Towards excellence in regulation
Stephen Bland, Director of Small Firms, and Retail Intermediaries sector leader, FSA (given by Andrew Honey)
BIBA Conference
24 May 2007
I am pleased to have been asked to speak today at the key BIBA event of the year. Our relationship with BIBA is important to us - we have regular contact and we've also been pleased to accept several invitations to BIBA regional events. This is a good way of keeping in touch and hearing what is on your mind.
I do think excellence in regulation is an important topic for us all – and it was understandable that Eric Galbraith raised some concerns about regulatory issues in his opening speech. The fact that the General Insurance market is now subject to statutory regulation has been widely recognised as good for the market's reputation and standing with consumers – and thus good for your business. Together we need to make sure that the benefits of regulation are not outweighed by the costs. Some of these costs are inevitable, and some are not. We are working towards excellence in every area of our regulation – we have not got there yet – and I want today to outline some of the areas in which I think we have made progress.
The areas include initiatives where we are trying to make our rules less of a straightjacket and to operate instead at a more principles-based level, particularly in the area of Treating Customers Fairly. They include areas where we are trying to give you the extra help you have requested in complying with our requirements, for example on client money and on goodwill. And they include areas where we are working together with the industry to find industry solutions, or partnerships, such as contract certainty, commission disclosure, and fighting financial crime. In each of those three areas – principles-based regulation, providing help, and working with you in partnership - I think we are making good progress towards excellence in regulation. And naturally we need this to be matched by your excellence in running your businesses in a way that is consistent with the aim of consumer protection that we are all seeking to achieve. That should benefit you, and of course, importantly it should benefit your customers. You will tell me in our question and answer session at the end where you think we have further to go, either in those areas I cover or in other areas: we are up for any improvements to help you to help your customers.
Principles-based regulation
In April 2005 Stephen Bland from the FSA spoke at the BIBA National Conference in Manchester. At the time FSA regulation of insurance was only a few months old. We were aware of many doubts about the implications of statutory regulation and there were various views of how the future would look. One perspective, though not widespread, was that the industry would be choked by the iron hand of regulation while the victim was buried underneath a mound of paperwork! Another view was that we were tinkering at the edges of an industry which fleeced the unsuspecting and made off with the spoils. Fortunately neither view prevailed and although we have seen changes in the last few years, the British insurance industry is still alive and well. Its structure may have changed but there was still more than £54 billion of net written premiums for general insurance in 2005.
But, as I said earlier, there is always room to strive further for excellence. And I want to concentrate most of my remarks on the move towards principles-based regulation, particularly in the context of Treating Customers Fairly.
Principles-Based regulation is of course not new. Principles have always underpinned our rules. The 11 ‘Principles for Businesses’ are, in some sense, the FSA’s version of the ‘Ten Commandments’. Trust us to go one better! Like the Ten Commandments there can be a good deal of discussion about the finer points of detail, although few have any doubts about the overall direction.
Emphasising principles and high level rules is a move away from detailed prescription of processes. This is about agreeing the outcomes we all want to see and ensuring businesses work to achieve these.
For those who might be concerned that rules protected against mis-selling, past-experience shows that this was not in fact the case. You will all be familiar with the range of past mis-selling episodes in the UK - personal pensions, endowment mortgages, split capital investment trusts and ‘precipice' bonds.
Faced with this, we concluded that a ‘step change’ was needed in the behaviour of firms. And we concluded also that it was wise for us to rethink our own approach and find a new way of engaging firms' attention. A more principles-based approach focuses on outcomes, and is in keeping with the spirit of what we want to achieve. Principles are more durable as markets develop because they can be applied to different and changing business practices.
Treating Customers Fairly (TCF)
In the retail market the major part of our move towards principles-based regulation is our Treating Customers Fairly (TCF) initiative. In case you haven't noticed, this is a priority for the FSA and we are looking for specific outcomes for consumers. This is where it is most easy to see the relationship between excellence in business and excellence in regulation. There's no doubt that when customers are not treated fairly they make sure that they tell anyone who cares to hear what has happened. Likewise when they are treated fairly the firm will get good publicity by word of mouth.
In our recent work we've identified some good as well as poor outcomes but what might count as excellence - or at least approaching it - in treating customers fairly?
First of all, the firm's culture. This is the sum of all the ways the firm behaves towards its customers and enables the customer to be confident about their dealings with the firm. From this will flow products and services designed to meet the customers' needs, clear information before, during and after a sale, and suitable advice taking full account of customers' circumstances.
After the sale and to the end of the product life-cycle the product will perform in a way that the consumer has been led to expect. Also there should be no unreasonable post-sale barriers so that customers can change product or switch provider. There should also be a clear and accessible way of making complaints. If a complaint is made it will be dealt with promptly and taken seriously.
