General insurance regulation: FSA publishes conduct of business rules
On 30 June 2003, FSA published CP187 containing draft conduct of business rules on sales and administration of non-investment insurance products (general and protection policies). The consultation paper follows on from FSA's initial proposals in CP160. Some significant changes to those initial proposals have now been put forward.
FSA's General Approach
In line with its initial proposals, the rules which FSA proposes to apply to sales and administration activities will be determined by the identity of the customer and the product sold. The initial proposals have, however, been amended in two important ways.
Firstly, customers will be classified as either retail customers or commercial customers. Retail customers are individuals acting outside their trade or profession. Everyone else is a commercial customer. This is a more practical approach than under FSA's initial proposals where small businesses would have been classed as private (retail) customers. This would have required firms to look at the turnover of some of their customers to ascertain their categorisation. The simplification does, however, have a number of consequences and FSA is proposing to introduce additional rules for all commercial customers which it considers to be necessary for the protection of small businesses.
Secondly, FSA has dropped plans to treat critical illness, private medical and income protection policies as high risk products. As a result, they will not be treated any differently to other non-investment insurance contracts. Long time care insurance will, however, be regulated as an investment product with additional conduct of business and consumer protection obligations.
The conduct of business rules will not apply to reinsurance contracts or contracts relating to large risks outside the EEA. Only the product disclosure rules (and client money which was discussed in CP 174) will apply to large risks situated in the EEA where the customer is a commercial customer. The rules will, however, apply to EEA large risks for retail customers.
Disclosure of firm status
Insurers and intermediaries will be obliged to provide certain basic information about themselves to their customers. FSA has, however, stepped back considerably from its initial proposals. The status disclosure requirements in CP187 meet the minimum requirements of the Insurance Mediation Directive (the "IMD") with one addition: any fees (which is broadly defined but which does not include commission) for advising on or arranging insurance must be disclosed. This additional requirement is aimed, in particular, at reducing instances of grossing up.
The following proposals from CP160 have been withdrawn:
Advice
There will be no need for firms to explain whether or not a sale is advised on initial contact with a customer (though this will need to be disclosed as part of the demands and needs statement – see below).
Initial disclosure documents
There will be no prescribed initial disclosure document ("IDD"), although FSA has included an IDD in its guidance so firms can make use of it as an easy means of complying with the rules.
Timing
The required information must now be provided before the conclusion of the contract and not on initial contact with the customer.
Whole of market advice
The concept of whole of market advice, which is the service an IFA currently provides on investment products, has been withdrawn as FSA accepts it is not generally possible to meet this standard for non-investment insurance sales. Instead, when disclosing the range of insurance undertakings on which the firm has based its advice or information, the IMD formula of "a fair analysis" will be used. This is defined as advice based on an analysis of a sufficiently large number of insurance contracts available in the market that enables the firm to recommend, based on professional criteria, which contract will be adequate to meet the customer's needs.
These are all welcome developments to reduce the paper burden on firms.
Sales standards
In CP160 it was proposed that when a firm provides advice it should recommend one or more policies that are "adequate" to meet the customer's needs. This has been amended so that the obligation will be to provide "suitable" advice. FSA considers, however, that "suitable" and "adequate" are legally the same. Importantly, the obligation is still lower than that which applies to investment products, where the obligation is to recommend the "most suitable" product available. One important change is that all firms giving advice to commercial customers (other than on large risk or reinsurance) will also be required to meet this standard of "suitable" advice.
A statement of a customer's demands and needs must be provided before conclusion of the contract by:
- Intermediaries and insurers when selling to retail customers.
- Intermediaries and insurers for advised sales to commercial customers.
- Intermediaries only for non-advised sales to commercial customers.
FSA does not, however, consider this requirement to be too onerous and it suggests that the requirement can be met by using a tick box on an application form or by a simple sentence in a letter or the insurance certificate. Further guidance is provided in the draft rules.
Training and competence
The existing FSA rules applicable to investment business contain a number of basic training and competence requirements. 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 retail customers. In this context, CP187 mainly confirms the proposals in CP160. There will not be prescriptive training and competence requirements (over and above the basic commitments) for those giving advice to commercial customers or for claims handling staff.
Product disclosure
Prescribed information about the product sold to a customer must be provided. Disclosure is made up of a policy summary, price information, information required under European legislation, a policy document and information on how to make a claim.
The precise timing of the disclosure will depend on the sales medium. For example, in face to face sales, the policy summary, price information and, if practicable, information prescribed by European legislation, should be provided before conclusion of the contract, whereas the policy document and claims information may be provided after conclusion of the contract. In an internet sale, however, the policy document and information on the claims handling must also be provided in good time before the contract is concluded.
One significant change from CP160 is that policy documents no longer need to be provided in all circumstances before contract conclusion. This was considered to be too costly for some intermediaries.
The disclosure obligations for sales to commercial customers are less prescriptive, although the CP187 proposals go beyond those set out in CP160. Firms must provide enough information, including information on fees and premium, for the commercial customer to make an informed decision before the contract is concluded. The insurer must provide full policy terms and conditions promptly after conclusion of the contract to the intermediary and the intermediary must pass them promptly to the commercial customer, and the intermediary or insurer must tell the commercial customer whether or not renewal is being invited in good time before the cover ends.
