General insurance regulation "FSA

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Speech by Clive Briault, Managing Director, Retail Markets, FSA
Chartered Insurance Institute Annual Conference, London,
23 September 2005

Good afternoon ladies and gentlemen. I am delighted to have this opportunity to talk to you at the UK Insurance and Financial Services Conference.

I will cover today the progress made since we took responsibility for the regulation of general insurance intermediaries in January this year. The general insurance sector is very diverse, ranging from small high street brokers providing motor and household insurance, to the wholesale market where huge risks are placed from around the world by global intermediaries. Given this diversity, I have chosen today to focus my remarks mostly on the retail sector.

But I want to begin by taking this opportunity to say a few words about the work the Chartered Insurance Institute itself does to promote higher standards of competence and integrity in the insurance industry, and to develop the management talent of the industry, principally through the provision of relevant qualifications for employees across all sectors. As John Tiner made clear when he addressed your graduation ceremony earlier this week, we are very supportive of the CII's work, and it is encouraging to see the industry continuing to invest in the professional knowledge and skills of its people.

We also welcome the CII's efforts to expand its education and qualification services to reflect the changing requirements of companies – whether driven by market or regulatory developments. A good example is the CII's launch earlier this month of its Contract Certainty Certificate. You will know that we have challenged the market to find a solution to the problems associated with contract certainty by the end of 2006, and the CII's certificate will complement the new code of practice for contract certainty recently launched by the ABI and BIBA.

When we took on responsibility for general insurance regulation in January this year, we were aware that we were facing a significant challenge. We estimated then that each year about 35 million UK consumers take out or renew 77 million policies for contents, vehicle, medical, payment protection and other types of general insurance. There are over 10,000 authorised brokers whose primary activity is general insurance. The ABI estimates that annual net premiums total £28.5 billion. The general insurance industry is clearly a very substantial one that serves an important economic and social purpose.

Before updating you on some of the thematic work we have undertaken since the new regulatory regime came into force in January, I want to cover three more general issues.

Effectiveness review

First, it is important to step back from the detail and to consider what outcomes the new regime is intended to deliver, and whether these outcomes are in practice being delivered. Are we changing the behaviours of firms and consumers in the real world?

Our retail agenda focuses on delivering an effective and efficient retail market for financial services and products, and thereby a fair deal for consumers. This requires:

Capable and confident consumers.
Clear, simple and understandable information available for, and used by, consumers.
Soundly managed and well capitalised firms who treat their customers fairly.
And risk based and proportitionate regulation.

These four components of an effective market apply equally to the market for general insurance. Within our wider regulatory objectives, the general insurance regime was designed to deliver four specific outcomes:

Consumers buying insurance on a non-advised basis should receive sufficient information to be able to make an informed decision, and the firms selling the insurance should check that their potential customers are eligible to claim on the policy;
Consumers understand the key features of a policy, including significant exclusions, before buying;
Consumers buying insurance on an advised basis are recommended suitable policies that meet their demands and needs; and
Consumers claiming on their insurance policies have their claims dealt with promptly and fairly.

I am therefore announcing today that we will be undertaking a review of the effectiveness of the general insurance regime. This review will begin in April 2006, and will focus in particular on our retail conduct of business requirements in this area, and on the effectiveness of the regime in meeting the intended outcomes for consumers.

This review will be undertaken alongside the review of the effectiveness of the mortgage regime, which we have already announced and which will begin at the end of this year. This joined up approach will recognise the linkages between the mortgage and general insurance regimes, and the fact that many firms are active in both these markets. In addition, the review will take into account our determination to find ways in which we can improve the effectiveness of our regulation and can contribute to the better regulation agenda.

If the review leads us to conclude that changes to our rules and guidance are necessary, we will, of course, consult on these in the usual way. However, we need to recognise that our ability to make changes is constrained by European Directive requirements – in particular, those in the Insurance Mediation Directive and the Distance Marketing Directive.

The core of the review will be threefold:

to encourage feedback from yourselves and other stakeholders on what you think is effective or ineffective in the regime we have introduced. Here – as well as more generally – we are keen for the industry and other stakeholders to come forward with views on the areas which could benefit from re-examination;
to undertake consumer research to see whether the intended benefits of our regime are beginning to come through - especially through consumers making good use of the information you are now required to provide to them; and
to continue our thematic and firm-specific work to check that the industry is complying with our regime – since without such compliance the intended consumer benefits have little prospect of being delivered.

