Insurance update - Europe

The Financial Conduct Authority (FCA) has fined Stonebridge International Insurance Ltd £8.3 million for poor oversight of its outsourced sales and customer service functions, weaknesses in systems and controls and inadequate information disclosure. Transposition of the Solvency II Directive in the UK has moved forward with two further consultations. The Prudential Regulation Authority (PRA) has proposed changes to the PRA Rulebook required to implement the new solvency regime, while HM Treasury is seeking feedback on two policy issues to complete the consultation process on how the UK government should implement Solvency II.

The Financial Conduct Authority (FCA) has fined Stonebridge International Insurance Ltd (Stonebridge) £8,373,600 in relation to sales of accident insurance products for breaches of Principle 3 (management and control) and Principle 6 (customers’ interests) of the FCA’s Principles for Businesses. Stonebridge outsourced the sales and customer services operations of its personal accident, accidental death and accidental cash plan insurance products (underwritten by Stonebridge) to various authorised intermediaries. The FCA final notice identifies a number of failings including weaknesses in systems and controls, poor oversight of outsourced functions, inadequate information disclosure at point of sale and a failure to take reasonable steps to ensure that customers were treated fairly.

Background

Between April 1, 2011 and December 31, 2012, Stonebridge sold its accident products, through outsourcing companies, to customers over the phone on a non-advised basis across the UK, Germany, France, Italy and Spain. Premium costs ranged between £6.19 and £7.17 for single cover and £8.76 and £12.93 for family cover, depending on the product. Stonebridge earned revenues of approximately £93.8 million during the relevant period. Stonebridge identified its target market as being persons who typically were in the middle-to-low income bracket, without a university degree or professional qualification. The FCA argues that, given its sales strategy, Stonebridge should have had in place robust controls to ensure compliance with regulatory rules, particularly TCF.

A number of reviews were undertaken in relation to Stonebridge’s sales practices during 2012. First the Financial Services Authority (the FCA’s predecessor) reviewed a sample of sales calls which raised concerns that customers were buying products without fully understanding the extent of cover provided. Although Stonebridge did not agree with the FSA’s findings, an independent legal review was commissioned to investigate. The review concluded that while certain areas required improvement, there were no serious concerns in respect of Stonebridge’s sales process. Stonebridge then, on its own initiative, commissioned a review of 1703 post-sales cancellation calls of which 16 per cent were deemed to have resulted in potential customer detriment. These findings were reported to the FSA at which point the regulator requested that Stonebridge appoint a skilled person to review sales and post-sales cancellation calls in the UK. The skilled person found there was a risk of potential customer detriment but no evidence of actual detriment. Whilst there was no indication of wilful mis-selling, deficiencies in the sales process were identified and consequently the regulator launched an investigation.

The fact that deficiencies in Stonebridge’s sales process were noted but no serious concerns were identified reveals the shift in regulatory focus, since April 2012, toward greater emphasis on conduct issues and how firms mitigate risks when they are identified.

Key failings

The FCA’s final notice identifies a range of failings which can broadly be summarised as weaknesses in the following areas: the sales process; systems and controls; training; compliance; and quality assurance. The sales scripts and call flows which provided guidance to sales personnel at the outsourcing companies were poorly designed by Stonebridge. The sales process provided insufficient information about the range of products available, payment options and exclusions and limitations of cover. Some customers with families were channelled toward more expensive family cover without being offered the option of individual cover. Firms should ensure that customers are given appropriate information including the different levels of cover available to them at the point of sale in order to make an informed decision as to which level of cover is appropriate to their needs.

Firms should take note of the significant failings in Stonebridge’s oversight of the outsourced operations detailed in the final notice. Sales personnel often did not provide customers with information in a clear, fair and balanced manner and, in some cases, customers were given inaccurate or misleading policy information. A further issue was the emphasis during sales calls on cancellation rights. Customers were told that if they found that the policy was not suitable for their needs it could be cancelled without incurring any fees, however, when customers later tried to cancel their policies they faced barriers to cancellation. Due to these barriers many customers who tried to cancel instead opted for reduced cover, but in a significant number of cases customer services personnel failed to provide appropriate and comprehensible information about the policy change.

The FCA investigation also uncovered weaknesses in Stonebridge’s systems and controls relating to the oversight of the outsourcing companies. A combination of inadequate management information and ineffective governance at board level and the various executive committees meant that Stonebridge could not effectively monitor outsourced functions and therefore failed to manage and mitigate risks to customers. Internal audit and review processes, conducted before and after the customer services outsourcing company was created, identified serious deficiencies within Stonebridge’s outsourcing policies and procedures. The customer services function was operating without approval from the compliance department for the procedures, training and scripting used. Furthermore the training material, designed by Stonebridge, was found to encourage poor selling techniques, was not consistent with regulatory requirements and did not consider good and poor customer outcomes. In order to comply with its customers’ interests obligations under Principle 6, the FCA expects insurers that outsource customer service functions to review the training material used by its intermediaries, ensure it is suitable and take reasonable steps to ensure that training is being undertaken to a satisfactory standard.

Lessons

This is the second largest insurance fine issued by the FCA (after HomeServe) and is particularly significant because it is against an insurer rather than an intermediary firm. Stonebridge’s business model and sales strategy were heavily criticised for targeting vulnerable customers with low value products. Recent thematic reviews and enforcement action have highlighted products with high sales volumes and low claims ratios as an area of concern for the regulator and firms offering such products should ensure their sales process and customer services operations satisfy the regulatory requirements in terms of product information, cancellation and customer needs.

Stonebridge is carrying out an independent review of its past sales in the UK and EU and is contacting affected customers to determine whether they should be compensated as a result of its poor sales practices. The firm has already paid redress of £400,000 to UK customers and has ceased distribution of the accident insurance products in question. In addition, Stonebridge has taken a number of steps to address the failings identified.

