A view from Canary Wharf
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Speech by Sarah Wilson, Director responsible for the Insurance Sector, FSA
Chartered Insurance Institute Annual Conference: Rising to the Challenge
5 October 2006
Introduction
Good afternoon. I am delighted to return to the CII's annual conference – as the FSA's insurance sector leader – to give a view from Canary Wharf on current challenges from a regulatory perspective. It almost seems that I have come full circle since the last time I was here as Director of our High Street Firms Division, with responsibility for delivery of the new regulatory regime for conduct of business in general insurance. At that time, we were concerned with two issues: the need to focus on risks to consumers; and the need to accommodate market diversity, by ensuring we delivered a regime that was proportionate, reflecting the risks in different parts of the general insurance market. My own responsibilities have since changed to include coverage of life sector issues, and I am well aware that only six months ago, the CII unveiled a new Faculty for Life and Pensions. I hope you will forgive me however if I narrow my scope slightly today – to give you the view from Canary Wharf on the general insurance sector’s progress in getting to grips with the new regulatory regime two years on. (I will pick up one or two life sector comparisons where the read across is particularly direct.)
Principles-based regulation
My starting point, however, is the evolution in the FSA's own approach to regulation over that the past two years – and in particular, our move to a more principles-based approach to regulation. And you will recognise of course that there is nothing unique to the general insurance sector here. Perhaps I can set the scene by quoting from John Tiner's recent address at the Rendez-vous in Monte Carlo. He said of more principles-based regulation: "In essence, this is where the focus is on delivering outcomes, in real terms, rather than the prescription of detailed processes. If firms target outcomes – such as customers being treated fairly, or by holding sufficient capital resources to cover the risks they are exposed to – they are then able to decide the best route to achieve these ends. Allowing them to focus on the substance of what is good for their business, their customers and for society."
There are, I hope, a number of areas where such an approach should be very much in evidence to you already. First, many of you will have found over the past two years (and over a longer period for insurers) that we have taken a strong interest in your corporate governance – whether it is in the relatively complex structures and chains of accountability necessary in a larger firm, or the simpler but no less important controls exercised in smaller businesses. Our approach here has in fact always been largely principles-based – we take a strong interest in how firms govern and organise their affairs because we take the view that if you get this right, much else follows. In doing this, our approach is generally to ask for explanations as to why the structure put in place offers the necessary challenge and level of control, and where such explanations are unconvincing, to seek change that achieves a better outcome.
Second, and of relevance to insurers but not intermediaries, our new capital regime - ICAS - is of course principles-based. Here, we specify that firms must hold capital that is sufficient over a one-year time horizon at a 99.5% confidence level, and individual firms have developed models and frameworks to establish the level of capital that this implies in their case.
Third, the FSA's treating customers fairly initiative is principles-based, and asks firms in all sectors whose actions affect the retail market to review the manner in which they treat their customers fairly, to identify any gaps, and where gaps are found, to implement change.
Overall, in each of these areas, and referring back to pre-occupations in general insurance two years ago, a more principles-based approach should allow us to continue to focus on risks to consumers, while also making it easier to ensure that regulation accommodates market diversity and is proportionate in its effect.
But, notwithstanding the fact that I can cite three important areas where we are already getting on with more principles-based regulation, the move to this approach presents important ongoing challenges to us.
Challenges to the FSA
First, we need to reconsider the contents of our Handbook (where not constrained by European law) to see whether there are areas where can move to a higher level approach. Alongside this, we need to consider the case for keeping detailed rules where there is a clear need. For example, we take the view that a certain amount of detail is likely to remain in disclosure rules (to ensure that consumers can become familiar with key information and compare products), and have therefore made clear that proper compliance with such rules remains a necessary part of treating customers fairly.
It is in this context that we are conducting a review of both the Conduct of Business Sourcebook for investment business and, as you will be well aware, the effectiveness of its counterpart, ICOB. In the latter case, our primary purpose is to review – two years on – whether the rules are in practice delivering the outcomes we had in mind at the outset. This includes looking again at whether there is a case to be made for introducing a differentiated approach for protection and non-protection products – taking account both of the nature of consumer risk in each case, and of compliance and other costs. However, as part of this review, we will also consider whether there is a case for removing some areas of prescription, whilst maintaining the same level of protection, so as to make the approach more principles-based.
The second challenge is finding the right way to get material that helps firms to interpret the FSA Principles into the public domain. Following publication of examples of good and bad practice and case studies (most obviously in TCF work), our most recent step has been to publish views on our interpretation of the Principles in a particular area – namely the respective responsibilities of producers and distributors in the retail market place. We have done this in the form of a Discussion Paper.
I should say in passing here that our work in this area has not been straightforward. Following extensive and detailed dialogue, the Discussion Paper reflects our view that producers are responsible for ensuring the products are soundly designed for the target market, are sold with clear, understandable information (for distributors and where relevant, customers) through appropriate distribution channels, and perform as the provider promised. The distributor's primary responsibilities are to ensure that the customer has the information they need, that (for an advised sale) the product is suitable for the customer, and that post-sale service meets any expectations created.