So what have we found out from our recent review of firms' progress on TCF?
As I suggested earlier we have been able to identify examples of good and poor practice which a large number of firms need to address. I will give a few examples - you can find some more on our website (plug!) and we will be adding to these as time goes on.
- First of all, a good example of management action resulting from an analysis of complaint statistics. Managers became aware of a flood of complaints about a provider and its poor customer service in handling claims. They took a proactive approach and moved business away from the provider. Each customer was contacted and provided with an explanation.
- An example of poor communications. In another firm it became clear that a covering letter sent out with the Terms of Business was unclear, however, no action was taken. Statistics showed that the majority of customers returned their Terms of Business letter with other documentation. No improvements were made to ensure that customers understood the importance of the document and the need to keep it.
- A good example of a robust renewal process was in place in a firm. This made sure that customers were contacted in plenty of time ahead of renewal to check for any changes in their circumstances. This meant that if necessary, the firm could shop around for the best deal for the customer.
- And finally, some poor practice in sales and advice. One firm made no attempt to find out whether their customers were eligible for payment protection insurance although they were selling large numbers of these policies. In particular, the firm had no knowledge of the customer's employment status. It is likely that if they became unemployed some would not be able to claim because they were self-employed, contract workers or part–time staff who are specifically excluded from the policies.
As you will be aware, in this connection the distribution of PPI is, and continues to be a key concern both for the FSA and the OFT. We realise that most primary GI brokers don't sell PPI but would like to applaud the efforts BIBA have made to develop a stand-alone PPI contract available to all.
Customer satisfaction
We also encountered one of the common misconceptions about how to identify fair treatment. Some firms send out customer satisfaction surveys to their policy holders or in some other way try to gauge satisfaction. They think this will give them an idea as to whether they are treating customers fairly. I would suggest that a customer could give a firm a very high score on the satisfaction index but still not have been treated fairly. Customer comments could relate to the high level of courtesy and the polite way they had been treated but they might not be aware that the policy they have bought is entirely inappropriate for them. I suppose the kindest way to describe their state is blissful ignorance!
The overall results of our work in the run-up to the March deadline for implanting TCF in a large part of a firm's business was that 45% of small GI brokers were not doing this. This does not mean that they were Treating Customers Unfairly – it is a process, not an outcome. But it does mean that they were not running their business in a way that allowed them to be sure of that, and that itself is worrying.
As a result, TCF remains a high priority for us and we will be carrying out further work to ensure that firms are treating their customers fairly. This is likely to include further visits as well as an analysis of information we receive from a wide range of sources. We also plan to develop some more tools to help you analyse your own situation available from the FSA small firms' division website (plug!).
By the end of March 2008 we will expect firms to have appropriate management information or measures in place to test whether they are treating their customers fairly and by December 2008 we will expect all firms to be able to demonstrate that they are consistently treating their customers fairly.
Linked with Principles-Based regulation is of course our review of insurance conduct of business rules. We have aimed to be responsive to what we have heard and found. We believe that, by being aware of what is going on in the industry and to tailor our regulation to be proportionate to the risk, we are more likely to achieve excellence.
Review of Insurance Conduct of Business (ICOB) rules
We announced a review of Insurance Conduct of Business in September 2005, published our interim report at the end of March this year and our consultation paper is due in June, with a view to implementation at the end of this year. We hope you will contribute thoughts and suggestions of how best to achieve the outcomes.
The review was not an assessment of whether firms are complying with our rules. We have other procedures in place to do this. Instead it focussed on how effectively general insurance markets are working for retail consumers.
The key points are that for general insurance products such as household or motor policies, markets work reasonably well in the interests of consumers, and that most consumers do not rely on disclosure documents from firms (prescribed by our rules) when making decisions.
However personal protection products, such as payment protection and critical illness are longer term products, they are often secondary or tertiary purchases and consumers lack confidence when buying them. Our research also showed that buying these products can be an emotionally charged experience in which consumers look - above all - for peace of mind. They are also very concerned about their ability to meet future financial liabilities. In these circumstances they can be highly reliant on advice and information which will meet these needs.
Because we have identified these particular issues with personal protection products we will be bringing in a small number of targeted additional requirements to help ensure that consumers can make informed decisions about the purchase of these products. In the new principles-based world, this is the outcome we want to achieve. These changes will include a requirement that in part-oral sales of these products, the key information for an informed decision is provided orally as well as on paper.
For the sales of other "products", we are not proposing any new specific requirements for our NEWICOB handbook. Firms selling motor, home, pet and standalone travel policies should face no extra costs, provided that they already comply with our current rules and with our Principles for Businesses in their dealings with customers. Indeed, we will offer firms more flexibility. We propose an outcome-focused standard that a firm must provide the customer with appropriate information in good time for the customer to make an informed decision. We are not telling firms what they must do to achieve this.