We expect to feed back on our initial findings from this review towards the end of 2006.

Graduated approach

My second general issue is to make clear our risk-based and proportionate approach to regulation. We have, as you will have noticed, set out the standards we expect firms to meet. These were finalised in early 2004. And we authorised 11,000 general insurance intermediaries during 2004. This year we have been looking at how well our standards are being met across a number of key areas.

Our 2005/06 Business Plan published in January this year set out our priorities in the retail general insurance market for the first year of regulation. These were:

policing the perimeter, to ensure that firms are correctly authorised and operating lawfully;
ensuring that disclosure documentation (including Key Facts) is provided at the right time, and is clear and accurate;
reviewing systems and controls of general insurance networks to monitor sales by appointed representatives;
work to quantify the risks posed by specific products such as linked sales of Payment Protection Insurance and critical illness cover;
thematic work on claims handling; and
regulatory returns, to ensure we receive accurate and timely data to enable us to focus our supervisory efforts in the right areas.

In addition to these, in response to emerging risk and issues, we also decided to conduct some work on the management of conflicts of interest and on client money. And I have mentioned already our challenge to all participants in the insurance sector to secure a market-driven solution to achieving greater contract certainty.
We know it is important to provide feedback on the progress of our work and to help raise industry standards as well as to take stock of what is and is not working in the new regime. Over the last few months we have met with a number of trade associations and consumer bodies to keep them informed of our work. We have provided regular feedback on specific projects and themes through our newsletters and we will continue to take up further opportunities to communicate with the industry.

We understand that the burden of regulation can be heavy, particularly for smaller firms. We are taking this issue seriously, and our Business Plan outlines the range of tools and initiatives we are using in make it easier for smaller firms to do business with the FSA. To give you some examples – regional visits and roadshows, industry training, targeted newsletters, the Handbook Guides for mortgage and general insurance intermediaries, payments of FSA fees in instalments and many more.

We also understand that adapting to regulation takes time. So in our general insurance work (as well as more generally) we are taking a graduated approach. Where our initial work identifies problems, we will work with the industry to tackle these issues. We only take enforcement action at this stage in the most serious cases. In most of our work with general insurance intermediaries we are still at this first stage.

The next step will be follow up work to check that our messages have been received and acted upon. Where at this second stage we find problems that have still not been tackled, we will not hesitate to intervene, including taking enforcement action if necessary.

Treating Customers Fairly

My third general issue is to remind you of our initiative on Treating Customers Fairly. And to advertise a conference on TCF that we are holding on 4 October.

We expect firms to follow the principle that a firm must pay due regard to the interests of its customers and treat them fairly. Most firms aim to do this – after all, it would not make commercial sense to set out to treat your customers unfairly – but we still see instances where this is not the case.

Our approach places responsibility on firms, and in particular their senior management, to consider themselves how they ought to organise their business to respond to their regulatory obligations. We believe that this is a better course of action for us and for the industry than our continuing to set ever more detailed rules and guidance. In the last eighteen months we have been working with the industry to develop a common understanding of how we can make treating customers fairly a reality. Our latest publication, 'Treating Customers Fairly – building on progress', published in July and available on our website, provides a detailed update on this work, including the progress that firms have made.

We have structured our work around the stages of the product life cycle, including product design, marketing, the sales and advice processes, and complaint handling.

We have done 'cluster work' on a number of these stages, and visited a range of firms to explore in more detail what good and less good practice looks like in these areas. We have published the findings of this work. Case studies have also been developed to bring some practical issues to life and to provide firms with ideas they may use.

We are looking to firms to undertake a gap analysis to highlight any areas where the firm is not meeting its obligation to treat its customers fairly. Where necessary, firms will need to embark on a programme to address any shortcomings. These firms will need to set clear priorities and targets to determine how progress will be tracked.

Some have questioned the need for our initiative on treating customers fairly. But we have found from our contacts with many firms that having looked at this issue they have discovered that there was more to do than they had initially thought, because the review process had identified things which they themselves recognised needed addressing.

Our July publication includes a range of helpful pointers for general insurance and smaller firms to consider. For general insurance firms, these relate to:

product design and information: for example, checking that policy conditions are not unnecessarily complex or difficult for customers to understand and that features are clearly reflected in marketing material;
sales and advice: for example, is it clear to the consumer what information they need to provide in obtaining cover and the consequences of a failure to provide this?
producer/distributor interfaces: for example, do distributors tell manufacturers about difficulties with the product (eg lack of consumer understanding) or concerns about marketing materials; and
claims handling: for example, are claims handled fairly, so that genuine claims are paid while firms are taking reasonable steps to address claimant fraud?

