Chapter 1 - The Legal Environment and Licensing

Question 1

Sole Proprietorship

Answer 1

A business owned by a single individual.
It may consist of the owner alone or may employ others.
+ Profits belong to owner
+ Control
+ Inexpensive to operate
- Unlimited personal liability for debts, losses, and judgements
- Owner relies on personal capital to finance business
- Owner’s expertise may be limited
- Business lacks continuity and may be difficult to sell because it will not automatically continue after the death, disability, or retirement of the owner
- Attracting and retaining employees, see above

Question 2

Partnerships

Answer 2

A partnership is a voluntary association of two or more persons who are co-owners of a business operating for profit.
+ Increased Expertise compared to SP
+ Enhanced ability to raise capital compared to SP
+ Strategic and operational plans are based on the partner’s position.
- Unlimited personal liability for all debts, losses and obligations of the company.
- Discord regarding compensation
- the partnership is dissolved on death, disability, or retirement of one of the partners and there is therefore a lack of future certainty for employees.
- While the corporate intelligence of a partnership may exceed that of a sole proprietorship, it is still limited to that of the partners and paid external expertise.
- Partnerships are subject to more government regulation than sole proprietorships.
General Partnership - All rights and obligations of the partnership fall on all partners equally.
Limited Partnership - In a limited partnership (which is usually preceded by a general partnership), the limited partner is not active in running the business and has only limited liability, whereas the other, active partners are subject to unlimited liability.

Question 3

Shareholders Agreements

Answer 3

Agreement sets out rights and obligations of the shareholders that go beyond the basic ownership of shares.
Shareholders’ agreements can set rules for the transfer and valuation of shares when certain other events occur, such as the death, resignation, dismissal, personal bankruptcy, or divorce of a shareholder.
Set rules directing how the future obligations of the company will be shared or divided.
“Shotgun Clause” - This clause sets out the conditions under which one or more shareholders would buy out another shareholder.
Other provisions can include non-competition clauses and confidentiality agreements; dispute resolution mechanisms; and details respecting how the shareholder agreement itself is to be amended or terminated.

Question 4

Corporations

Answer 4

A legal entity whose incorporators are granted a charter by either the provincial or federal government, depending on where the business is registered.
A corporation’s name generally includes the words limited, corporation, incorporated.
Ownership of the corporation is evidenced by shares that can be transferred or sold.
A corporation may be privately or publicly held.

Question 5

Fiduciary Duties (LORAD)

Answer 5

Loyalty
Obedience
Reasonable Care
Accounting
Disclosing Information

Question 6

Fiduciary Duties - Loyalty

Answer 6

Broker has duty to act primarily for the benefit of his or her principal and to deal fairly with both principals in every way
This principle is complicated by the fact that the broker has DUAL RESPONSIBILITIES to two principals

Question 7

Fiduciary Duties - Obedience

Answer 7

Duty to obey lawful instructions of the principal
If the agent fails to obey, the principal may bring action against the agent for any damages that result, and may terminate the relationship
Always consider whether obeying the lawful instructions of one principal will run counter acting for the benefit of the other.

Question 8

Fiduciary Duties - Reasonable Care

Answer 8

Duty to exercise the degree of care that a reasonable, prudent person (with similar training) would use in the same or similar circumstances

Question 9

Fiduciary Duties - Accounting

Answer 9

Broker owes a duty to his or her principal to account for all property and money of the principal in the agent’s possession.
The agent must keep such money and property separate from the agent’s own and may only use it for purposes authorized by the principal.
In addition to being entitled to a financial report, the principal has the right to examine the agent’s books of account.
Due to the special nature of insurance, brokers are required to keep premiums and operating funds separate.

Question 10

Fiduciary Duties - Disclosing Information

Answer 10

The agent is responsible for providing the principal with all information that materially affects the principal’s interests; all information that is relevant to the affairs entrusted to the agent.
The duty to inform is strengthened by the legal principle of Utmost Good Faith, which governs all insurance transactions, and requires brokers to disclose all material information to insurers.

Question 11

Affiliations

Answer 11

Careful assessment and wise selection can assist a brokerage in achieving its financial and production goals. Operating affiliations include a brokerage’s relationship with other brokers, its insurers, and other groupings outside its own legal structure.

Question 12

Informal Affiliations

Answer 12

Networking Groups
Could comprise a group of brokerage managers who meet for coffee, lunch, or a regular game of golf.
Other groups of brokers might hold meetings to discuss common industry problems or to network.
Neither of these types of affiliation places members under any formal obligations to other members or to attend regular meetings.

Question 13

Formal Affiliations

Answer 13

Generally involve some type of contractual relationship and/or obligation.
Clusters
Joint Ventures
Common Identity Groups
Franchises
Insurer Investment in the brokerage

Question 14

Clusters

Answer 14

A group of independent brokers or brokerages who agree to share certain expenses, to make unified volume commitments to their insurers, and to conduct specified aspects of their financial affairs in an agreed-upon manner.

Question 15

Joint Ventures

Answer 15

Someone who owns his or her book of business goes into partnership with a larger broker to obtain access to markets and to gain marketing and administrative services in exchange for a percentage ownership of the book.

