The Financial Services Authority (FSA) was moved to regulate general insurance (GI) in order to implement two EU Directives – the Insurance Mediation Directive and the Distance Marketing Directive. The government gave extra responsibility to the FSA rather than leave it to self-regulation that was overseen by the General Insurance Standards Council. This decision had far reaching consequences both in terms of cost and business practices for almost every firm employed in the selling or advising on hundreds of GI products ranging from motor to protection products and employers’ liability. This seismic shift in procedure to regulation had already been felt in the independent financial adviser (IFA) sector and the FSA looked to import some of the rules it had imposed on IFAs to GI brokers and their product providers.
But how successful was this approach and was the GI sector really crying out for regulation in the first place?
A prescriptive approach
The FSA rules implementing the EU Directives were prescriptive. The FSA ‘goldplated’ the Directives and set additional detailed standards.
Rather than setting out what a policy summary should achieve, the rules set out in detail what it should contain. Was this approach correct?
GI is bought like many other goods and services. Customers choose between competing providers and products. As with some other products, mistakes made in the sales process may only come to light at a later stage. So getting the sales process right and ensuring customers understand what they have bought is important.
The information customers need depends on what they want to buy and how they decide to buy it. A customer buying direct from an insurer knows who they are approaching and develops their own knowledge of the market. A customer seeking professional advice is more likely to rely on that advice and be less prepared to assess the product.
The Association of British Insurers (ABI) says these differences in customers’ situations should be reflected in regulation. It believes that in order to achieve this, the regulatory framework should move towards being principles-based, where that makes sense. A principles-based regime looks at what should happen, rather than dictating how it is to be achieved.
Principles-based regulation
Principles-based regulation is especially appropriate for the sales process, where the right outcome can be achieved in different ways. This has been recognised with the Davidson Final Report on the implementation of EU legislation proposing action to cut the burden of regulation in insurance mediation and other areas. The way the Insurance Mediation Directive (IMD) has been transposed into UK legislation came in for particular criticism. This review was commissioned by the government and forms part of its better regulation agenda.
Two of its main recommendations were to simplify rules on product disclosure and reduce the amount of information that insurance intermediaries are required to provide to their customers when selling lower risk products and cut prescriptive rules that overlay principles and are not required by the Insurance Mediation. It also said that the client money rules should be reduced and simplified and recommended that the FSA implement this by July 2008. Happily, the FSA is moving toward a more principles-based regime, to shift emphasis away from firms’ processes to the outcomes for consumers, firms and markets. The move towards more principles-based regulation will give firms more flexibility to innovate as to how they achieve the outcomes the FSA is seeking.
As John Tiner, CEO of the FSA recently said: “We see real benefits for firms, markets and consumers, as well as our own people, in tipping the balance more towards principles and away from prescription.” Not before time. It seems only sensible that the FSA should focus on areas of greatest harm and intervene only where the market is not working. However this means a delicate rebalancing act between the current rulebook (8,500 pages and counting) and the 11 core principles for businesses (194 words). This may not be easy to achieve while many firms, their lawyers and compliance departments prefer the certainty of rules to general principles.
ABI standpoint
Meanwhile, the ABI undertook a review of the FSA regulatory regime for general insurance to understand how it has affected customers. It commissioned some independent research and also charged it with finding what the financial impact regulation has been on customers. Included in its findings were that few were interested in ‘status disclosure’ information, such as who regulated the company selling the policy or whether it sold products from one or more insurers; 40 per cent of all respondents thought that the sales process contained irrelevant information, rising to more than half for telephone sales.
The ABI wants to see the FSA develop a better understanding of the impact of regulation on the insurance market with particular emphasis on the customer costs and benefits of regulation, via an understanding of the impact of regulation on customer behaviour. A bit late for that you might think, but where the customer and the intermediary have been directly affected has been in the ‘Treating Customers Fairly’ (TCF) rules. The TCF campaign is based on the principles and it spearheads the current move towards more principles-based regulation. Principles-based means that the regulator pays particular attention to outcomes and, over time, there will be less and less prescription as to how the desired outcomes are achieved.
The onus will be on senior management to maintain systems, controls and procedures, which are appropriate to their business, to meet the principles. This has caused some confusion for GI brokers, mortgage brokers and product providers. In the case of a valuable insurance cover like mortgage payment protection insurance, the scent of a mis-selling scandal has seen some brokers even refuse to recommend it. By doing so they may believe that they are protecting themselves and the consumer. But by not recommending this cover where it is appropriate, it could be decided that they have not treated the customer fairly. Just before Christmas the FSA fined Redcats (Brands) Ltd £270,000 for failing to treat its customers fairly when selling payment protection insurance in connection with home shopping products.
The regulator found that the home shopping specialist did not have adequate systems and controls in place to minimise the risk of unsuitable sales. There were also weaknesses in the way that Redcats operated and maintained its compliance systems, Training and Competence arrangements and sales processes. Similarly the FSA imposed a public censure on Eastern Western Motor Group (EMWG) for failures relating to its sale of payment protection insurance in connection with vehicle finance agreements. The FSA stated that EMWG had failed to ‘organise and control its regulated business effectively’. This is a main area of concern that relates to the secondary intermediary sector, i.e. those firms for whom insurance is not their principal business activity. TCF is one of the building blocks of the new regime. The FSA expects firms to complete the implementation phase of their gap analysis against the FSA’s Principles and high-level rules by March 2007. This is a very tight deadline for some firms.
Outsourcing
This has led to some mortgage brokers, for example, outsourcing the whole process to a GI wholesaler in order to avoid falling foul of the rules. It has also seen both GI and mortgage advisers buying in the services of a compliance specialist. The demand for this kind of service has rocketed with the advent of regulation as advisers seek to protect their business.
The ABI says its research shows that GI regulation is not justified on cost-benefit grounds – the regime has an overall cost of nearly £400 million for customers. This is made up of the direct impact on customers, which it estimates as a cost of £122 million, and the indirect costs of companies’ compliance of about £266 million.
For some products, such as motor and household insurance, where there is a wide choice in a competitive market, the negative impact of sales regulation was calculated to be £362 million a year. But it also noted that regulation has had a positive effect for customers who purchase insurance alongside other goods or services, and for customers of health protection insurance. These benefits were estimated to be £177 million and £62 million a year respectively, and arose from improvements in suitability. Regulation of GI has brought both costs and benefits to both broker and consumer in its first year and will continue to do so, going forward. What is pleasing to observe is the willingness of the regulator to listen to the industry and seek to amend its approach where necessary.
Shaun Godfrey is sales director at UKGI