We also note, however, that in the insurance markets just as in other parts of the retail market, innovation makes structures complex. So, for example, defining a producer is not straightforward - in the general insurance market, there are examples of distributors designing products to be underwritten and in our view, where this is clearly the case, the producer responsibilities that I have set out should rightly be transferred across to the distributor. Similarly, in both life and general insurance markets, distribution is growing in its complexity – with the advent of wrap platforms on the one hand, and the long-standing incidence of chains of brokers on the other. Our analysis has needed to take such situations into account. We look forward to your comments.
The last challenge for the FSA that I would like to note today relates to the role of industry guidance in a principles-based world. You will be well aware that the CII have, for example, produced helpful guidance notes in treating customers fairly and conflicts of interest. A further recent example is the material that the ABI are currently consulting on to elaborate for insurers the principles that we have set out for ICAS. We plan to say more about our position in a discussion paper later in the autumn.
Challenges for the industry
So much for the challenges we have set ourselves. What about our view of the challenges you face? And here, I want to concentrate my remarks on the challenge to treat customers fairly, and – briefly before I close – on the challenge to achieve contract certainty.
In July, we provided further explanation of what the TCF initiative was designed to achieve by specifying six consumer-focused outcomes. In short, these are the outcomes that we expect in firms where TCF is genuinely embedded, and we expect senior management in firms of all sizes to get themselves into a position where their measures of a firm’s performance includes assessment against these outcomes. They will mean that:
- consumers can be confident that they are dealing with firms where the fair treatment of customers is central to the corporate culture;
- products and services marketed and sold in the retail market are designed to meet the needs of identified consumer groups and are targeted accordingly;
- consumers are provided with clear information and are kept appropriately informed before, during and after the point of sale;
- Consumers receive suitable advice;
- Consumers are provided with products that perform as firms have led them to expect, and the associated service is both of an acceptable standard and as they have been led to expect; and
- Consumers do not face unreasonable post-sale barriers imposed by firms to change product, switch provider, submit a claim or make a complaint.
You will also be aware that we set a deadline of end March 2007 for firms to have reached the implementing phase of their TCF work in a substantial part of their business. In our experience, many firms in the general insurance sector are now getting on with the necessary work. Initially, there had been something of a two-tier dimension to progress within the insurance sector – with the life sector making greater progress in identifying issues and planning a response. I am pleased to say that on the whole we are now encouraged that differences are reducing – with many insurers and intermediaries in general insurance conducting gap analyses and starting to implement change. (This is in a context where we do acknowledge that competitive markets can help to achieve fair treatment of consumers by delivering improvements in aspects of the products and services firms offer, for example by improving product design, quality of service or value for money. However, I think there is now general recognition that competition will not deliver fairness alone.)
Let me turn now to some areas in more detail.
Claims handling
First claims handling. Here you will recall that we fed back a good news story from thematic work with insurers. The chief outcomes that we are seeking though the rules are that claims are handled fairly, are settled promptly, and that customers are provided with an explanation of why a claim has been rejected or not settled in full, where relevant. We found that many insurers were doing this well.
We did note, however, that the most common reason given for rejection of a claim was its being outside the scope of cover. In a firm that has embedded TCF that finding would feed straight back to those designing, targeting and marketing products – with the question ‘why do so many of our customers misunderstand the scope of what they buy?’
Product Design
Which takes me neatly to product design? In July we published a report on key issues that the general insurance market needed to address to ensure that customers are treated fairly, and product design was an area we highlighted. As I indicated earlier, depending on the circumstances of this case, this may be the responsibility of the insurer or the distributor. Our key finding was that an important sub-set of general insurance products (PPI would be a good example) are quite complex, and yet the distribution approach chosen may not be calculated to allow for adequate explanation. This is particularly important where customers may have unrealistic expectations about what a product will do or cover them for.
We also acknowledged good examples where firms are using various means to inform the design process - customer focus groups, underwriters - as well subsequently as their own internal reviews to determine whether their intended target market has been reached.
Advertising and product disclosure
Moving on to a couple of areas where there is more work to be done. First, advertising and product disclosure.
We have had reason to express some concern about how general insurance products are being advertised - for example price matching, which can be unrepresentative of what the customer is actually offered or subject to limitations or both; unsubstantiated savings claims; and the use of small print to qualify prominent claims. We have seen these deficiencies across general insurance advertising and including promotions for car and home insurance. This has prompted us to carry out some thematic work in respect of which we will be publishing our findings noting poor practice in this area in the next few weeks.
And in common with the life sector, we continue to be concerned about the clarity and fairness of general insurance product disclosure. You will recall that we conducted thematic work almost a year ago – focusing on material issued by insurance firms, to be used by them and by intermediaries. Amongst a number of important findings, the key one was that the vast majority of policy summaries we reviewed omitted one or more significant or unusual exclusions or limitations. Whatever the outcome of our work on the effectiveness of our rules in this area, it will remain the case that firms failing to draw such matters to consumers' attention could not be said to have implemented or embedded TCF.
