Last week, FSA published its first consultation paper ("CP160") on the approach it intends to adopt when regulating the sales and administration of general insurance and non-investment life insurance contracts. A further consultation paper, to be published in January, will consult on the conditions that firms have to meet to obtain FSA authorisation, the application of FSA's high level standards, the need for people performing at certain functions to be individually approved by FSA, minimum capital requirements, professional indemnity insurance, protection of premiums and claims monies held by intermediaries, extension of the existing Financial Services Compensation Scheme and financial crime. Both consultation papers will affect insurers, intermediaries and everybody else involved in the sale or administration of general or non-investment life insurance.
FSA's general approach
In line with its existing approach to regulation, the rules which FSA proposes to apply to sales and administration activities will be determined by the identity of the customer and the nature of the product being sold. Unsurprisingly, FSA believes that private customers (individuals and small businesses with a group annual turnover of less than £1m) require greater protection. It therefore proposes to apply a more prescriptive regime to intermediaries and insurers dealing with private customers than to those who deal with non-private customers. All insurers and intermediaries will therefore be obliged to categorise their customers as either private or non-private at the outset of their relationship to determine which set of rules will apply. One crucial point which CP160 fails to address, however, is who is a firm's customer. If an insurer or a broker deals with another intermediary, is the intermediary or the ultimate insured the customer? This point will need to be clarified.
The second factor to be taken into account in determining which rules apply is the type of insurance policy. Many of FSA's proposed rules will not apply to business with non-private customers which relates to reinsurance or large risks [1]. On the other hand, certain products are considered to be particularly high risk, including long-term care, income protection, critical illness and private medical insurance. Additional rules will apply to these products.
A brief analysis of FSA's main proposals is set out below.
Disclosure of firm status
Insurers and intermediaries will be obliged to provide certain basic information about themselves to their customers before the conclusion of any insurance contract and, if necessary (ie. if there is any change) on amendment or renewal of a contract.
FSA is also proposing that private customers should be told whether the service being provided involves the firm giving advice or not and the amount of any fee the customer will have to pay to the firm for advising on, or arranging, the insurance contract (as distinct from a product related charge which will need to be disclosed under product disclosure rules – see below).
The consultation paper contains a template form which can be used to deal with many of the disclosure requirements. One of the pieces of information to be disclosed is the range of insurance companies from which products can be selected. Intermediaries who offer a "whole of market" service to their customers may select a panel of intermediaries on which to base their service so long as the panel is selected on the basis of a robust research process, the composition of the panel is regularly reviewed and the basis of the selection is not primarily the commission payable to the intermediary.
The status disclosure rules will not apply to transactions with non-private customers that meet the definition of large risks or involve reinsurance cover.
Sales standards
When a firm provides advice it should recommend one or more policies that are adequate to meet the customers needs. If no policies are adequate then no recommendation should be made. This is a different advice standard to that which currently exists for investment business, and which is proposed for mortgages, where the firm must recommend the most suitable product from the range it is advising on. The adequate advice requirement will apply to all advised sales involving private customers and to renewals of existing policies for private customers if advice is provided at that stage. In order to meet the required standard, a firm will need to collect enough information from a customer so that it can recommend an adequate product. This process is likely to be more involved for the higher risked products identified above. In addition, in all advised sales to private customers, a written statement of the customer's insurance demands and needs and the reasons for any advice should be given to the customer before the conclusion of any insurance contract.
A statement of the customers' demand and needs must also be provided before the conclusion of any insurance contract in a non-advised sale. In the case of higher risk products, if a non-advised sale involves a private customer interacting with sales staff, the complex nature of the questions might lead to sales staff giving advice without being qualified to do so. As a consequence, FSA is considering the introduction of a requirement that questions be scripted or that sales staff be supervised by an individual who is competent to give advice.
It seems that, in the case of non-private customers, the adequate advice rule will only apply to intermediaries providing a whole of market service. A demands and needs statement (and, if advice is given, a suitability statement) will, however, always be required unless the transaction relates to large risks or reinsurance for a non-private customer.
Training and competence
The existing FSA rules applicable to investment business contain a number of basic training and competence commitments. These state that it is the responsibility of regulated firms to ensure that individuals are (and remain) competent for the work they do, that they are appropriately supervised, that their competence is regularly reviewed and that their level of competence is appropriate to the nature of the business. These commitments will apply to all insurers and intermediaries.
Additional, more prescriptive obligations will apply in respect of advised sales to private customers, and where an individual advises on higher risk products, FSA is contemplating introducing an examination requirement.
Product disclosure
One of the key risks identified by FSA is that customers may buy unsuitable or poor value policies. The product disclosure regime is one of the main tools that FSA proposes to use to address this risk. Before a customer submits an application for a contract, the firm advising or arranging the insurance should provide information on:
- The name of the insurer.
- The main elements of the policy including basic cover and duration.
- Excesses, any significant exclusions and limitations on cover.
- The premium and cancellation charges, payment options, a warning about premium increases and any switching costs.
- Whether the insurance is optional or included with another purchase.
- The specific costs of the premium unbundled from other costs.
In addition, before the customer is bound by the contract, the insurer should provide a complete policy document, a policy summary with appropriate cross references to the policy document and, where the contract is concluded at a distance so the Distance Marketing Directive applies, information on cancellation rights. The insurer may outsource these requirements by ensuring that the intermediary provides the information, but the insurer will remain ultimately responsible.
