Insurance update - Europe

Publication June 25, 2014


Introduction

The PRA has published several papers that are significant for insurance firms. The revised approach document explains how the regulator will supervise the industry going forward, the PRA Rulebook Policy Statement includes the new 'Fundamental Rules' applicable to PRA-authorised firms and the annual report announces plans to consult on whether certain policyholders should be granted additional protection in the event that claims may not be met. We also cover the draft Insurance Contracts Bill published by the Law Commissions last week, the CMA's package of remedies aimed at the motor insurance market and EIOPA's latest risk update.

PRA publishes revised approach to insurance supervision

The Prudential Regulation Authority (PRA) has revised its statement on the approach it will take to insurance supervision. The approach document summarises the aims and objectives of the PRA in relation to insurers and is updated to reflect new developments or priorities.

The revised approach document highlights the addition of the new secondary objective, to promote effective competition in the markets for services provided by firms supervised by the PRA. The competition objective must, as far as possible, facilitate competition in the insurance market. This objective however, only applies where the PRA is advancing its primary objectives (ensuring the safety and soundness of firms it supervises and protecting policyholders). In relation to the insurance objective the approach document states that the PRA’s focus is to ensure that policyholders have an appropriate degree of continuity of cover for the risks insured against.

The PRA has replaced the Principles for Businesses with eight ‘Fundamental Rules’ which have been designed to align high-level behaviours with the PRA’s objectives. The Rules are discussed in more detail in the article below.

The revised approach includes new text on the use of powers to address serious failings in the culture of firms. The PRA expects firms to have a culture that supports their prudent management. Under its statutory powers the PRA may require a firm to do or cease to do a particular thing. One of the grounds for exercising this power is to advance one of the PRA objectives enabling the regulator to take action should concerns about the culture of a firm pose a risk to one of their objectives. The power has the flexibility to mean that serious cultural concerns in a firm may be addressed. For example, the power might be used to require that an individual is nominated within a firm to have responsibility for recommendations specified by the PRA or requiring the retention of an independent individual to ensure compliance with PRA recommendations. The PRA may also use its own-initiative powers to vary permissions in certain situations or it can agree with a firm to voluntarily alter its permission.

In addition to the above, the new version of the approach document includes additional text to reflect the way in which insurers will be categorised and clarify the approach to financial resources, updated text on the PRA approach to international regulation, and an up-to-date organisational structure.

For further information:

Revised PRA approach to insurance supervision (June 2014)

PRA introduces final set of Fundamental Rules

In CP 2/14, published earlier this year, the PRA consulted upon the creation of a Rulebook to replace the parts of the former Financial Services Authority Handbook which relate to prudential matters. The new Rulebook will contain all the prudential requirements for firms – including INSPRU and GENPRU as well as replacement ‘Fundamental Rules’ (FRs) to replace the familiar Principles for Businesses (the Principles). The PRA has now published PS 5/14 which includes the final set of FRs, with some amendments following consultation. According to the PRA, the FRs are drafted to be a clearer expression of the PRA’s expectations and more closely reflect the underlying detailed rules than the Principles.

The FRs apply to all PRA-authorised firms, however, the Principles will still apply under the Financial Conduct Authority’s (FCA) supervision. Although some of the wording is the same, insurers and other dual-regulated firms will be subject to separate requirements for each regulator. Whereas the PRA applied only four of the Principles, firms must now have regard to eight FRs (as well as 11 FCA Principles):

  1. A firm must conduct its business with integrity.
  2. A firm must conduct its business with due skill, care and diligence.
  3. A firm must act in a prudent manner.
  4. A firm must at all times maintain adequate financial resources.
  5. A firm must have effective risk strategies and risk management systems.
  6. A firm must organise and control its affairs responsibly and effectively.
  7. A firm must deal with its regulators in an open and cooperative way and must disclose to the PRA appropriately anything relating to the firm of which the PRA would reasonably expect notice.
  8. A firm must prepare for resolution so, if the need arises, it can be resolved in an orderly manner with a minimum disruption of critical services.

