The Financial Conduct Authority (FCA) is consulting on proposed updates to its Finalised Guidance, FG18/4: The FCA’s approach to the review of Part VII insurance business transfers (the Original Guidance), which was initially published in May 2018. Since the Original Guidance was introduced, it has had a significant impact on how Part VII insurance business transfers are undertaken and has led to the FCA being much more involved in the process. The FCA is proposing to amend the Original Guidance following the UK’s departure from the EU, its experience over the past few years and feedback from the industry, with the aim of clarifying expectations on Part VII insurance business transfers.
It is worth noting that, whilst the Prudential Regulation Authority (PRA) leads the process, the FCA has an active role on Part VII insurance business transfers and is entitled under section 110 of FSMA to be heard on applications to sanction a transfer and to give its views to the Court based on the FCA’s assessment of the transfer against its statutory objectives. The updated draft guidance is largely consistent with the FCA’s current approach on recent Part VII transfers that we have advised on, and indeed formalising this guidance has the advantage of confirming the FCA’s position more widely. Many of the proposed changes are points of clarification designed to give firms more precise guidance where questions have been raised before.
Independence is key
The importance of the independence of the independent expert (IE) is stressed in the revised guidance and the FCA provides that if the proposed IE intends to work on two interacting projects concurrently or consecutively they must be able to demonstrate that they can act independently, for example by challenging one project that may affect the other. The FCA states that it may not agree with nominations where it is not satisfied that the IE will be able to manage those conflicts effectively. The FCA may challenge proposed IE appointments where it is not satisfied about the independence of the IE and, in our experience, it is important to begin the IE selection process and engagement with the FCA on this early on in the planning of a Part VII transfer. In practice, transferors are finding it increasingly difficult to find suitable independent IEs – the proposed draft guidance means that this search will continue to be challenging.
The independence of the peer reviewer is also highlighted in the revised guidance and, to the extent that a suitably independent candidate for peer reviewer cannot be identified, a peer reviewer from an unrelated firm may need to be nominated.
It’s not just independence that is crucial, but skill and experience too. In recent transfers, we have seen the FCA look to the experience of not just the IE, but also the IE’s team and the peer reviewer – this expectation is also something the FCA is proposing to add to the guidance.
FCA expectations and governance
The amendments include requiring that applicants and IEs submit near final documents, confirming in witness statements that applicants and the IE have acted in line with expectations in FG18/4.
Judgement calls need to be flagged to the FCA if the manner in which the firm considers it has acted in accordance with the proposed draft guidance (or fully taken into account the considerations set out) meant a judgement call by the applicants and/or there is some room for discussion about whether the applicants fully meet the FCA’s expectations (including expectations to proactively raise material conduct issues with the FCA). The FCA expects the details of those judgement calls and/or areas where there was room for discussion to be raised with the FCA in good time.
Where applicants and/or the IE have, for whatever reason, not acted in accordance with a particular point or parts of the proposed draft guidance, they must explain to the FCA why those provisions are not appropriate or relevant. In practice, where this situation arises on Part VII transfers, any deviation from the guidance should be discussed with the regulators in good time – the proposed amendments to the guidance reflect this, and any deviations would also likely need to be flagged up in the witness statement.
However, the proposed draft guidance places an additional onus on applicants and the IE to consider whether there are particular issues arising in relation to a scheme which the FCA is likely to want to consider. This broad requirement would mean identifying issues that are based on the FCA’s approach as set out in the guidance and also more generally. Here, the FCA is concerned about both wider issues and also material conduct issues arising in the scheme where the applicants and/or IE considers that the applicants have made a judgement call on a matter that is not straightforward or where there may be scope for affected policyholders to raise concerns.
Senior managers have a role to play here too. The FCA proposes to expect applicants to raise considerations and issues proactively with the FCA and for a senior manager within the firm to take responsibility for this and to confirm to the FCA that this has been done. Any such material conduct issues will also need to be the subject of appropriate governance processes.
Effect of the transfer on policyholders and objections
The FCA isn’t just thinking about adverse effects of the scheme on policyholders, but any effect of the scheme on policyholders – applicants and the IE need to look at everything that is changing for policyholders. Vulnerable policyholders have been the focus of much of the FCA’s work in the market in recent years and it comes as no surprise that the proposed guidance requires the applicants and the IE to expressly consider the scheme’s impact on vulnerable policyholders and how vulnerability was taken into account in the design of documents and in the provision of guidance and advice.
What has been said to policyholders historically is also of significance. The FCA already examines statements made to policyholders when considering objections raised to a scheme. The proposed guidance will require the applicants and the IE to ensure that they have “done enough” to identify previous statements made by the applicants (such as on their website or in communications with policyholders including policy documents) which policyholders could reasonably seek to rely on to object to the scheme. Where policyholders raise objections on these grounds, the applicant should take reasonable steps to address those concerns in sufficient detail and consideration, and to engage with the policyholders – this also means ensuring that contact centre staff are appropriately trained.
From the IE’s perspective, the proposed draft guidance reflects the evolution of the IE’s role in recent years. It would mean the IE considering objections from the perspective of policyholders, and also considering whether the applicants have done enough to respond to them and address concerns about the potential effect on policyholders.
There is the potential that the scheme would need to be amended in response to policyholder objections. As is the case in practice now, issues that remain unresolved before the directions hearing have to be followed up in the respective documents for the sanction hearing.
Focus on the content of the IE report
The depth of reasoning, critical review and analysis in the IE report to support the conclusion that there is no material adverse effect on policyholders has been commented on by the FCA previously. The FCA has added to the proposed draft guidance new areas that it believes are not always considered sufficiently in the IE report and that should be provided for: claims handling, where the scheme includes employers’ liability/ public liability claimants and run-off claims and where there are significant changes during the process, for example due to pandemic-related or economic fluctuations.
Firms will welcome the draft proposed guidance to notify policyholders of any proposed transfer by digital communications and not by traditional postal methods. The proposed draft guidance sets out certain factors that firms must take into account including for example, the policyholder’s preferred method of communication, reliability of the communications and highlighting the importance of the notification that is made to policyholders.
Early engagement with both the PRA and the FCA still remains key, including providing the regulators with a detailed proposed timetable. Changes to the timetable cannot be made without notifying the regulators and there are no changes to the 6-8 weeks the regulators need to review the scheme documents. The revised guidance makes clear that the period of document review finishes when applicants submit the documents to Court ahead of the respective hearings or the supplementary IE report is published ahead of the sanction hearing.
The proposed guidance will ultimately give the FCA further grounds on which to object to Part VII insurance business transfers and indeed the FCA makes it clear in the proposed draft guidance that it can object to a scheme based on conduct concerns, even if there is no prudential concern. In practice, both the PRA and the FCA will work with applicants to ensure that the scheme is appropriate, highlighting where they have concerns and engaging on issues, even where these are very complex transfers. Applicants can make the process more straightforward by carefully going through the guidance and ensuring that the relevant aspects have been addressed.