Insurance for multi-occupancy buildings: How much should be read into FCA proposals?

Opinions differ on this consultation (CP23/8: Multi-occupancy building insurance). Some read the Financial Conduct Authority’s (FCA’s) approach as a market-specific response to failings revealed following the Grenfell Tower fire. According to this reading, the regulator’s objective is simply to place leaseholders of properties in multi-occupancy buildings in the same position as the policyholders.

Others find pointers to future FCA action in wider insurance markets once the Consumer Duty comes into force at the end of July. To some extent, it depends whether one reads the letter of the Handbook changes, or the FCA’s commentary.

What are the changes to the Handbook?

In brief, the Handbook changes do four things:

• They create obligations in ICOBS for disclosure to leaseholders in multi-occupancy buildings. The information includes a summary of the policy, information on pricing so leaseholders can understand how the premium is composed, total remuneration received by the intermediary, and remuneration passed on to other market participants, potential conflicts of interest, and details of any alternative quotes. This gives leaseholders more information than policyholders in other general insurance (GI) markets — offering support for the sector-specific view of these measures.
• They extend to leaseholders the obligations in PROD on product governance and oversight. As a reminder, these rules cover product approval, design of the target market, the selection of distribution channels, and ensuring fair value. This puts leaseholders on the same footing as policyholders in this market, and in other GI markets.
• The measure which will cause these proposals to spill over into other GI markets is the FCA’s suggestion that these obligations should apply not just to leaseholders, but also to other “policy stakeholders.” Policy stakeholders are loosely defined as a person obliged to pay part of the insurance costs, or who has an interest in or benefits from the insurance. Potentially, this could cover many people.
• Section 19F2 of SYSC will be amended to require companies to ensure that their remuneration practices do not conflict with their duty to act in the best interests of leaseholders — and therefore also “policy stakeholders” as defined above — as well as other customers. The associated guidance in SYSC will be amended so that companies will be obliged to consider the totality of the remuneration they receive. Also, commission paid to other market participants as an incentive to use the company’s services will be considered a breach of the rules. These measures put leaseholders in the same position as policyholders, but also clarify the position on conflicts of interest in all markets, particularly with regard to dealings involving third parties to the contract.

What elements are added by the FCA commentary?

The consultation paper, and the review of fair value assessments published alongside it, contain an unusually large number of explicit statements about the FCA’s expectations. These include:

• All market participants should consider the findings in this report when assessing their compliance with PROD and delivery of fair value: “We expect all firms to consider our findings when assessing how they comply with PROD and deliver fair value, and to act if they identify they are not meeting these obligations fully.”
• Assessments of fair value should include the impact of commission shared with third parties, and the value of that work to the customer costs and benefits: “Many of the firms in the sample provided limited evidence that they had considered the role and activities undertaken by these parties and assessed appropriately the level of commission being shared with them in this context. Given the large amounts of commission involved in many cases and the regulatory focus on value this lack of consideration is very disappointing.”
• A clear statement that rigorous application of fair value will lead to reductions in commission levels: “Where firms are receiving percentage-based commissions, the rules are likely to mean they will need to reduce the percentage rates unless there has been a corresponding increase in benefits provided to customers. Increased total commission which results purely from the risk premium increasing would be likely to breach the rules, because the increase would not reflect additional benefits provided to leaseholders.”

Conclusions and recommendations for market participants

The Handbook changes are — in the main — designed to place leaseholders in the market for insurance for multi-occupancy buildings in the same position as policyholders. They are market-specific, though some of the changes to SYSC clarify the position on conflicts of interest in all markets.

The exception is the proposal on “policy stakeholders,” which could affect a wide range of markets. The FCA’s logic is understandable: it wishes to prevent future failings for third parties similar to leaseholders. However, the concept is loosely defined, and its use and development are not wholly within the FCA’s remit. There is serious potential for unintended consequences. Hopefully, the FCA will tighten the definition. However, market participants should not rely on this. It would be prudent to review all contracts for potential “policy stakeholders,” and consider whether the product governance takes them into account, and whether they have received fair value.

The FCA’s comments on fair value assessments should be taken at face value. Market participants should read them alongside other FCA pronouncements on PROD 4 and the FCA’s May review of fair value assessments under the Consumer Duty, and take action accordingly. In particular, it is clear that the FCA is not satisfied when fair value assessments gloss over the contribution that other participants in the distribution chain make to the costs and benefits of insurance to the customer.

The impact of the FCA’s rule changes and comments on commission is more ambiguous. On the one hand, this is the first time that the FCA has imposed commission disclosure, and therefore a precedent has been set. On the other hand, the FCA does not have to follow its own precedent. It may argue that this is a response to serious failings in a specific market.

We know that the FCA has for some time had concerns about levels of commission. However, action on commission risks disruption in the market, and would have consequences for the UK as a location for insurance. We may assume that the FCA will base any future action on commission on the fair value assessments they receive under the Consumer Duty.

For the time being, market participants should review their commission arrangements for all markets, as is required by the Consumer Duty, to check that it remains the appropriate means of remuneration and can be justified with reference to the cost of the work.

Percentage-based remuneration means that shifts in market sentiment may vary the level of remuneration without any change in the underlying cost of the service. Remember also that these checks will need to be extended to take account of fair value for possible “policy stakeholders.”

This article was first published on Thomson Reuters Regulatory Intelligence.