Some respondents to the consultation criticised differences between the wording of the FRs and the Principles. The PRA has noted this and amended FRs 1 and 2 so they are consistent with the FCA Principles 1 and 2. FRs 5 and 7 have been revised following consultation: the inclusion of ‘sound’ in FR5 has been removed as the PRA considers this to be an unnecessary addition; and FR7 now omits the word ‘timely’ as this is deemed to be an implicit requirement of firms’ dealings with regulators.

The draft FR9 (a firm must not knowingly or recklessly give the PRA information that is false or misleading in a material particular) has been deleted altogether as the PRA believes this requirement is adequately covered by FSMA and other FRs.

FRs 3, 4, 6 and 8 remain unchanged following the consultation. FR3 is a new requirement reflecting the Threshold Conditions and PRA approach documents, which should be read in conjunction with this rule. As firms are already expected to act in a prudent manner, the PRA does not intend to issue additional guidance or qualification of the meaning of ‘prudent’. Respondents had questioned what FR3 added to the requirements already covered by FRs 2 and 4 and noted that the vague nature of the term is open to interpretation. There is no explicit requirement in the Principles for firms to exercise prudence implying, probably unintentionally, that firms are not required to act in a prudent manner under the FCA regime, however, neither regulator is likely to accept such an interpretation.

FR4 retains the inclusion of ‘at all times’ to bring it in line with the requirements on firms in the Capital Requirements Directive (CRD IV) and proposed Solvency II requirements. It does not impose any additional requirements on firms and merely ensures the FR wording is aligned with the underlying detailed rules. Similarly, FR6 aligns with existing detailed rules and is unchanged following consultation. Feedback noted that ‘must’ imposes a significantly higher standard than the Principle 3 wording of ‘must take reasonable care’, however, the PRA states that there is no change of expectation under FR6.

For insurers, the most significant change is the introduction of a new resolution requirement under FR8. Although this is unchanged following consultation, the PRA responds to insurers’ requests for further clarity on the application of this rule. Unlike the rules for deposit-takers, the resolution regime for insurers is less advanced and the PRA’s expectations of insurers with regard to resolution is set out in the approach document. The PRA has made no detailed rules concerning the provision of resolution information as yet and insurers’ discussions with the regulator on resolution plans will vary according to systemic importance and proximity to failure, among other factors. The PRA appreciates that, in the absence of detailed rules, compliance with FR8 will need to be judged in the context of an insurer’s own perception of its resolvability. The PRA will consult as and when requirements for insurer resolution are developed in the future.
In addition to the FRs, the PRA provides feedback on proposals to replace rules and guidance on:

  • Information gathering found in Chapter 2 of the Supervision Manual (SUP).
  • Auditors, found in SUP Chapter 3.
  • Reports by Skilled Persons in Chapter 5 of SUP.
  • Notifications in Chapter 15 of SUP.

PS 5/14 includes the following PRA Rulebook instruments, which were passed by the PRA Board on June 13 and came into force on June 19, 2014:

  • Fundamental Rules Instrument 2014
  • Information Gathering Instrument 2014
  • Auditors Instrument 2014
  • Lloyd’s (Auditors and Actuaries) Instrument 2014
  • Permissions and Waivers Instrument 2014
  • Use of skilled persons Instrument 2014
  • Notifications Instrument 2014
  • Handbook (Rulebook Consequentials) Instrument (No 1) 2014

The PRA is rewriting the PRA Handbook over the coming years to create a PRA Rulebook containing rules and directions made by the PRA which apply only to PRA-authorised firms. For now, firms should consult both the Handbook and Rulebook, links to which are available on the PRA webpage.

