The Latest FCA thematic review report, “General Insurance Distribution Chain”, is a culmination of two simultaneous but separate reviews. The first of these focused on the value in the distribution chain. The second, investigated whether firms that outsource activities to other parties under delegated authority arrangements have responded appropriately to the findings of a thematic review carried out by the FCA in 2015.
These reviews were performed in parallel to the Regulators diagnostic work on General Insurance (GI) pricing practices. They each looked at a different range of GI products, considering how they are distributed, the range of parties involved and how that impacted on value, but they had a similar focus on identifying parties, the risks of potential harm to customers and their causes. These complementary pieces of work are aligned because they both emphasised the economics of the products and services being provided to customers, and the distribution chains and methods by which they are delivered.
The resultant thorough report sets out key findings, provides the FCA’s clear expectations and outlines the next steps that firms will need to take. Published alongside this report is the proposed non-handbook guidance and a “Dear CEO” letter. The documents released by the FCA are relevant to all firms within the GI sector, with the guidance and expectations set of particular relevance to insurers and intermediaries that manufacture GI products or services, given the new obligations arsing from the implementation of the Insurance Distribution Directive (IDD) in October 2018.
The report covers several interlinking areas that the FCA have been working on over the last few years, including IDD (especially Product Governance and Oversight) Publishing Data Value Measures, GI Pricing, the FCA’s Delegated Authority review and Senior Managers & Certification Regime (SM&CR), all of which I will expand on later in this article. There is no doubt that the FCA is tightly focussed on ensuring firms understand the links between each of these.
The FCA’s work identified significant potential for harm to customers arising from the product development and distribution approaches currently employed in some sectors of the GI market. The risk of harm that the FCA have identified relates to both features of the distribution chain and of the particular product involved. Additionally, the FCA have recognised that some distribution chains are potentially subject to significant influence from parties that are not FCA regulated, such as retailing groups whose main business is unregulated and therefore may have a higher risk attached to them requiring greater oversight and governance by regulated firms.
The following potential harms were identified by the FCA;
- Customers buying GI products at prices which appear significantly higher than the production and delivery costs of the products, due to high level of commission within the distribution chain.
- Firms failing to fulfil obligations to customers, including where the services provided to customers are not delivered appropriately. Examples of this include shortcomings in the processes and practices surrounding claims handling, particularly where this responsibility had been delegated creating a risk that legitimate claims could be rejected.
These potential harms stemmed from two key causes. The first of these was a firms’ business model and strategy. This was characterised by firms lacking focus on customer outcomes, with it not being clear that the firms’ purpose and culture paid sufficient regard to customer outcomes. In the FCAs’ view customers are not being placed at the heart of GI firms’ business models and this was leading to potential harm for customers.
The second cause of potential harm to customers related to poor governance and oversight and the failure to have adequate systems and controls over the end to end product as a result of failings in the manufacture, service and delivery chain. This meant that in some cases, even where the purpose and intent of the firm was to produce GI products which met genuine customer needs and resulted in good customer outcomes, the firm has not taken appropriate actions to make sure these were delivered. This manifested in a few different ways:
- Lack of appropriate governance and risk structures. This included in relation to performing due diligence of partners/delegated parties within a distribution chain.
- Failings in approaches to risk management, oversight and/or compliance, including in relation to delegated parties within distribution chains. These resulted in the arrangements in place not being adequate or sufficient to achieve intended objectives.
- Lack of clarity regarding roles and expectations, including in relation to pricing decisions and practical delivery to customers.
- Lack of MI or failure to adequately use or consider MI focused on customer outcomes.
The work on the GI distribution chain has revealed the extent to which many firms have failed to respond sufficiently to the FCA previous work and intervention, most notably their 2015 report on Delegated Authority (DA) arrangements and the expectations that the FCA set out. While the FCA have seen some progress in the governance and controls around GI distribution chains, there is still a lack of customer focus or consideration of value. This is evident in deciding what activities to undertake, who to partner with and what products to sell/distribute, as well as in the systems, controls frameworks, monitoring and Management Information (MI). All of these are, in the view of the FCA inter-related when it comes to product governance and oversight.