Question 16

Common Identity Groups

Answer 16

Marketing organizations established to give participating firms the image and resources of national or international-strength organizations.

Question 17

Franchises

Answer 17

Affiliated with a franchisor to which it pays a percentage of its revenues in return for various services.

Question 18

Insurer Investment in the brokerage

Answer 18

Insurers invest in a brokerage by purchasing shares in the business, thus providing the brokerage with an infusion of cash to use to operate the business, to finance growth in the book of business, or to expand operations.

Question 19

Agency Contract

Answer 19

Granting Authority
Ownership of Expirations
Billing Procedures
Commission Schedules
Agency Expenses
Cancellation
Rehabilitation
Profit Sharing and Bonus Commission Agreements

Question 20

Granting Authority

Answer 20

This clause authorizes the broker to act as an agent (in the legal sense) to the insurer.
It sets out what the broker can do without asking the insurer’s permission;
indicates any limitation in the relationship (for example, the authority may be terminated if the brokerage’s license is suspended or terminated);
and specifies the types of business a broker can bind.

Question 21

Ownership of Expirations

Answer 21

This clause specifies whether the broker or the insurer owns the expirations, and therefore, who has the right to sell the book of business. Ownership of expirations lies at the heart of a broker’s financial position. It is a key element in the valuation of the brokerage, generally combined with other criteria (such as key employees and the quality of management) to determine the brokerage’s selling price. For instance, the selling price can be expressed as a multiple of the commissions earned on the book of business. If the insurer owns the expirations, it can transfer the book to another broker, seriously reducing the value of the brokerage as an asset.
Also establishes who has control of documents, such as inspections, surveys, applications, and rate books, among others.

Question 22

Billing Procedures

Answer 22

Specifies the methods of invoicing clients. Two of the major methods used are broker bill and direct bill.

Broker Bill - The broker invoices the insured, collects payment, and sends the policy premium less commissions to the insurer. The records of transaction are generated either by the insurer or the brokerage, with periodic adjustments made to the calculations. In general, accounts are payable at the end of 30, 45, or 60 days from the end of the month in which the premium was generated.
+ Brokerage has control over billing
+ Able to invest premiums between collection and remittance to the insurer.
- Costs of bookkeeping and collection
- Potential for bad debts.

Direct Bill - Insurer bills the insured directly and submits the commissions to the broker periodically as agreed.
+ Broker is not responsible for collection of premiums
+ Broker has less work
+ Broker has less need to employ accounts receivable staff
- Loss of interest on premiums since the broker cannot invest them
- Loss of control of accounts
- Broker out of communication loop
* Contract should include a hold harmless agreement where the insurer agrees to hold your brokerage harmless for errors in accounting, including failure to collect premiums. Also, ensure the contract obliges the insurer to refer to the client to you if the agency contract is cancelled.

Question 23

Commission Schedules

Answer 23

Usually attached to the agency contract as an addendum, lists the lines of insurance written and the rates of commission payable by line. Since commissions are generally negotiable and vary from insurer to insurer, review each offering carefully.
Most contracts specify a notice period, which is usually 60 or 90 days from the notice date, during which the insurer may adjust commissions. A shorter notice period may be specified for changing the commission payable on new policies than for changing commission on endorsements to existing policies.
Most brokerages are paid mainly through commissions, the commission schedule affects the profitability of the brokerage.

Question 24

Agency Expenses

Answer 24

With some exceptions, most agency contracts oblige brokerages to pay their own operating expenses. In practice, although not required to do so under the contract, insurers often assist brokers with expenses by, for example, placing joint advertisements in local newspapers and telephone directories, providing financial support for the broker’s Web site, and offering training courses of the brokerage.

Question 25

Cancellation

Answer 25

Specifies the notice period required for cancellation of the contract by either party. When negotiating the contract, aim to secure the longest possible period of time between the insurer’s giving notice of cancellation and the actual cancellation date. This allows time to make arrangements to transfer accounts to another insurer, including time for that other insurer to underwrite the accounts being transferred (which often means allowing time to contact the client for additional information or clarification), time to process the new policy, and to deliver the new policy before renewal date.
Also states which party is responsible for notifying the insureds. Insurers that have automatically provided renewals may be held liable if the insured does not receive proper notification that his or her policy will lapse or if the policy is not placed elsewhere on renewal. If the insurer agrees to notify the insureds, ensure the contract holds you harmless should the insurer fail to do so.

Question 26

Rehabilitation

Answer 26

This clause makes provision for the insurer and broker to work together to preserve the contract. One of the main reasons for an insurer cancelling an agency contract is poor loss experience. The rehabilitation clause states how the broker and insurer will work together to improve the experience.
Steps to be taken could include inspection of properties, cancellation of certain classes of risks (for example, commercial automobile long-haul risks), increasing deductibles, or reducing coverage.
Often the period permitted for rehabilitation is limited.
If the required improvements are not achieved within the the designated time period, the insurer will cancel the contract.