For further information:

PS5/14 The PRA Rulebook

More equal than others: PRA annual report proposes greater protection for certain policyholders

The PRA published its annual report for 2014 on June 17 including a review of 2013/14 and business plan for 2014/15. For the insurance industry, the following highlights should be noted. Clearly, governance and risk management are considered to be at the top of the agenda for the PRA who continue to focus on senior persons responsibility in prudential supervision.

Governance, controls and risk management account for nearly half of s.166 reviews

There were 33 section 166 reports by skilled persons in 2013/14 (up from 27 in 2012/13), four of which were commissioned using the new PRA power to contract directly with a skilled person. Prudential insurance issues were the subject of 8 skilled persons reviews, while governance, controls and risk management framework was the focus of 16 reviews. Both the total cost to firms concerned (£11.4m) and the cost per report (ranging between £14,602 and £1.3m) dropped from the previous year.

Greater protection for certain policyholders

The PRA is considering adapting its supervisory approach to give particular focus to certain types of insurance or policyholders that might require a higher degree of protection. It will take into account the impact of the cover being withdrawn and the ability of and cost to the policyholder of obtaining insurance from another provider. Such a framework would suggest greater focus on compulsory insurance, any disruption to which would have an impact on the real economy, and long-term life insurance products which are difficult to transfer.

The PRA acknowledges that tension between the general objective (safety and soundness) and the insurance objective (policyholder protection) may arise when a firm is stressed. With-profits business is one example of when this type of situation could occur; management action to protect solvency might cause with-profits policies to underperform relative to policyholder expectations. In such circumstances, the PRA will exercise its supervisory judgement and consider the trade-offs between the objectives to determine whether policyholders are best protected by: continuation of the firm if possible; closure to new business and solvent run-off; or the firm’s orderly failure.

The extent to which the insurance objective applies to UK policyholders of incoming EEA branches and non-UK policyholders of UK groups will need to be clarified by the PRA.

Key dates

The annual report also sets out upcoming policy consultations and key deliverables over the next year:

  • Transposition of Solvency II is a priority with consultation in Q2 (June-August) and feedback and final rules expected between December and February.
  • Consultations on remuneration and the senior manager regime are expected in Q2.
  • The PRA will consult on insurance policyholder protection in Q3 (September – November).
  • A key deliverable in Q4 is to support and influence work carried out by the International Association of Insurance Supervisors on the development of the basic capital requirement for global systemically important insurers.

The PRA invites responses on the annual report, the way in which the PRA has discharged its functions (or failed to do so) and the extent to which the PRA has advanced its statutory objectives by September 17, 2014.

For further information:

PRA annual report and accounts 2014

Insurance Contracts Bill – final draft published

On June 18, the Law Commissions of England and Wales and Scotland published the complete draft of the Insurance Contracts Bill, together with explanatory notes. The draft Bill contains the proposals to revise the law in relation to aspects of non-consumer and consumer insurance contracts and follows over eight years of consultation.

The draft Bill, if enacted, would replace sections 18-20 of the Marine Insurance Act 1906 with the requirement for an insured to make a “fair presentation of the risk”. This duty would replace the existing duty of disclosure and misrepresentation but will retain certain familiar obligations such as the requirement to disclose material information that the insured knows or ought to know. The draft Bill will enable the insured to make a fair presentation where sufficient information has been disclosed to put a prudent insurer on notice that it must make further enquiries.

The draft Bill also changes the existing law in relation to warranties. In particular, the Bill would abolish “basis of the contract” clauses in non-consumer insurance (the Consumer Insurance (Disclosure and Representations) Act 2012 has already abolished the use of these terms in consumer contracts). Presently, where a warranty is broken by the insured, the insurer will automatically cease to have any further liability under the contract. The effect of the law can have severe consequences where a warranty is broken which is later remedied or has no connection to the cause of loss. The draft Bill does not change the definition of warranty but changes the law with the effect that a breach of warranty will suspend liability rather than end it. As a result, a breach of warranty may be remedied where the remedy will have the effect that the risk continues to be as originally intended under the contact.