Disclosure is of course not a one way street. Consumers also need to provide accurate and honest information about themselves and their circumstances in relation to the policy. Crying foul after the rejection of a claim not within the scope of the policy is not an adequate defence if all the relevant facts were not disclosed at the point of sale. But equally, firms must be explicit about what information is required, so that both parties can be confident that expectations have been met.
Commission Disclosure
Of course, one aspect of disclosure that there were extensive discussions about when creating the general insurance regime was commission disclosure. In our analysis at the time, we drew a distinction between the retail market on the one hand and the commercial and wholesale on the other. For the retail market, we concluded that information on commission was an unnecessary distraction – where consumers were better directed to focus on product coverage and exclusions. For the commercial and wholesale markets, we concluded that consumers could make use of the information, but that they were also well able to ask for it and – not least given the costs - we did not need to prescribe disclosure.
Our views in respect of the retail market remain unchanged, but in the wholesale and commercial markets arguments have been put forward by parts of the industry for us to consider a change in our stance. To this end you will have seen from a speech given by John Tiner earlier this week we have now announced our intention to explore in more detail the issues around commission disclosure in these parts of the market. In the FSA's coming Business Plan for 2007/8 we will include plans for work on both Market Failure Analysis and corresponding Cost Benefit Analysis, and we will consider transparency to both the customer and the market itself.
This work will enable us to gather detailed and balanced evidence of the extent to which a lack of transparency is leading to customer detriment and/or impairing market efficiency, and whether mandating commission disclosure will lead to benefits that outweigh the costs of introducing it. Only – and only - if both the market failure analysis and CBA tests are met will we even begin to contemplate whether regulatory intervention is the best way forward.
Client Money and Conflicts Management
Where product disclosure is predominantly an area of concern affecting insurers, I wanted to finish my remarks on TCF by mentioning two areas where the focus is intermediaries – namely client money and managing conflicts of interest.
We recently announced a larger scale review of the handling of client money by general insurance intermediaries. This is because our general supervision work has continued to identify a significant level of failure by a number of wholesale and retail intermediaries in complying with our client money rules. Indeed there have been a number of referrals to enforcement. Proper handling of client money is essential for the fair treatment of customers (in all markets) and is also key for market confidence.
The review is focusing on common problems we have identified – accuracy of client money calculations, ability to track money held by third parties, observance of trust requirements on the client money accounts, and disclosure to clients about the handling of their funds. At the same time, our recently published client money guide should mean that no intermediary can claim ignorance as to the expectations we place on senior management or the application of our client money rules in practice. And indeed, we have observed some improvements in the general level of understanding of the problem of client money and the seriousness with which we view any breaches of our requirements.
We take a similarly strong view of the significance of conflicts management. Following poor findings in this area a year ago, we announced our intention to undertake further work on the management of conflicts of interest by wholesale and retail intermediaries during 2006. The focus of our attention was on whether senior management were taking sufficient responsibility in this area, whether the full range of potential conflicts (extending outside remuneration) were being identified and managed, and whether sufficient care was being taken to deal with clients fairly. Our work has therefore included reviewing the performance of conflicts mitigation strategies and the policies and practices in place for compensation, training and embedding conflicts management and mitigation in the firm's culture. This work is now nearing completion and our initial findings are that some progress has been made by intermediaries, in both the wholesale and retail market, in developing frameworks within their businesses to identify and manage conflicts of interest. We hope to provide feedback on our findings more formally before the end of this year.
Contract Certainty
Before concluding, I would like to move from the challenge of fair treatment of customers to the challenge given to the market two years ago to achieve contract certainty.
Any description of what has been achieved over the period would be incomplete without acknowledgement of the market-led progress in this area. As with TCF the big prize is embedding a changed culture – in this case achieving a lasting improvement in risk management, and an associated system improvement with wider benefits in terms of market efficiency and London’s competitive position. You will be aware of the need to maintain momentum in all parts of the market – subscription and non-subscription, and insurer and intermediary alike. We have a particular concern about the engagement and commitment of smaller brokers – particularly those outside of the London Market – and strongly encourage such firms to take the work seriously. And, as with my comments on embedding TCF, senior management need to take a strong interest in the measurement of performance and the robustness of their data. However, notwithstanding the remaining challenges, we confirmed just two weeks ago, that we remain sufficiently confident of progress that we do not at this point see a compelling case for policy making.
Conclusion
In conclusion, how should I summarise the ‘view from Canary Wharf’? In terms of evolution in the FSA’s regulatory approach, we hope that more principles-based regulation will make it easier to focus on mitigating risks to consumers while also ensuring proportionality. That is of course essential if customers of all kinds are to have access to general insurance products, with all the wider social and economic benefits they bring. In terms of industry progress since introduction of regulation, we think a huge amount has been done to bring in changed processes etc, and do not under-estimate this. The challenge now is to complete this work (where for some firms in some areas there is still a significant amount to do) and then – critically - to move to embed change in culture – both to ensure that customers are treated fairly and that wider market processes (starting with contract certainty) are improved. For this reason, both TCF in its many guises and contract certainty will remain priorities for us in 2007, and I very much hope that they will be yours.
Thank you for your time today.