1. Product Governance
These expectations set out by the FCA are consistent with the new Product Governance and Oversight rules bought in by IDD (PROD 4). This report re-emphasises that Manufacturing firms need to consider these rules when:
- designing and manufacturing products,
- deciding how products will be distributed and sold,
- the pricing policy and approach to be adopted,
- deciding how claims and complaints will be handled,
- considering what controls and oversight is required including what MI must be regularly provided to ensure the controls are working effectively, and
- what action should be taken if failings become evident.
Manufacturers or Co-Manufacturers are expected to have a formal and documented Product Approval Process in place, with timely and relevant MI being received on the performance of products, enabling them to remain informed and make changes to the product or distribution strategy if the MI leads firms to believe that the products could be performing better or that customer harm may be occurring.
The new IDD rules only applied to new or substantially changed existing products from 1st October 2018, however, on the back of this FCA report, firms may need to consider reviewing their Product Governance and Oversight processes for all current GI products they manufacture and distribute. Especially for the products that are being sold to customers through more complex distribution chains, where the likelihood of poor customer outcomes is increased.
ICSR published an article on IDD Product Governance in August 2018 and it may be worth firms revisiting that article as a refresher. In this article we explained that Product Governance involves not just having an approach to overseeing the development of product wording, it encompasses all aspects of the lifecycle of the product, including the sales and servicing, and review of performance, all points that have been revalidated in this FCA report.
2. Pricing and Value
Firms must look at pricing, product terms, including transparency of information provided to the consumer at the point of sale and the suitability of the distribution chain. The suitability of the distribution chain is a prominent area in this report, meaning the FCA are looking at this very carefully. Firms are expected to have oversight of every firm involved in the distribution chain, not just the next firm in the in line. They will need to know and document exactly what role each firm is playing in the distribution strategy, why they are in the chain and what value they add to the customer. The FCA also expects manufacturing firms to know how much commission and/or administration fee each firm, regulated or not, in the chain is charging and the regulator has made it clear that they will not accept high commissions on product which have low claims and or very restricted terms leading to lots of declinatures.
Pricing and Value have been a major concern for the FCA over the last few years. In Q4 last year the FCA released a report on Pricing Practices in the Retail GI sector which highlighted a concern that loyal customers were getting overcharged for insurance products, compared to new customer purchasing that same product at the same firm. The regulator is also looking at publishing value measures data for the GI sector, after the running of a successful pilot scheme and released a consultation paper on this in February 2019. These measures will provide consumer groups, firms, and market commentators with additional indicators of value for a range of insurance products.
This recent report is also concerned with value to customers, with FCA finding value of products was diminished in long and complex distribution chains, due to the level of commission each party in that chain was charging for their services. With this is mind, the FCA has highlighted in this report that as part of the Product Design process, product manufactures should consider the the total price that the customer will pay. This includes remuneration of other parties in the distribution chain that is included in the premium, and any fees which the distributor may charge. Where the manufacturer offers a ‘net-rate’ to another party in the chain, they should ensure they receive all relevant information on the remuneration of other parties in the chain, and the final selling price. This is to enable them to consider how the distribution strategy affects overall value to the customer, given the final price that the customer will pay. Once the Product is being sold to the market, product manufacturers will be expected to get MI from each firm in the distribution chain, which shows the commission and/or fees that the firms are charging for distributing the product.
A difference between risk premium and the final selling price that bears no reasonable relationship to the benefits or services provided by firms in the distribution chain, can indicate that the level of value that product is offering is causing harm to customers. In this case the product or distribution strategy may need to be changed. This is regardless of whether the differential results from a single firm in the distribution chain receiving the remuneration in question, or if it is split between multiple firms in the distribution arrangement.
3. Impact of SM&CR
Firms will also need to ensure that they have the suitable Senior Managers in place on a Product Governance Committee or the like, who have the appropriate level of knowledge and are best placed to make decisions based on MI they receive. Insurers are already subject to SM&CR, with the wider insurance industry coming under the regime in December 2019, enhancing the level of firm and individual accountability. Meaning Senior Managers at firms responsible for Product Governance and Oversight may be found personally accountable if customer harm was caused by due to a failing in the firms Product Governance processes. This is another reason why all firms should consider reviewing their processes in this area over the coming months to ensure that they are meeting the regulators expectations.