We hear comments that treating customers fairly should be less of an issue for the general insurance market. We agree that good practice should be easier to achieve for more straightforward and highly competitive products such as motor and household insurance. However, it is also clear that more complex product types such as critical illness and payment protection insurance pose a significant challenge to the fair treatment of customers.

Perimeter and Authorisations

Let me now turn to the specific initiatives set out in our plan for the new regime. Two of our initial priorities were processing the late applications from general insurance intermediaries received in the run-up to 14 January this year, and enforcing the perimeter where firms are undertaking regulated activities without being authorised to do so.

The processing of late applications for permission has virtually run its course. At 14 January there were 960 interim authorised general insurance firms, whose applications had not been fully processed but who had received provisional authorisation. There are now only 10. And meanwhile we have received 225 new applications from general insurance intermediaries since January, of which 200 have already been authorised.

The second priority was our work on the perimeter. There has been a lot of positive press coverage surrounding our work on tracking down firms that are acting illegally without authorisation (I particularly liked the reference to the "Men in Black" in the Insurance Times recently). This work is key in protecting consumers and maintaining a level playing field within the industry – something that I am sure, as authorised firms, you will appreciate. It has also enabled us to assess the impact of regulation on the market.
Across the UK, we have already visited over 1500 unauthorised firms that were potentially acting illegally as primary or secondary insurance intermediaries, focussing on five key sectors of the secondary market (namely motor, freight/removal, travel, property managers and high-value retailers).

The vast majority of these firms were, in fact, acting legally and had either stopped conducting insurance business or had restructured their activities in such a way that they are not captured by our new regime. The message so far from the team undertaking this work is that they have been pleasantly surprised by the level of awareness of the FSA and of our requirements.

Where we have come across issues, we have worked with firms to ensure that they stop doing the business, or become authorised, or change the way they do their business so that they do not need to be authorised. In a few cases, where firms have not co-operated with us, we have taken enforcement action using the powers available to us.

Disclosure documentation

Disclosure is a key part of the new regime and is integral to our work on protecting consumers. Indeed, as I mentioned earlier, the disclosure of relevant and understandable information is the second pillar that needs to be in place for the market in retail financial products and services to operate efficiently and effectively. Both insurers and brokers have a role to play here, especially in making sure that the policyholder understands the level of cover and exclusions.

We have reviewed the policy summaries and key facts documents from a cross-section of about 30 insurers covering over 100 different contracts, to check whether they are in the right format with the right content. The sample was deliberately risk based, with a bias to more complex policies. Further details of our findings will be communicated over the coming weeks, but overall we have found that firms are frequently not producing policy summaries and key facts documents in line with our rules.

This is disappointing and worrying, not least because our new regime cannot be effective if firms do not comply with it.

In particular:

The presentation and style of the product disclosure documents do not meet an adequate standard. Clarity and readability are key to the customer understanding the product that they are buying, at the time of sale. But we found that a significant proportion of the documents reviewed were of poor appearance, mostly due to the font being too small and the layout too cramped, and thus uninviting to the customer. In some cases policy summaries were up to 14 pages long. We do not prescribe the length of these documents, but under a 'less is more' approach this seems excessive.
Significant and unusual exclusions are not always being brought to customers' attention in the product disclosure documents as required. We found on average that each document omitted three or four significant and unusual exclusions - these often related to eligibility criteria or limitations to cover.
Critical illness and payment protection policies. In keeping with other areas of work we found significant issues with these products. More on this in a moment.

Alongside this work we have undertaken a review of status disclosure and demands and needs statements produced by general insurance intermediaries. Our findings indicate that many firms' documents are non-compliant.

In line with the graduated approach I outlined earlier, we are currently at the stage of communicating these results to firms. We will do further follow-up work in due course, including taking enforcement action if necessary.

Controlling Appointed Representatives (AR)

Another area I mentioned where we had concerns was that the rapid expansion of networks meant that there could be significant systems and control issues in firms with appointed representatives. This could have an adverse impact on those firms' fair treatment of their customers - especially if their Appointed Representatives are not complying with our rules - and could expose firms to reputational and other risks.