Firms operating a similar business model should ensure their products and processes comply with FCA expectations on conduct risk, including an executive management team and governance structure with adequate oversight of sales and customer service functions, product design and policy documentation that is clear, fair and balanced, effective systems and controls to ensure customers are treated fairly and customer services outsourcing arrangements that are regularly monitored and reviewed.

For further information:
FCA Final Notice – Stonebridge International Insurance Ltd

On August 11, the Prudential Regulation Authority (PRA) issued a consultation paper (CP16/14) setting out proposed changes to the PRA Rulebook in order to implement the Solvency II Directive, as amended by the Omnibus II Directive. This is the third consultation paper on Solvency II transposition and follows CP11/22 and CP12/13 published by the FSA in November 2011 and July 2012 respectively.

Overview

With Omnibus II now in force, the PRA is consulting on rules to transpose the amendments to Solvency II and implementation of those areas deferred from the previous two consultations. Omnibus II introduced a number of substantive changes, most significantly the long-term guarantees (LTG) package which comprises a set of measures to ensure that the new solvency regime is adequate for insurance products offering an element of guaranteed return. Draft rules consulted on in CP11/22 and CP12/13 therefore require amendments to reflect the LTG package along with the other provisions introduced by Omnibus II such as transitional arrangements and supervisory reporting.

CP16/14 consists of four sections:

• Section 1 covers the proposed rule changes to implement changes introduced by Omnibus II including the matching adjustment, the volatility adjustment, risk management for LTG measures, transitional provisions, external credit rating assessments and requirements relating to groups.
• Section 2 considers areas not covered in the previous two consultations or where the PRA’s approach has developed. In particular it includes new proposals on surplus funds following feedback on CP12/13. Other issues include insurance special measures, third country insurance branches and reporting.
• Section 3 provides feedback on responses to two parts of CP12/13: the approach to Lloyd’s; and public disclosure of capital add-ons and undertaking specific parameters (USPs).
• Section 4 provides an economic cost benefit analysis of the LTG package.

Future consultations

Further changes to the PRA’s Rulebook are expected, along with supervisory statements in order to implement the new solvency regime. Areas include but are not limited to:

• The PRA’s expectations for approval processes (such as the volatility adjustment approval process, if implemented) planned for Q4 of 2014.
• Further national specific reporting templates which the PRA may consider necessary.
• Transitional measures to enable firms to adapt to the new regime in an appropriate and proportionate way.
• Further rules covering third country branches.

The PRA states that it will need to make amendments to the Approved Persons Regime to take into account the Solvency II measures relating to governance and the fitness and propriety of relevant individuals. The PRA notes its intention to align the approved persons regime more closely to the regime proposed for banks, but explains that the regimes will not be identical. Recognising that many groups contain both banks and insurers, the PRA states that operating two distinct regimes would be complex and inefficient for such firms and the regulator itself. A consultation on proposals to implement changes in the Approved Person Regime is expected later this year.

Finally, the PRA intends to consult on rules relating to with-profits business (possibly alongside a supervisory statement) later this year. The consultation is likely to have regard to the PRA’s objectives, Solvency II requirements and the interaction with the FCA’s conduct regime in respect of with-profits.

The deadline for responses on CP16/14 is November 7, 2014. The PRA is expected to publish a policy statement with feedback, finalised rules and supervisory statements in early 2015. The deadline for transposition of Solvency II is March 31, 2015.

For further information:
CP16/14 – Transposition of Solvency II: Part 3

HM Treasury has also issued a short consultation intended to complete the consultation process on how the government should implement the Solvency II Directive. The Treasury published a consultation in November 2011 but has been unable to proceed before now due to the delay in adopting the Omnibus II Directive.

The consultation seeks views on two policy issues related to Solvency II transposition:

The use by undertakings of the volatility adjustment and whether it should be subject to prior approval by the PRA

The volatility adjustment is one of the LTG package measures, introduced to cover those insurance products which would not be eligible for the matching adjustment. The detail on how the volatility adjustment is to be calculated and applied will be set out in the implementing measures. The volatility adjustment raises prudential issues, however, and it is the government’s view that the measure may be less appropriate for liquid or volatile liability types, such as products with significant surrender risk meaning a firm could be undercapitalised relative to the true risks it faces. To help avoid inappropriate use of the volatility adjustment, a safeguard was introduced which would allow the PRA to approve the use of the volatility adjustment on a firm by firm basis.

The government is seeking comments on whether the use of the volatility adjustment should be automatic, or whether approval from the PRA should be required before a firm could apply the volatility adjustment. Should the government decide that PRA approval is required, decisions on approval will be communicated within 6 months of application and the process would be transparent, proportionate and timely.

The approach to be adopted in removing business permissions where an undertaking fails to meet the Minimum Capital Requirement

The second issue the government is consulting on arises out of the obligation on the PRA to withdraw authorisation where an undertaking does not comply with the Minimum Capital Requirement. In the UK, the problem of insurance firms in financial difficulties has often been addressed by run-off over a course of time. The government considers that Article 144 of the Solvency II Directive would require a firm to be closed to new business but would permit the firm, where appropriate, to continue to manage existing insurance contracts, subject to on-going supervision by the PRA. Respondents are asked whether they agree with the government’s approach to the de-authorisation of insurance firms and, alternatively, what the consequences would be, particularly for policyholders, if firms were not permitted to enter into run-off.

The consultation closes on September 19, 2014. HM Treasury will issue a further consultation later this year to include feedback on this and the previous Solvency II consultation, an updated impact assessment and final statutory instrument to be submitted for Parliamentary approval.

For further information:
HM Treasury: Solvency II: resolving the remaining policy issues for UK transposition