We will only be keeping detailed rules above directive requirements where they are essential to protect consumers. Examples of these include the requirement in a linked sale that the price for each insurance contract is shown separately and that the customer is told whether the purchase is optional. Another example would be continuing to apply a cancellation period to sales of all general insurance policies.
All firms will benefit from the removal of detailed rules, particularly those relating to suitability and to product disclosure. Our handbook will be much shorter, slimmer and easier for firms to understand. Firms will have more freedom to choose how they meet our high-level standards. There will be help available and we will continue to produce information and tools to help firms assess their understanding and progress. We will be working with trade associations such as BIBA to produce guidance for members on how to meet the requirements.
The "Level Playing Field"
Then there is the "level playing field" issue. We understand intermediaries' concerns about removing certain detailed rules for insurers for the sale of motor, home, pet and travel insurance, rules which we cannot remove for intermediaries because they derive directly from the IMD, notably rules on status disclosure, on suitability and on statements of demands and needs. We believe that the IMD can be improved, and we are taking a leading role in promoting its review. Inevitably, that takes time.
We don't believe the removal of rules on status disclosure, on suitability and on statements of demands and needs will in practice provide insurers with a material competitive advantage. All advice they give will still have to be suitable because of Principle 9 - "A firm must take reasonable care to ensure the suitability of its advice and discretionary decisions for any customer who is entitled to rely upon its judgment." This will have implications for insurers who will still need to ensure that sufficient resources are committed to support the sales process and will still need to be able to show us how they are meeting the standards we require for consumers.
But this is only one small part of the wider picture of our move to more principles-based regulation and to removing detailed rules that do not benefit consumers. The removal of detailed rules for the sale of most general insurance provides will allow greater freedom for all firms to decide how they will meet our high-level standards as they develop their own business models.
So in our rules and how we implement them in a principles-based fashion, we are striving towards excellence.
Providing help
I would now like to come on to my second category of us trying for excellence: our work on providing help for you in areas where you have requested it. In many of these areas, BIBA has helped us in a variety of ways - consulting you, developing material, refining our thinking and helping us to get messages out. We are grateful for this and want it to continue.
Let's start with client money, which is primarily about client protection and which will serve to move insurance brokers a step further towards excellence in business and regulation.
Client Money
Between September and December 2006 we carried out the third phase of client money work visiting 161 general insurance intermediaries. Results showed that most intermediaries in the sample who had used the FSA's new tools provided to help them, which include the Guide to Client Money and a web-based training course, had a better understanding of client money handling than in previous FSA work on this issue. Despite improvements, we are still concerned about the overall level of compliance in this area as some firms only used the help available once they were aware of our forthcoming visit or did not use it at all.
The report showed that there is willingness on the part of firms to comply but some way to go in their being able to fully understand what needs to be done. We have produced further help for firms, the Client Money flowchart and the Client Money Healthcheck which are available on our website. Both of these aim to educate firms about the issues and allow them to check their understanding.
That is not the end of the story. We have offered a considerable amount of help and have made sure that firms have a range of information and tools which they can use. We will continue to monitor practice in holding and protecting client money during the course of our visits and other supervisory work. If we find client money failings in a firm in the future, this will be taken seriously and could result in enforcement action. We will take a dim view of any firm which has had every chance to put things right and has failed to do so.
Goodwill
I turn now to Goodwill, another area in which we have tried to provide help for you on how you can comply with our requirements.
First of all I want to explain why we regard this as so important. One of the purposes of the capital resources requirement is to reduce the probability of consumers suffering loss, or markets being disrupted, as a result of financial failure. Goodwill is an asset which often cannot be readily converted into cash and may only be realised when a business is sold.
We first outlined our position on goodwill in September 2003. As we were aware of industry concerns, particularly about the need to allow time for changes to be made, we set up transitional arrangements in which the value of goodwill could be included when calculating capital resources. This arrangement as you will know ends on 15th January 2008 but action needs to be taken well in advance of that date.
We know of BIBA's interest and we have been working on a joint effort to provide some help to firms who need to take action on this. This issue is high on BIBA's radar and they published a factsheet towards the end of last year. We have also sought to remind firms and have recently published some FAQs on our website. At the risk of making yet another plug for our website, if you are one of the firms potentially affected by the goodwill issue, I really commend these FAQs to you. They are a further example of a valuable, collaborative effort between ourselves and BIBA.
Some firms have asked us to give detailed formulae or to provide examples of how this could be done. We need to be clear that we cannot provide a "one size fits all" solution; however, our answers give some indication as to the way that firms could change their balance sheets and make genuinely robust arrangements to ensure that customers are protected in the event of liquidation.
