A Warning Shot Across The Bows, Or The Opening Salvo From The Regulator?

The FCA has updated insurance firms on its plans for addressing the issues that it has been investigating around the placement of insurance for multi-occupancy buildings following an intervention by the then Secretary of State for Levelling Up, Housing and Communities, Michael Gove, in January 2022.

A change in government has not slowed the pace of work and the FCA has now issued its report, setting out in detail actions it will take and that it asks other parties to undertake, some recommendations and a list of potential remedies. The message is clear to those insurers and brokers involved in the placement of these risks – act quickly or expect more significant intervention.

There is much overlap with other ongoing work being conducted by the FCA and firms should consider this report in light of the Product Governance rules, in particular, the ongoing work required to be undertaken on ‘Fair Value’, and the implementation of the new rules on Consumer Duty.

The scope of the work could broadly be categorised as falling into two areas:

• The consequences of significant and swift changes in risk appetite following the Grenfell disaster; and
• More systemic issues that arise from distribution chains that are more complex than the norm for the placement of insurance and include interested parties not currently protected within the existing perimeter of the FCA authority.

It is probably fair to say that the first of those issues has been the catalyst for change in the second area, which had mostly been conveniently ignored for the period that low insurance rates masked the issues. With rapidly rising premiums, the question of fairness quickly became a political issue.

What The FCA Has Concluded

There will be few surprises for anyone who has followed this work from the outset when reading the initial conclusions the FCA has reached. Namely:

• That changes in risk appetite have created a market place where competition is limited, driving a reduction in markets and rapidly increasing premium levels, to the detriment of ‘consumers’;
• That the protections afforded to ‘consumers’ through the ordinary regulatory controls do not provide the requisite protections to those who the average citizen might consider should be protected – namely the people who end up paying the premium;
• That in many, albeit not all, cases, commission rates being paid are not consistent with the concept of ‘fair value’ for the consumer, and in real terms, the monetary amounts earned have increased at significant levels. Indeed, the FCA reports commission rates in its sample data between <10% to 62%. Additionally, the level of commission and the nature of any work actually done by the broker and the property managing agent, with whom a significant portion of the commission is normally shared, came in for particularly stinging criticism, with the FCA saying: “We are very concerned that this practice does not represent value ultimately for the leaseholder.”
• The inability of leaseholders to exert any leverage on the supply chain is a significant detriment to their ability to seek fair value;

FCA Recommendations

The FCA has highlighted a number of recommended actions that it will take and on which it now seeks specific feedback from stakeholders. These are:

• To develop proposals for a risk pooling solution. The FCA has recommended the ABI, BIBA and government representatives work with it to develop a proposal within the next 2 months;
• Improved transparency and disclosure for leaseholders. This would in all likelihood extend beyond the current powers of the FCA to impose such a condition and it has specifically asked the government to consider imposing a new obligation on freeholders and property managing agents to provide information on the insurance policy to leaseholders. Given the need for new legislation, this would be longer term in its implementation. This particular issue, transparency, was a concern even before the Spitzer proceedings in the US affected the market in 2004 and when secret commissions become a considerable market issue. It was not fully dealt with at the time, the FSA and then FCA spotlighting its rules on conflicts of interest but to little effect and with no further action taken.
• Making leaseholders ‘customers’ under FCA rules such that they are afforded appropriate protections by the FCA. Whilst it indicates it is looking at ways of achieving this outcome through amendments to its own rules, the FCA also highlights the possibility of a government-led change to insurance contracts, by which leaseholders would be formally recognised as a party to the insurance contract.
• Through the application of its rules on ‘Fair Value’. Those brokers charging the highest commissions have been placed on notice they will be subject to a review. In regulatory speak this may mean proceedings.
• Looking at the possibility of new rules to manage remuneration, including the prevention of payments to unauthorised parties and the possibility that commission will have to be expressed in monetary terms, not as a percentage.
• The improvement of risk data coding to facilitate the functioning of a competitive and effective market.

With a market that is so steeped in historical practices and legal principles, some of these changes will strike at the core of the way business is conducted. Insurers are well versed in meeting a range of regulatory obligations in the way they do business and conduct themselves vis a vis their contractual partners. What is being proposed might strike at the core of what has historically been understood to be the ‘contractual community’ in so far as insurance law is concerned. Insurers might start to ask some interesting questions about the possibility of a conflict arising between different parties that might both otherwise claim to be the ‘customer’ in so far as the insurance is concerned. Rightly, the FCA is seeking feedback on its proposals and it will be interesting to see what different stakeholders have to say about these.

The question of remuneration for brokers is perhaps less of a legal dilemma and more of a cultural one. The possibility of mandatory commission disclosure has raised many arguments over the years probably at a peak during the Spitzer years, and the suggestion brokers might move to fixed monetary ‘commission’ payments is bound to raise questions about commission v. fees and whether perhaps policies should be ‘net rated’ or not. Although with Fair Value and Product Governance requirements net rating must be considered to be dead except for Large Risks and bespoke arrangements because of the need for manufacturers and distributors to understand the value in the distribution chain. The suggestion that the FCA might ban payments to unauthorised parties is related and will itself give rise to many conflicting views on the question of to whom a duty of care may be owed by such parties and how that should be reconciled with the question of their remuneration.

Next Steps

Those paying close attention will have noticed that some proposed next steps are more ‘consultative’ in nature and some seem to be jumping far more quickly to solution and implementation phase.

At present, the FCA work does not amount to a formal ‘Market Study’, but there is an explicit warning from the FCA that it may lead to that if it does not see “swift action and progress from the industry”. That may lead to the Competition and Markets Authority becoming involved, something the insurance market is all too familiar with from its work on ‘price walking’. We do not believe that the insurance market would want to end up again in the position in which it found itself on 2004 during the Spitzer period. It may be that the FSA has gone but with the issue coming to the forefront for a second time and at a time when the FCA is being less conciliatory about the treatment of customers such an outcome is likely to not be very positive for the market.

There are a number of issues where the FCA seeks additional input from stakeholders, with a series of specific questions posed on which it seeks further input by 31^st October. Be warned though, this is not an opportunity to park the issue until the end of October – it is a very specific set of questions on which the FCA seeks input, not ‘cease fire’ pending further negotiations.

Our Conclusion

Insurers and brokers involved in the placement of multi-occupancy buildings insurance must look very carefully at their own approach to this type of business now. Whether you were involved in the initial data gathering exercise or not, now is the time to understand how your own approach to the placement of this business measures up against the issues specifically raised and the related regulatory work on Product Governance, ‘Fair Value’ and the new Consumer Duty. This is more than a warning shot from the regulator, it is a very explicit instruction to firms to consider carefully their own actions.

If the experience of the FCA in its work on ‘Fair Value’ is anything to go by, it’s very likely the FCA expects to find that a significant number of market participants fail to take its warning seriously and we will all see more regulatory interventions on this subject within the relatively near future. That will not be a comfortable position for any firm to find itself in. Further, if the market does not respond rapidly and appropriately, we may see consequences which could have a longer lasting and deeper impact on all participants.

If you would like to discuss any aspects of your own approach to handling multi-occupancy buildings insurance with the author, or one of the wider compliance team, please do contact us.