Commission disclosure and unfair inducements
The commission disclosure proposals are similar to those in CP160. There will be no obligation to disclose commission to a retail customer. Intermediaries must, however, disclose commission earned by them and any affiliated intermediaries to a commercial customer upon request.
FSA is proposing a general rule which would prohibit unfair inducements that may conflict with a firm's duty to its customers. This could catch inducements made by insurers to intermediaries or inducements by intermediaries or insurers to their staff. There is no proposal to prohibit or restrict profit share arrangements or volume overrides provided they are not used in a way that results in customers being treated unfairly. FSA appreciates, however, that there is a lack of certainty around their general proposal and it has invited suggestions as to how greater certainty may be introduced and whether there are any features of inducements which should be explicitly prohibited.
There will also be a rule which prohibits excessive charges to retail customers. Its scope will, however, be limited as it will not apply to premiums (or therefore to commissions paid out of premiums).
Cancellation rights
A significant change is proposed in relation to cancellation rights so that all retail customers will have the right to cancel a non-investment insurance policy no matter how the policy was concluded (the previous proposal would have applied cancellation rights only to contracts concluded at a distance, for example, by telephone or over the internet). Customers will have 14 days to cancel general insurance contracts and 30 days to cancel pure protection contracts (mediation contracts themselves can also be cancelled within 14 days). The cancellation period starts from the day after the day on which the contract is concluded or, if later, the day after the day on which the customer receives the policy terms and other required information. Insurers will be allowed to charge customers who cancel general insurance contracts for the costs they incur in relation to the service provided so long as the charge reflects costs and could not be seen as a penalty. These costs can include both the administrative costs associated with selling insurance and the costs for the cover provided.
Claims handling
The proposed rules differ depending on whether the claim is made by a retail customer or a commercial customer. This raises the question of who is the customer in a claim scenario. It will normally be the policyholder, but for group policies sold to a commercial customer (for example, an employer) the person making the claim (for example, an employee) could be a retail customer in which case the retail customer claims rules will apply. Third party claimants could be retail customers or commercial customers. Claims by third parties should be treated in the same way as claims by a policyholder.
In CP160 FSA proposed to make the insurer responsible for complying with claims handling rules for private customers even if the insurer outsources claims handling activities. It has decided to proceed with this proposal and also apply it to commercial customer claims. In the context of the Lloyd's market, obligations imposed on insurers will fall on managing agents and when risks are underwritten by subscription or co-insurance, the lead underwriter (or his managing agent) must observe the claims handling rules.
Complaints
FSA's latest proposals on complaints handling by firms do not differ significantly from those in CP160. Prescriptive complaints handling rules will apply if the complaint is made by an eligible complainant (defined, in summary, as a private individual or a business with a group annual turnover of less than £1 million, so certain commercial customers will fall within the definition). For other complainants, intermediaries must simply register and respond to complaints as required by IMD. Eligible complainants will also be able to make complaints against intermediaries to the Financial Ombudsman Service. The levy which intermediaries will be obliged to contribute to the Ombudsman has not yet been decided. A further consultation paper will be issued on this around the turn of the year.
Money Laundering
FSA does not propose to apply its money laundering rules to intermediaries carrying on insurance or reinsurance mediation activities relating to general insurance or pure protection contracts. This does not, however, mean that such intermediaries can simply ignore money laundering. Firstly, the provisions of the Proceeds of Crime Acts 2002 which create a set of general offences relating to dealings with the proceeds of crime apply to intermediaries. Secondly, FSA has made it clear that it will enforce in its rules relating to the maintenance of proper systems and controls to counter financial crime. This means that if a firm (perhaps inadvertently) becomes involved in any way in money laundering, FSA may be able to take disciplinary action against it and its management because they have failed to maintain proper systems and controls to combat money laundering.
Conclusion
FSA has continued to liaise with trade associations and industry bodies since publication of CP160. It has taken on board a number of the industry's concerns and one of its aims in CP187 has been to develop a more practicable method for ensuring customer protection. The rules are, however, lengthy and the devil is in the detail. Industry participants are encouraged to consider the rules and respond to the consultation paper by the deadline of 30 September 2003. Further changes to the detailed rules are likely. However, firms now have a foundation which enables them to begin planning properly for NGI (the name given to the date on which regulation of general insurance and protection products takes effect - 15 January 2005).
Alternatively, if you would like to discuss your firm's preparations for regulations and how we may be able to help, please contact:
Paul Edmondson
Partner
CMS Cameron McKenna
+44 (0)20 7367 2877
paul.edmondson@cms-cmck.com
Nick Paul
Partner
CMS Cameron McKenna
+44 (0)20 7367 2806
nick.paul@cms-cmck.com
If you do not wish to receive any further invitations to seminars or events or to receive any other marketing materials, please let us know, at the e-mail address above, and we will amend our database accordingly.
