The UK general insurance distribution chain – back in the spotlight

The FCA recently published TR19/2, its latest Thematic Review of the general insurance (GI) market, under cover of a Dear CEO letter. TR19/2 follows the introduction on 1 October 2018 of amendments to the FCA Handbook designed to implement the Insurance Distribution Directive (IDD) and the extension of the SMCR to insurers. Its publication demonstrates that the FCA is renewing its focus on the distribution of general insurance products – driven by the potential for customer harm it has identified by analysing firms’ distribution arrangements.

The FCA’s areas of concern

The FCA’s concerns with the GI distribution chain fall into two main areas:

• price and quality, where the size of the distribution chain has an adverse effect on product value; and
• sales and service, where the complexity of the distribution chain results in either mis-selling or poor service delivery to customers.

These concerns are illustrated by two examples taken from the Thematic Review:

1. In the travel insurance market the FCA found that the prices charged to insure short UK trips of not more than 5 days appeared very high relative to the risks covered. One monthly bordereaux showed that, of the £92,167 (net of IPT) paid by 4,320 customers, £67,741 was retained by the tour operator as commission and only £24,426 was passed on to the MGA and insurer.
2. The FCA saw one insurer delegate claims authority to a coverholder which then constructed its claims processes and service standards with limited oversight and no regular conduct related MI. The insurer was therefore unable to demonstrate that the service standards applied by the coverholder were equivalent to those the insurer itself applied, or provide assurance that claims were being handled appropriately.

What will the FCA focus on?

The FCA takes the view that customer harm emanates from firms’ culture and business models, and from two causes in particular:

• firms’ purpose and values, notably a lack of focus on customer outcomes; and
• poor governance and oversight, including a failure to implement adequate systems and controls over the end to end distribution chain.

The Thematic Review reinforces the FCA’s focus on purpose, evident from its 2019/20 Business Plan, and it is clear that the regulator will not fail to act where it sees a firm’s culture as problematic. However, the FCA considers systems and control failings in relation to the distribution chain to be particularly harmful. Such failings can result in firms not delivering the right customer outcomes even when they intend to do so and their culture and values are directed towards this aim.

Consistent with this, the FCA found that customer harm occurred more frequently where there were multiple parties involved in the distribution chain as a result of insufficient understanding of the fees and charges applied, both between the parties within the distribution chain and on the part of customers. The FCA has made clear that customer outcomes should not vary according to the size of the distribution chain.

What can firms expect?

The FCA is consulting on proposed non-Handbook guidance (GC19/2) which is intended to achieve “step change” in the GI sector, make the FCA’s expectations of both manufacturers and distributors clear, and remove any potential ambiguities from the regulatory scheme. This guidance is intended to set out the regulator’s view of how firms should consider value when complying with the requirements on the manufacture and distribution of insurance products.

Key points include:

• firms in the distribution chain must act fairly, honestly and professionally in accordance with the best interests of the customer;
• firms must take account of value when designing products, determining distribution strategies and setting remuneration structures;
• manufacturers must design, monitor and review products to ensure they meet the needs of the target market and prevent/mitigate customer harm; and
• firms must have clear lines of individual accountability for each of the expectations and related activities detailed in the guidance.

Increased enforcement risk

The FCA’s concern and disappointment at the extent to which many firms have failed to respond sufficiently to its previous work on GI distribution is clear, and it has stated that it wants the results of TR19/2 to serve as “an immediate call to action to all GI firms”. Such firms must now address their culture and governance issues as a matter of urgency.

The regulator has recently pursued three successful enforcement cases in the GI sector and states in the Thematic Review that it will not hesitate to take such action again where firms are failing to meet their obligations. Based on past experience of similar exercises, further enforcement cases may well be opened once the FCA has reviewed all of the information it received as part of the Thematic Review exercise.