The Law Commissions have proposed that where a warranty is designed to reduce a risk of a particular type or at a specific time, liability will only be excluded where a breach relates to losses of that type during the particular time. Where a loss occurs that does not relate to the risk identified by the warranty or during a different time the Commissions propose that the insurer should be liable for that loss.

Also included in the draft Bill are insurers’ remedies where the insured has made a fraudulent claim. Where fraud is committed by the insured, the insurer will not be liable to pay the claim to which the fraud relates. Any money already paid out for that claim may be recovered. The insurer will remain liable for claims made in relation to events that take place prior to the fraudulent act. Once the insurer has elected to treat the contract as terminated it can refuse to pay claims relating to “relevant events” (i.e. notice of claim or potential claim) that take place after the fraud.

The Law Commissions are consulting upon the wording of an implied term to the effect that an insurer has an obligation to pay valid claims within a reasonable time.

The draft Bill prevents insurers from contracting out of any provisions to the detriment of a consumer. In non-consumer contracts the Bill provides that, generally speaking, parties can agree to contract out of terms in the Bill. However, in order to do so the insurer must comply with transparency requirements. Importantly, it will not be possible for an insurer to contract out of the prohibition of the use of basis of the contract clauses or any deliberate or reckless breaches of the requirement to pay claims within a reasonable time.

Consultation on the draft Bill closes on July 2, 2014.

For further information:

Insurance Contracts Law Draft Bill

CMA proposes package of remedies to address anti-competitive elements of motor insurance market

In December 2013, the Competition Commission (CC), published the provisional findings of its investigation into the UK private motor insurance (PMI) industry. The Competition and Markets Authority (CMA) inherited this project from the CC in April 2014 and has now published its provisional decision on the package of measures required to remedy the adverse effects on competition and the resulting customer detriment. Broadly, the remedies can be summarised as:

  • A dual rate price cap for subrogated claims relating to the provision of temporary replacement vehicles.
  • Application of the rate cap to all replacement vehicle providers at the point of subrogation of the claim to the at-fault insurer.
  • Prohibition of financial inducements from replacement vehicle providers.
  • Insurers to inform claimants promptly if they are non-fault.
  • Hire duration to end 24 hours after completion of the repair or seven days after the submission of the total loss payment.
  • Mitigation declaration statements to be completed by first notification of loss providers.
  • Requirements regarding the provision of information by insurers to consumers about the costs and benefits of no-claims bonus (NCB) protection covering: the implied price of NCB protection; step-back procedures; average NCB discount; and specific statements about how NCB protection works.
  • A prohibition on price comparison websites (PCWs) and PMI providers entering into agreements that include ‘most-favoured nation’ clauses (MFNs), with the exception of ‘narrow’ MFNs (defined as covering the insurance provider website but excluding possible aggregator platforms).

Theories of harm

Initially, the CC report identified the following theories of harm:

  • Separation of cost liability and cost control.
  • Possible underprovision of post-accident repair services.
  • The sale of add-on products.
  • PCWs and MFN clauses.

The provisional remedies proposed by the CMA are based on the CC’s provisional findings, evidence received from interested parties and further working papers. Having considered the responses and supporting evidence submitted, the CMA now takes the view that there is not an adverse effect on competition relating to the possible underprovision of post-accident repair services and, therefore, does not propose any remedies in this area. The package of remedies focuses on the remaining three theories of harm.

Separation of cost liability and cost control

The provisional findings identified a possible adverse effect on competition caused by certain features of the PMI industry. The insurer of the at-fault driver often has little control over the costs incurred which, combined with various practices such as claims handling and car hire intermediaries charging at-fault insurers more than the costs incurred, means that the cost of claims rises and is reflected in higher premiums amounting to an estimated detriment of £113 million per year.