However we will not approve arrangements based on some of the "paper exercises" which have been circulated which propose making cosmetic changes without ensuring that the underlying position is strong.
Firms should be taking steps to address this and should be aware that we may, at a later date, ask for evidence of the action taken by them to ensure that they meet the capital resources requirement after January 2008.
Market solutions
My third and last category of where FSA is trying for excellence in its regulatory approach towards you is in areas where we want to rely wholly or partly on market solutions.
Contract Certainty
The most obvious example of this is contract certainty and the industry-led solution which has been put in place. This is a very pleasing example of how a collaborative approach can solve a problem with minimum fuss and maximum effect. Definitely a move towards excellence in regulation!
BIBA have been working with us along the way on this. They have also supported our our industry-led approach to the issue, and have helped in getting the message out to members.
In December 2004 we announced that, as part of our approach to broker regulation, we would be looking to the industry to find a solution to the issue of contract certainty. We have seen two years of change and improvement to the point where we have no inclination to make rules on this. There's no need to! We announced this in our Dear CEO letter of December 2006.
This is the sort of outcome which benefits the regulator and the regulated. It avoids the need for new rule writing and saves time and effort on consultation. It also means that businesses can work effectively without inordinate amounts of resource spent on measurements of compliance. So far so good.
But this is not the end of the story - we will not forget about this and we will expect all firms to be able to demonstrate that they are achieving contract certainty. We will give particular attention to firms which are less engaged with this than others and we will be asking them to justify their position.
Commission disclosure
Turning now to the more controversial area of commission disclosure, the position here was set out by John Tiner our Chief Executive at the Insurance Institute in October last year. This is another issue where we would like to see an industry-led solution but this is not yet forthcoming. In spite of comments in the press and elsewhere – including by Eric Galbraith earlier - we have not made our minds up on this issue. I cannot emphasise this enough.
The concerns that have been expressed by market participants include:
- the emergence of an unlevel playing field between brokers who have chosen voluntarily (post-Spitzer) to provide full disclosure and those which have not;
- the lack of transparency to the customer about what they are paying for - for their risks to be covered or for other services? and
- the lack of full transparency in the market (ie to insurers as well as to customers).
We are therefore undertaking a review which will analyse whether lack of transparency is leading to customer detriment or impairing market efficiency, and, if it is, whether mandating commission disclosure would lead to benefits that outweigh the costs.
The review will draw on data from a wide range of sources, including existing industry and academic work and an extensive interview and survey programme with trade associations, insurers, brokers and clients. This research is being led by independent consultants, CRA International. Thank you to all who have participated in the review and who plan to do so in the future. We will publish the results of this work towards the end of this year.
We will consider regulatory intervention if, and only if, both the market failure analysis and the cost-benefits test are met, and the market has still not come forward with a solution.
Fighting financial crime
A final example of working in partnership with you is that of financial crime.
An important dimension of excellence in business is the integrity and honesty of firms. The more universal the best practice the more the industry as a whole will have the respect of customers and other businesses.
With this in mind and following a successful project in the mortgage sector we set up a streamlined system for reporting financial crime in March. Under the system we asked insurance firms and intermediaries to inform the FSA when they suspect criminal behaviour, so that the FSA can decide whether to investigate further. This may arise when an insurer terminates an agency agreement with an intermediary where they see doubtful practice or suspect misconduct. It may also arise where an insurance intermediary has concerns about another intermediary they do business with.
Last year, the mortgage system produced 34 referrals to our Enforcement colleagues. Although the Insurance scheme has only been in existence for a couple of months, we have had a number of responses already and are following these up. As you will understand we cannot go public the results of our investigations except where we have sufficient evidence of malpractice to take Enforcement action. When the time comes we will be sure to do this. In the meantime we appreciate the help we have received and encourage anyone with anything to tell us to come forward. We have outlined the reporting system on our website (plug 4!) and we have some named individuals who you can contact on this.
Conclusion
So, to conclude, I have made a case today that FSA is striving towards excellence in regulation: in adopting a more Principles-based approach, in the help it gives you and in working in partnership with you. We have already gained many of the benefits of regulation in terms of the industry's reputation. We hope that these efforts will keep the costs of regulation to a minimum by allowing you to run your businesses in the most efficient way to the benefit of your customers. That is the goal for which we are all striving.
I do want to stress that it will take two to tango, us and the industry together, if we are to achieve our aims.
In Principles-based Regulation, we need you as management to run your businesses in a way that does Treat Customers Fairly. And we need a healthy and detailed response to our proposals on the ICOB review in June. In areas where we have provided guidance, such as client money and goodwill, we hope you will use it. In areas where we are looking for market solutions and working in partnership with you, we need you to step up to the plate. Towards excellence in regulation was the title of this speech – achieving this is not a spectator sport.
Thank you.