The review focused on consumers and SME customers, but the FCA explicitly recognised the importance of outsourcing across the general insurance industry. The FCA's sample included large composite insurers, smaller specialists, Lloyd's syndicates and 'passported' EEA insurers, and books that were written up to 100 percent through coverholders.
In the report the FCA presents a wide range of findings, recommendations and requirements, which amount to a material challenge to the conduct of both insurers and intermediaries. For insurers, there is an implicit challenge as to the accuracy and completeness of the assessment of a range of risks relevant to prudential management, including operational and underwriting risk.
The report suggests three key causes for the FCA's concern, which can be summarised as 'Over-legalism', 'Localism' and 'Over-commerciality'.
Some market participants may be focused on the arguability of (often implicit) contractual terms in agency or co-venturing agreements, at the expense of having a proper appreciation of regulatory obligations and therefore compliance risk (in short, the risk of financial or other loss or damage from actual or alleged failure to meet regulatory requirements).
Over-reliance on contractual terms — and the idea that the arguability of a contractual position can amount to a complete and unfailing mitigant of compliance risk — can, for instance, be seen in the FCA's view of certain misuses of audit rights (e.g., insurers auditing of coverholders), with:
- the "scope of requested audit [being] very broad and, on occasion … unachievable … related, in part, to the absence of due diligence or internal controls"; and
- insufficient "evidence [of] who was responsible for...remedial work, whether this work responded to all of the points raised,...had been completed and how effective [it was] in mitigating...risks [especially where] there was no clear framework or risk tolerance around the audit outputs and findings..."
Such over-reliance can also be seen in the example of: "a household product...developed by the intermediary based on the insurer's own comparable products and wordings, with various insurer inputs to the process. The insurer...believed the product was designed and owned by the intermediary...while the intermediary considered that [it] had relied extensively on the insurer's work in developing the underlying product, and remained reliant on [the insurer] for issues such as identifying any customer issues with the product or identifying the need for updates."
Some market participants may be misunderstanding or misapplying rules that set out the effect or scope of regulation. Aside from being a compliance risk problem, this is in effect a legal risk issue (in short, the risk of loss or damage from unexpected outcomes from legal agreements or proceedings) since UK regulatory rules arise under statute.
This problem can be seen in the FCA's references to distribution chains that included unregulated businesses, such as: "An insurer was underwriting a retail product designed by an intermediary (acting as a MGA) and ultimately sold via unregulated retail outlets (under the connected contract exemption).
The insurer had limited understanding of the types of claims received, the claims processes followed, the services provided, historical issues with the supply of these products and services, the parties involved in the supply chains to deliver these services and what could result in customers' claims being turned down."
The connected contracts exemption (Financial Services and Markets Act 2000 [FSMA] Regulated Activities Order 2001/544, Article 72B) may have affected the insurer's understanding of its position. It can sometimes be perceived by market practitioners that the effect of the exemption is to create an 'unregulated product' or 'unregulated sale'. However, the actual effect is narrower. In summary, a person with certain economic attributes may intermediate an insurance policy (with certain limited cover) without needing to be an authorised person or an appointed representative. Regulatory rules still apply to the insurer on the policy and any intermediary that is already authorised.
On cross-border business, the FCA has highlighted the risk that using a delegated authority to effect, carry out or intermediate insurance in or into the UK, in attempted accordance with permissions arising via a 'services passport' under FSMA, could cause an overseas insurer or intermediary to establish a permanent place of business in the UK, thus breaching its permissions, and potentially causing other problems (e.g., tax).
Again, UK market practitioners can sometimes underestimate the compliance risk they may run from the rules governing cross-border business, especially insurance mediation, in or into other countries; the strictness with which such rules are interpreted and applied by foreign regulators; and the severity of local, and even extra-territorial or consequential UK, enforcement.
Some market participants may be too focused on their commercial relationships, and not enough on customers, thus risking unfair treatment of insureds and potentially even the integrity of the market.
The possibility that one or more insurers and intermediaries could be putting their mutual interests ahead of the fair treatment of customers can be inferred from the following example cited by the FCA: "In one case an insurer was underwriting a number of single risk and add-on personal lines products for a range of third parties under the umbrella of a new relationship with a MGA, entered into due to an existing relationship with a wholesale broker. It became apparent in the course of our review that the insurer had not considered or understood the products being underwritten, their distribution to customers or the delivery of post sales services prior to agreeing to underwrite these. [emphasis added]
"Consequently the insurer was almost entirely unsighted on these products and was unable to state whether customers buying these products were treated fairly or demonstrate that they had previously considered this question. The value of some of these products was unclear and in some cases they appeared to be targeted at more vulnerable customer groups, which should have indicated heightened levels of conduct risks to the insurer."
The reference above to the "unclear" value of insurance raises again the question of the FCA's wish that the insurance market can demonstrate that (i) policies are fair in the way they address and respond to definite and substantive risks that insureds face and (ii) communication about such policies is clear, fair and not misleading.
In this regard, the FCA's and insurance market's respective views as to the publication of claims-related data have been well publicised, but the wider question remains as to balancing prudential safety and soundness with some sort of open commitment to paying a minimum number or value of claims.
Finally, insurers should be wary of scrutiny on the prudential ramifications of the review. Internal models, for instance, may be challenged if an insurer has replicated the example in the FCA report where: "MI (from the intermediaries designing and delivering...product[s]...) [was] limited [as to] how and by whom...product[s] [were] sold, levels of cancellations, claims frequency, claims repudiations, claims service standards or complaints volumes, or indeed any other conduct related or customer outcomes focused information."
This article by DWF was first published on Thomson Reuters website, 'Accelus' ('Complinet').