Adequacy and insurance sales

Hot on the heels of CP159 which we touched on last week, the FSA has published Consultation Paper 160 – on the selling of insurance – which is of a similar size at 109 pages.

It is an informative read, and while I knew beforehand about the European Union&#39s Insurance Mediation Directive, I am now learning about its E-Commerce Directive and Distance Marketing Directive.

I also learn that I have missed out on CP138 (Disclosure of status under the FSMA 2000) and CP150 (Identifying contracts of insurance). The FSA also says we can look forward to a January CP on conditions that firms will have to meet for authorisation, and later consultations on fees and e-commerce. We will then, of course, have the follow-up CPs on all matters before the final rules are published.

At least I won&#39t have to scratch around for subject matter for this column.

CP160 is about the selling of general insurance and non-investment life insurance contracts, principally term assurance and critical illness options. It also covers administration, but this is primarily the province of insurers and outsourced claims handling, and not of real interest to intermediaries or myself.

The FSA now repeatedly refers to the three regulatory areas of investments, mortgages, and insurance.

CP160 focuses on insurance with due mention of the other two areas and the FSA makes it clear that the new rules will not only incorporate the requirements of the EU&#39s IMD, but are heavily influenced by them.

The FSA&#39s starting point is to look at the potential risks of consumer detriment arising from insurance sales. Its analysis has led it to conclude that private customers and small businesses need a greater degree of protection, that some products should be deemed high risk and subject to more stringent rules, and that the sales process should distinguish between advised sales and non-advised sales. The rules will cover the well-trodden paths of disclosure of the intermediary&#39s status, standards for advising and selling, product information, and after-sales treatment of customers.

CP160 pays close attention to differentiating types of customers and the degree of regulation that is required. In line with the investment market, the FSA wants to define three groups – private customers and small businesses, large businesses, and commercial (lines of business) customers.

The FSA is minded to classify businesses with a turnover of less that £1m as small businesses and treats them the same as private customers. The onus will be on the broker to determine whether his business client falls into the small business category and hence the rules which must be followed.

The FSA explains the consumer risks (see box) and how these shape its thinking on the rules for selling and administration. It describes the range of firms and sales channels in the insurance market as “vast and diverse”. The products cover many areas and quite a few are not normally associated with the mortgage market, such as motor car and travel insurance, large commercial risks and re-insurance.

Interestingly enough, CP160 doesn&#39t not contain a list of insurance products and you would need to look up CP159 on the appointed representatives regime to see any kind of product list (see Mortgage Strategy January 6, 2002).

The FSA goes on to define a set of higher risk insurance products (see box). The reasons these products are considered to pose a greater risk of consumer detriment is down to complexity, barriers to switching products and the severity of impact to the consumers if they make a claim against an unsuitable policy.

Moving onto the sales process, the FSA considers three type of sales process similar to those for mortgages, including a non-advised filtering question sales process.

Having considered the risks (to the consumer) in the three sales processes, the FSA has concluded that it will apply the same rules to non-advised filtering question sales and non-advised execution sales, and hence only distinguish two types of sales process – advised and non-advised.

Turning to the risks to non-private customers, the FSA falls back on the centuries old principle of caveat emptor – buyer beware. Such customers should know what they are doing so they can look after themselves without the burden of regulatory protection.

Having carefully prepared the background, the FSA now drops a bombshell when it talks about its specific objectives in para 6.24 – the first of which says that “where advice is given, the product recommended is adequate for the customer&#39s needs”.

Get that? Adequate. Not the best, not even one of the best buys in terms of low premium, but simply one that is adequate. Imagine if they applied that logic to the mortgage market. A first-time buyer needs a mortgage to buy a flat, so fix him up with a sub-prime mortgage topped up with a secured loan. Not the most suitable arrangement I&#39m sure you would agree, but it would be deemed “adequate” insofar as it provides the funds required by the customer to buy the property.

I&#39m not sure where the FSA is coming from in this respect, but the cynical streak in me does wonder about the powerful lobby of the banks and building societies.

More often than not they only offer a single insurance product (for a particular line of business such as buildings insurance or payment protection) and cannot pretend to be searching the whole market or offering a best buy product. But it is adequate in so far as it provides the insurance cover required by the customer. As for their commission rates, the less said the better. Did someone mention excessive charges? I suspect we may hear a lot more about the word “adequate”.

Next week we will conclude our overview of CP160. As with CP146 and CP159, we will be preparing a downloadable response to CP160 from www.mortgagestrategy.co.uk in time for the deadline of March 10.

The risk factor

Consumer risks

•Unsuitable cover

•Poor value policies

•Consumers do not buy a product they need

•Poor claims handling

•Lack of appropriate redress (complaints)

Higher risk products

•Long-term care

•Income protection

•Critical illness

•Private medical