We therefore wanted to assess the extent to which the appointed representatives of newly authorised general insurance networks are complying with our rules. To this end, we have visited a sample of mortgage and general insurance networks to assess the systems and controls, governance and resources they have in place for the supervision of their appointed representatives.

We are concluding from this work in progress that many firms do not have sufficient systems and controls in place to monitor their appointed representatives adequately. Common themes include a lack of compliance resource, insufficient desk checks in place, minimal field visits taking place, an over-reliance on evolving computer systems, and a lack of any risk-based approach to monitoring appointed representatives. As an example, we found that some firms checked to see whether the appointed representatives had issued core documents to customers but they did not check the quality of any advice given. This could expose them and their customers to a variety of risks.

We will communicate our findings to you in more detail in the next few weeks. Again, this is just the first stage of our graduated approach, and we will extend this programme to a wider range of firms and will be making further visits later this year.

Linked sales of Payment Protection Insurance (PPI)

The PPI market has been the subject of bad press for many years. It was therefore only logical that we decided to look at this market shortly after taking on the regulation of the sale of insurance. We wanted to assess whether firms are complying with our rules, particularly our Conduct of Business and training and competence rules, and whether firms are treating their customers fairly. In particular, we were concerned about the risk of poor or aggressive sales practices, unsuitable products, small print and complex terms, and the risks arising where these products are sold to consumers on the back of another transaction. We have just completed a series of visits to look at PPI selling practices in firms ranging from high street banks to motor dealers and small mortgage intermediaries. We are also undertaking mystery shopping work and will be feeding back the results from the mystery shopping and firm visits later this year.
Our findings from the firms visits are variable. Some firms demonstrated good compliance with our rules - they were addressing problems that may have existed in the past, such as checking that customers are eligible for the policy before selling it. For example, we found that regular premium PPI sold with prime mortgages seems generally compliant with our rules. However, selling practices in other sectors were very poor.

As in the general insurance market more generally, we found that the quality of disclosure is generally low. For example, in some of the firms we visited the price the customer is paying for the PPI policy is not always clear in documentation and is sometimes only disclosed at the very last minute, after the customer has agreed in principle to make the purchase. This is contrary to our rules that require price disclosure to be made clearly and in "good time" before conclusion.

We also found that many products contain a wide range of complex exclusions (for example particular health problems are often excluded). And the broad descriptions of these policies provided at the point of sale ("cover for accident, sickness and unemployment") do not reflect the reality of the limited cover provided by many policies. Furthermore, the quality of training provided to staff and appointed representatives, and therefore their competence to sell PPI products, was found to be variable.

We are determined to improve standards in this market and intend to publish in November examples of good and bad practice so that firms know what we expect from them. We will also be following up problems with individual firms.

However, such measures are unlikely to be sufficient in themselves to turn this into an effective and efficient market. As recent reports by the Citizens' Advice Bureau (CAB) and others make clear, this market is not working at the moment. The CAB found widespread evidence of very high premiums (up to 56 % of loan value), high pressure sales tactics, policies apparently designed to exclude people from cover, and problems with the administration of claims. More generally, customers do not shop around and as a result there is little consumer pressure on pricing or the quality of the product. So there is significant consumer detriment in some cases.

I would prefer to see a market solution to these issues – that is the FSA's preferred approach. It has happened before and it can happen again. Twenty-five years ago you could pretty much only buy travel insurance from a travel agent and home insurance from your mortgage provider. Today there are thriving and competitive markets in which these types of insurance are readily available from a range of "third party" providers.

So the question is how best to bring about this market solution. Broadly speaking there are three choices. First, we could – if justified by cost benefit analysis – introduce tougher requirements. This could include more prescription on the disclosure of pricing, of policy exclusions, and of alternative sources of payment protection. And it could include the unbundling of PPI from the primary transaction. Second, the competition authorities might act, just as the Competition Commission set out only last week remedies for the sale of PPI linked to store cards. Third, and to my mind the simplest, quickest and most effective way forward, the industry could decide to improve its own standards and to move decisively towards putting in place the elements of a considerably more competitive market.

Critical Illness

There has been increased interest in critical illness and the fit of such protection with customer needs and potentially suitable alternatives. Questions have also been raised by commentators representing industry and consumer interests about the potential for customer detriment given low levels of awareness of the protection provided by this and other types of protection. We have already undertaken some work on financial promotions in this area.

