokers are not entitled to anything for introducing business. The entire historical role of the broker has been obliterated and forgotten. This has a number of far reaching consequences. As an operations manual, these 'regulations' are a disaster.

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