Question 27

Profit Sharing and Bonus Commission

Contingency Commissions Agreements

Answer 27

Incentive compensation offered to brokers in anticipation of exceptional profits or volumes of business. Depending on the result desired, bonuses are based on criteria relating to the following:

• the percentage of profit attained - where the insurer wishes to encourage low loss ratio business;
• the percentage of growth - where the insurer is interested solely in the volume of business written; or
• a combination of percentage of growth and profit - where the insurer wishes to encourage a stated minimum volume of growth of profitable business.

In addition, bonus commission may be offered for the transfer of a portfolio of business. This type of bonus is an incentive for the broker to transfer the business and helps the broker with the costs involved in transfer.

Brokers are ethically required to treat the best interests of their clients as paramount at all times. Thus the interests of the client always supersedes the broker’s interest in any bonus commission to be earned if a particular client’s business is to be included as part of a portfolio transfer.

Question 28

Legal Authority

Answer 28

The permission or right, coupled with the power, to act or have other act.
A broker receives his/her authority from Common Law or the Quebec Civil Code, and the agency contract.
This authority can be both express and implied.

Question 29

Express Authority

Answer 29

The permission specifically granted to the agent to carry out any legal action that the agent and the principal agree to in writing or verbally, including acts that enable the agent to carry out those instructions.

Question 30

Implied Authority

Answer 30

Authority that, although no proof exists of its having been actually given, may be inferred from the conduct of the principal or from the written authority of the principal.

Question 31

Ratification

Answer 31

In essence, a form of authority that a principal has the option of granting. When an agent has exceeded the authority granted to him/her by the principal, the agent has in effect made a contract for him/herself rather than for the principal. In insurance transactions the most common form of this would entail binding insurance outside of the broker’s authority.
If the principal ratifies (that is, agrees to) the agent’s act, the principal is bound by the original contract: if ratification does not take place, the agent alone is liable on the contract.
Note: Insurers do not have to ratify insurance contracts, and even where they do honour the contract and pay an insured’s loss (as the innocent third party), they may have a valid claim against the broker to recover the payment made on the claim.

Question 32

Broker Licensing

Answer 32

A brokerage must obtain a license to operate in the province or territory in which it is domiciled and, if it is doing business in multiple jurisdictions, may need to obtain additional licences in each of the jurisdictions in which it has clients.
The various insurance acts prohibit insurers from giving any authority to a brokerage that is not properly licensed. The agency contract generally reinforces this by providing for the automatic termination of the contract if the broker’s license is suspended or terminated.
The provincial government can issue licenses directly to brokers or it can delegate licensing authority to some other body, such as an insurance council.
Note that even where authority has been delegated to another body, licensing is still ultimately the responsibility of a government official, usually the Superintendent of Insurance or Superintendent of Financial Institutions.

Question 33

Licensing Requirements

Answer 33

Are intended to regulate the industry and to protect the consumer by ensuring that insurance professionals meet certain minimum standards of competency.
Each jurisdiction establishes its own requirements.
Typical requirements can include:
- passing an examination following a required course of study, such as specified Insurance Institute CIP courses;
- acquiring a minimum number of continuing education hours each year;
- compliance with the terms of the provincial Insurance Act, its regulations, and the rules of conduct of the licensing body;
- step licensing - where increased authority is granted to brokers once they have attained the higher levels of competency; and
- ensuring that insurance professionals operating within the jurisdiction:
- be free of criminal convictions;
- have not declared bankruptcy; and
- supply evidence of professional liability insurance and a fidelity bond.

In some jurisdictions, the licensing authority requires that the broker candidate must be sponsored. The sponsor may be an insurer who is appointing the new broker or brokerage, or the brokerage that will be employing the individual.

Question 34

Step Licensing

Answer 34

“Graduated Licensing” process used by many provinces
Grants broker increasing authority as they acquire a combination of additional education and years of experience.
Passing the initial or entry level examination qualifies the individual as the most junior grade of license holder, and permits him/her to function as an insurance broker (subject to restrictions) under the supervision of more experienced and higher qualified brokers.
In Ontario, RIBO requires that an entry-level broker, known as a Broker Acting Under Supervision, cannot control trust funds, act as a Principal Broker, or operate as a sole proprietor. Must be supervised by a Principal Broker.
The junior broker can graduate to an Unrestricted-Technical only license or to a full Unrestricted license following successful completion of the requisite examinations. Only the Unrestricted Broker (the highest level of license) can act as a Principal Broker and manage a brokerage office.
At least one individual must have an individual holding the highest license level.

Question 35

Consumer Protection

Answer 35

Due to the fiduciary nature of the principal-agent relationship, most jurisdictions have enacted safeguards to protect the interests of consumers.
The responsibilities of accepting and handling trust funds require a high degree of honesty and integrity.
Thus all licensing bodies require a criminal check of broker applicants.
In addition, the broker applicant must confirm that his/her suitability to fulfill a position of trust, including the ability to handle monies.
As further protection, in some jurisdictions (Ontario, for example) brokerage are required to carry a fiduciary bond that covers fraudulent acts committed by employees or other members of the company.
The various provincial insurance acts require brokers and brokerages to carry professional liability or errors and omissions insurance to protect innocent consumers from the effects of any mistakes made by brokers during the insurance transaction.