None of these product disclosure requirements will apply to non-private customers, save that when a policy is sold to a non-private customer and the intended beneficiary is a private customer (eg. employees under their employer's private medical cover) the insurer or intermediary should give the information to the non-private customer, so that he can pass it on to the intended beneficiary.
Fair treatment of customers
This is a key area of FSA's existing regulatory regime and one which will be expanded in four ways to include general insurance and non-investment long-term contracts. The first of these relates to commission disclosure. The basic legal position is that if an intermediary acts as agent for a customer then a fiduciary relationship exists and the customer can ask the intermediary to disclose the amount of commission received by it. FSA proposes to rely on this basic requirement and does not intend to introduce rules on commission disclosure for transactions involving private customers. FSA's view is that disclosure would simply lead to customer confusion, with the risk of information overload, and the need for very detailed rules to describe which commissions should be disclosed. FSA does, however, propose to introduce commission disclosure rules in the non-private customer market which would require an intermediary to disclose, at the request of its customer, all fees and commission earned by it or by any affiliated intermediaries in the distribution chain. The idea is to reduce the ability for groups to "hide" commission by having two intermediaries in a distribution chain with the profit being booked to the one who does not deal with the customer. It is not clear whether this disclosure obligation will apply only where the intermediary acts as agent for the customer or in all circumstances.
The second element of fair treatment for customers, which relates to both private and non-private customers (but not to transactions with non-private customers relating to large risks or reinsurance), is a rule which prohibits inducements that may conflict with a firm's duty to its customers. The precise scope of the rule is unclear, but it could catch certain commission arrangements, such as volume commissions or profit shares, as well as excessive sales related bonuses paid to individual staff.
The two remaining fair treatment protections apply in respect of private customers only. FSA is consulting on whether or not it should introduce a rule to prevent a firm from making excessive charges to its private customers. This would cover any charges for advice or arranging services, as well as premium. Such a rule could cover excess commission indirectly so, if the insurer's premiums are inflated by the excessive commission, the insurer could be in breach of the rule.
Finally, cancellation rights already exist for non-investment life policies sold to individuals. One of the FSA's higher risk products – private medical insurance – is not covered by the existing cancellation regime so FSA is consulting on whether the regime should be extended to include private medical insurance sales to consumers.
Claims handling
FSA is proposing that information about the claims handling process should be available to private customers at the time of the conclusion of the contract. Intermediaries who act for both parties in the handling of claims should inform customers of the potential conflict and gain consent to act for both parties before proceeding. In all cases, a response to an initial notification of a claim must be provided promptly and all claims must be handled fairly and promptly, with customers being informed of progress. Finally, once settlement has been agreed, any payment must be made promptly and an explanation should be given to private customers if the amount proposed differs from the amount claimed.
In the private customer market insurers will be held ultimately responsible for the handling of claims on policies that they have written and for compliance with the claims handling rules. FSA is minded to adopt similar provisions to those contained in the ABI's Statement of General Insurance Practice, namely that an insurer should not refuse liability on the grounds of non-disclosure of a material fact that a policyholder could not reasonably be expected to have disclosed, or misrepresentation unless it was a deliberate or negligent misrepresentation of a material fact, or a breach of a warranty or condition where the loss is unconnected with the breach (unless fraud is involved).
So far as non-private customers are concerned, FSA proposes a less prescribed regime but the proposals for fair and prompt claims handling, prompt settlement once terms have been agreed and the requirement to disclose and gain consent in respect of conflicts of interest will apply. As intermediaries are more heavily involved in the claims handling process in the non-private customer market, these obligations will apply to both insurers and intermediaries.
Complaints
Existing FSA rules which govern how complaints should be handled (including, for example, publishing complaints handling procedures and responding within prescribed time limits) will be applied to complaints from private customers. In all other cases, intermediaries will be obliged to set up procedures for registering complaints, but detailed rules on how such complaints should be handled will not be introduced.
The jurisdiction of the Financial Ombudsman Service will be extended so that the Ombudsman can investigate and resolve complaints made by private customers against all authorised intermediaries and insurers. Authorised firms will be bound by the Ombudsman's decisions (so long as they are accepted by the customer) and will also be required to contribute to the Ombudsman's funding.
Conclusion
In conclusion, CP160 deals primarily with customer protection requirements which focus primarily, but by no means exclusively, on the retail market. The consultation paper due out in January is likely to be of wider application and will cover fundamental organisational matters, such as the systems and controls that need to be implemented to ensure compliance with FSA requirements and the onus/personal liability to be placed on senior management of insurers and intermediaries. A consultation on the fees to be charged by FSA will follow later in 2003. Responses to CP160 should be with FSA by 10 March 2003.
If you would like to find out more about how FSA's proposals will effect your business, sign up for CMS Cameron McKenna's free breakfast surgeries by clicking here.
Alternatively, please contact either Paul Edmondson at paul.edmondson@cms-cmck.com or on +44 (0)20 7367 2877 or Nick Paul at nick.paul@cms-cmck.com or on +44 (0)20 7367 2806.
Click here for an analysis of the scope of FSA's regime.
Footnote
[1] Large risks include railway stock, aircraft, ships, goods in transit, aircraft and shipping liability; risks related to credit and suretyship where the risk relates to the commercial or professional activities of the policyholder; and risks relating to land vehicles, fire, property damage, motor vehicle, general liability and certain financial loss where the policyholder meets specified criteria as to assets, turnover and employees.