We found adverts that use "scaremongering" tactics, for example saying, "100,000 cases of cancer each year" or that imply that critical illness insurance is equivalent to income protection, when in fact it generally provides a lump sum. We also found examples of unsubstantiated claims about aspects such as price, uniqueness and coverage. We also saw examples where key terms and conditions or exclusions (such as reviewable premiums, non disclosure of material facts, own-fault and survival periods) were not sufficiently prominent in brochures. The full results are set out in our latest financial promotions bulletin for mortgage and general insurance firms.

Building on this and the work we are doing on disclosure documentation we plan to look at the selling practices of critical illness (which may include some mystery shopping) and will communicate our findings and next steps once we have completed this. We are also in discussion with the ABI on their statement of best practice on critical illness.

Conflicts of Interest

We visited a selection of insurance intermediaries during the first half of the year to see how they are identifying and mitigating conflicts of interest. Our findings revealed a mixed picture.

In particular, we found in most firms that the process for identification of conflicts of interest is not sufficiently developed, and that conflicts of interest are often perceived by firms in too narrow a manner. Some firms consider conflicts to be solely about how their staff are remunerated. In retail broking firms, we found there was a greater likelihood for conflicts to exist in respect of close links with an insurer. And there was generally little evidence of formal procedures to ensure that the broker’s duty to the client was not being compromised by the relationship with the insurer.

Given this, it is important that intermediaries start to think seriously at a senior level about the frameworks within which they identify and mitigate conflicts of interest. In particular, they should be aware of the need to review conflicts systematically, and have adequate systems and controls in place to identify emerging conflicts in their organisation.

We will be writing to insurance intermediaries shortly to set out a summary of our findings and request that they take steps to ensure that conflict risk is being managed effectively.

Claims Handling

Another area highlighted in our Business Plan was that of Claims Handling. We made this a priority because it is important that general insurance claims handling is done in a fair and transparent way. Our research suggests that this is an area of dissatisfaction in the general insurance sector and overlaps with issues on complaints handling. Firms should consider how they manage claims handling and how they balance the need to combat claimant fraud with the need to treat customers fairly.

We are currently gathering information to help us to understand better industry practices and associated risks. This will be followed by a programme of risk-based firm visits focused on the conclusions we have been able to draw from the information gathering stage. We also want to explore the use of outsourcing in the claims handling process in retail markets and the robustness of the insurers' control of these arrangements; and to draw industry attention to areas of consumer detriment in retail claims handling.

We expect to communicate our results early next year.

Client Money

The other new priority I mentioned is client money. We did some work earlier this year looking at general insurance intermediaries in the wholesale sector. We found significant issues in these firms which included deficits in client money accounts; problems with the client money calculations – including failure to identify third party balances; and issues around the correct trust status of client money accounts. As a result, we issued a letter in July setting out our concerns to the Chief Executives of all general insurance intermediaries involved in the wholesale market.

Due to the significance of the concerns we identified we felt it necessary to extend our review to include the retail market. Over the next few months we will therefore be visiting a number of retail firms to look at this issue. We expect to report our conclusions early next year.

Regulatory returns

The final area we have been focusing on is improving the facility for firms to provide automated regulatory returns. This enables us to receive accurate and timely data and to focus our supervisory efforts in the right areas, where the most risk lies. This is particularly important for smaller firms, where we do not have regular supervisory contact.

The new Integrated Regulatory Reporting system went live on 1 July to enable a range of firms, including general insurers, to report electronically. We experienced some teething problems with the first Retail Activities Mediation Returns or RMARs. Problems with new systems are not uncommon and we acted promptly to minimise the impact on industry by extending the deadline for submission. Whilst some system issues remain, we have been encouraged by the submission rates so far. The rollout of the system to capture Product Sales Data (PSD) from October this year is currently well under way. I encourage those firms who have not yet registered for integrated reporting to do so as soon as possible.

Conclusions

I hope I have managed to give you a good overview of the work we have undertaken over the past months, and of the difficult but exciting challenges that face the general insurance market. It is clear that we are finding a worrying number of problems from our thematic work, particularly in relation to higher risk areas and products. But we are attempting to adopt a balanced approach, and are providing a range of tools and support mechanisms to help firms adapt to regulation. However, given the support that is available and given that firms had significant time to prepare for the new regulatory regime, we hope and expect to see a real improvement in standards over the coming months.

Thank you for your attention.

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