The middle man
22 September 2003
Difficult choices lie ahead for general insurance intermediaries and those insurers who rely on them in order to sell general insurance business. Currently, non-life intermediaries are regulated only if they are members of the General Insurance Standards Council. Membership is voluntary, and it is fair to say that the council's touch is far lighter than that of the Financial Services Authority (FSA). However, that is about to change. The draft rules published by the FSA in response to the Insurance Mediation Directive (IMD) will impose significant extra regulation on intermediaries, with the result that the current dynamics of the market may change beyond recognition.
The IMD was first published in October 2002 and sets out minimum standards for the regulation of the sale of general insurance that will apply across the EU. After a period of consultation, in June 2003 the FSA published draft rules 'Insurance: Conduct of Business Sourcebook', to be included as a new book in the FSA's Handbook of Rules and Guidance. These rules go considerably further in some areas than is required by the IMD and reflect the FSA's statutory objective of ensuring that consumers receive an appropriate degree of protection. The rules are now crystallised in the policy statements and further 'near-final' draft rules published on 8 September this year. The final rules will be made by January 2004 and will come into effect for general insurance intermediaries on 14 January 2005.
The products that fall within the new rules include all general insurance and pure protection contracts other than long-term care insurance, which will now be regarded as an investment product irrespective of whether it is investment or insurance-based. Travel insurance will not be caught if it is sold as part of a holiday package, although the FSA has undertaken to review this in 2007. It has not yet been decided whether extended warranties, other than motor warranties, should be covered, because the Competition Commission is due to publish a report on its investigation into this area shortly. Contracts of large risk where the risk is situated outside the European Economic Area, or where the customer is a commercial customer, are also excluded, as are reinsurance contracts.
One of the key differences introduced by the new rules will be that general insurance intermediaries will need to be authorised by the FSA in order to carry out any controlled function in relation to general insurance and pure protection contracts. This means that if an intermediary wishes to sell, administer, advise on or carry out non-investment insurance contracts, it will need to be FSA-authorised. Such intermediaries will also fall under the compulsory jurisdiction of the Financial Ombudsman Service. Insurers will need to comply with the new rules in certain situations, notably when dealing with retail customers, but as this will only involve a relatively simple application to vary their existing permission, it is not anticipated that this procedure will be particularly onerous.
The additional requirements on intermediaries will include meeting the FSA's threshold conditions, including the tests for fitness and propriety and for adequacy of financial resources, and complying with various sections of the FSA's handbook. Some of their senior personnel will also need to become 'approved persons' and so become subject to individual regulation. The financial safeguards required will include professional indemnity cover for a minimum level - or a comparable guarantee from an authorised group company with net tangible assets of at least £10m - solvency requirements and compulsory membership of the Financial Services Compensation Scheme. The FSA is issuing a further consultation paper in November concerning the level of contributions to the scheme that will be required from intermediaries. Intermediaries will also need to hold client money, either in segregated client accounts or effectively as agent for the insurer so that the insurer accepts the risk of errors in handling or the insolvency of the intermediary. Further, the intermediary will be required to give certain information to the customer before and on formation of the insurance contract, in relation to the fees and commission, the product itself and the status of the intermediary and the insurer. Some of this will be in a prescribed format and some can be given initially on the telephone, but ultimately, there will be considerably more paperwork required to be completed for each policy sold.
The FSA commissioned National Economic Research Associates (Nera), an independent firm of economic consultants, to carry out a cost-benefit analysis of introducing the new regulations. Nera has estimated that the cost to the market will be an initial expense of £197m and an additional £166m per annum thereafter. The market may respond in a number of different ways.
It seems inevitable that many smaller companies will not be able to cope with the regulatory impact and expense, with the accompanying need for internal compliance officers, sophisticated training and competence systems and so forth. This will almost certainly lead to a degree of consolidation. This is acknowledged by the FSA, which asked Nera to consider whether such anticipated reduction in competition would ultimately be to the customers' detriment. The conclusion was that there will not be a significant reduction in competition among the product providers, and so very little detriment to the customer.
An alternative to an intermediary becoming an authorised company is to become an 'appointed representative' (AR). The effect of this is that the intermediary would act purely as agent for its principal, which would have to be an FSA-authorised entity that accepted responsibility for its agent's actions. This does not mean that the agent's actions are unregulated, but that the responsibility for ensuring they comply with the relevant regulations rests with the principal. The AR regime already in existence for life business and for investment and mortgage products will be extended to cover non-investment insurance intermediaries. In the investment business and mortgage markets, each AR has only one or two principals - and if two, they are for completely separate business - conversely, general insurance intermediaries typically offer policies from several different product providers. Accordingly, in order to reflect market practice, the FSA proposes to allow general insurance ARs to have as many principals as they wish, provided that all the principals enter into a multiple-principal agreement that seeks to apportion responsibility and, to ensure cooperation on those matters where clients' interests might be harmed, one of the principals must become the lead principal for the purpose of handling complaints, for example.
It is still open to companies simply to introduce business without taking any part in any of the controlled functions. However, there may still be disclosure requirements, and generally the remuneration for these services will be lower than for more comprehensive advisory and arranging services.
There is another possible development. As the number of intermediaries falls - whether through consolidation, a rise in the introductions-only business, or through companies exiting the market in search of more lucrative, less regulated activities - insurers may choose to dispense with intermediary services entirely. As has already been mentioned, some of the new rules will apply to insurers when they deal with the customers directly, but as insurers are already required to be authorised and to comply with the FSA's handbook, this should not impose too heavy a burden. Indeed, some of the requirements, such as those relating to disclosure of information, are actually relaxed for insurers. Further, initiatives such as the Distance Marketing Directive and the passporting regime are already making it easier for UK companies to conduct business across Europe on a more or less level playing field. The relative simplicity of this process may lead some insurers to question whether there is still a need to retain the services of an intermediary.
Maria Ross is a partner at Norton Rose and was assisted on this article by associate Bob Haken