4. Customers’ Best Interests Rule
The FCA are concerned of potential harms being caused to customers by complex or long distribution chain and took an opportunity in this report to remind all firms that they must act fairly, honestly and professionally in accordance with the best interests of the customer, an overarching rule which was bought in under the IDD. The Regulator also took the opportunity to reinforce their expectation when firms use a distribution chain to sell products that “a customer’s experience should not be affected by whether the product or services is distributed by a single institution or two or more institutions”. The fact that a distribution chain is long, and complex is not an excuse for a drop in the standard of the product or services provided to customers.
This point is one which we at ICSR have been focused on since the early drafts of the IDD and have written about many times. That the FCA are now highlighting how they see it operating gives significant warning to all firms in the distribution chain that the all-encompassing operation of the rule is as we had envisaged it might be.
FCA Expectations & Guidance
Alongside the report, the FCA are also , setting out their expectations which we advise firms to read in its entirety. The FCA hope that this guidance provides clarity to firms about their expectations, particularly in relation to the design and distribution of insurance products and the requirement to act in accordance with the customer’s best interest rule.
The guidance is relevant to all firms conducting general insurance and protection business- both insurers and intermediaries. This includes firms such as retail banks, mortgage intermediaries, independent financial advisors and other who distribute general insurance protection alongside their primary business. Firms have until 9 July 2019 to submit their comments on the proposed guidance to the Regulator.
The FCA’s key expectations are as follows;
- All GI firms must act fairly, honestly, and professionally in accordance with the best interest of their customers.
- All GI firms should maintain appropriate systems and controls over the remuneration they receive.
- All GI manufacturers should have sufficient knowledge of the role and remuneration of ALL entities in the distribution chains they use to be able to assess the impact they have on the value customers receive.
- All GI firms must maintain appropriate systems and controls (including the production and use of appropriate MI) over their GI products and services. This includes when delegating authority to another business.
- All GI distributors should consider the impact of their distribution strategy (including the distribution method and level of remuneration they receive) on the overall value of the product and their customers.
FCA Enforcement Action
The FCA has previously demonstrated is it prepared to issue heavy fines for firms who fail to meet the expectations set by the regulator.
In March 2019, the FCA fined the Carphone Warehouse over £29m for mis-selling mobile phone insurance and failing to properly investigate and fairly consider complaints arising from mis-selling. The Carphone Warehouse is an FCA regulated firm and was the retail distributor in this case. Following the implementation of the IDD, regulated firms selling directly to customers need to make sure that sales comply with certain standards, these include making sure the product meets the customer’s needs.
Fines for failings in this area stretch back to the FSA days, where the regulator fined CPP £10.5m for mis-selling a Card Protection product emphasising that customers would benefit from up to £100,000 worth of insurance cover- when this was not needed because its customers were already covered by their banks. CPP also overstated the risks and consequences of identity fraud during sales of its Identify Protection product.
The FCA intend that this report and the accompanying suite of documents, the non-handbook guidance and the Dear CEO letter, are to serve as an immediate call to action to all GI firms. Firms must urgently address the issues of culture and governance, and the accompanying failure to consistently focus on customer outcomes which in their view remain widespread within the sector.
The Non-handbook guidance should help make it clear to firms the FCA expectations and remove any remaining ambiguities. The clarity provided by this guidance, will facilitate FCA in any decisive future interventions they undertake, where it has been identified that firms are not meeting obligations to their customers.
To drive and embed meaningful change in the sector, the Regulator will also;
- Undertake a programme of further communications and engagement with the sector about its findings and expectations
- Consider the need for additional interventions further to their review of the information they received in the course of this thematic work, as well as that obtained from relevant supervisory work.
- Plan a programme of future supervisory work in this area, both through regular supervisory activities and further thematic or multi-firm work. This future work will involve firms being compared to the regulatory framework applicable 1 October 2018 (with specific focus on the rules introduced further to our implementation of the IDD) and senior managers being considered in the context of the materially enhanced standards arising from SM&CR (as applicable).
Firms which dabble in this sector or have non-core businesses will need to consider whether the cost of meeting these requirements is worth the value it brings to the firm. Other firms which, while not developing or distributing GI business have retail customers should also take note of the FCA warning as there can be no doubt that these principles will apply to many other products than those covered in the report.
The FCA have already intervened with enforcement action in cases and they have stated that they will not hesitate to intervene in future where when they see firms who do not meet their obligations.