The CMA proposes to take forward two remedies to address customer detriment in this area:

  • Information on consumers’ rights following an accident. This remedy is aimed at giving claimants a better understanding of their entitlements both under their policy and arising through tort law. The CMA proposes that targeted, short-form information should be provided orally at first notification of loss to any claimant that is not found to be immediately at fault following an accident. The information provided with policy documentation should give an overview of the consumer’s key entitlements in tort as well as contractual rights under the policy and would take the form of a statement of consumer rights and responses to frequently asked questions. The CMA proposes that consumer information should be standardised across the industry to ensure that a consistent message is delivered to consumers and all consumers are adequately and accurately informed of their legal entitlements. The paper sets out the proposed text for the documentation and proposals for the submission of annual compliance statements.
  • Measures to address features relating to replacement vehicles. This remedy would include: guidance on the duration of hire periods for replacement vehicles; and a cap on daily hire rates for each category of replacement vehicle. A remedy which would require replacement vehicle providers to ask non-fault claimants standard questions about their need for a replacement car is also proposed. Replacement vehicle providers would be required to complete a ‘mitigation declaration’ showing the at-fault insurer that the appropriate vehicle had been provided.

The sale of add-on products

The provisional findings identified two features in relation to add-ons that have an adverse effect on competition: information asymmetries between motor insurers and consumers in relation to the sale of add-ons; and the point-of-sale advantage held by motor insurers when selling add-ons. The CMA notes that the net earned premium of those add-ons which caused concern was about £390 million a year. Particular asymmetries exist between NCB protection as consumers do not understand the level of discount earned through their NCB and how this level of discount will be affected in the event of a claim if they do not take out NCB protection.

Remedies proposed by the CMA to take forward are:

  • Transparent information concerning NCB. The CMA proposes that all insurers be required to: make available to consumers details of their NCB scales; and include in the description of NCB protection a clear statement that a policyholder’s premium may increase following an accident in which that policyholder was not at fault even when that policyholder had taken out NCB protection.
  • Provision of all add-on pricing from PMI providers to PCWs. A possible remedy is to require each PMI provider that offers add-on products to provide pricing information on all add-ons it offers to the PCWs which list its policies.
  • Clearer description of add-ons. This remedy requires all insurers to revise their descriptions of add-ons to meet ‘plain English standards’ and to strike an appropriate balance between providing the relevant information to the consumer and ensuring that the information is understandable and not unnecessarily complex.

Given the work that the Financial Conduct Authority (FCA) is already undertaking in the general insurance add-on market, the CMA recommends that the FCA work with insurers, brokers and PCWs to consider how firms might improve their descriptions of PMI-related add-ons. Specifically, the FCA might consider whether insurers and brokers should be required to provide their prices for the add-ons offered to PCWs and how consumers’ information needs in this area can be met.

Price comparison websites and MFN clauses

An adverse effect on competition was found between PCWs due to the existence of ‘wide’ MFNs in conjunction with sufficiently high single-homing rates. Wide MFN clauses specify that the premium quoted through the PCW will always be competitive with prices available through other sales channels. Narrow MFNs meanwhile state, in effect, that the price on the insurer’s own website will never be cheaper than the price quoted on the PCW.

The CMA found that wide MFNs restrict price competition between PCWs and entry to the PCW market, reduce innovation and increase premiums for the consumer. Conversely, narrow MFNs have only limited anti-competitive effects and do not substantially reduce competition between PCWs.

The proposed remedy is a prohibition on wide MFNs and ‘equivalent behaviours’ to strengthen rivalry over premiums offered on different PCWs. The CMA proposes achieving this by prohibiting all MFNs and listing the exceptions i.e. those narrow MFN clauses that have consumer benefits.

Next steps

PMI providers, brokers and PCWs should review the remedies, particularly the measures around additional documentation requirements, and consider how these proposals could impact their business. The deadline for responses to the provisional decision on remedies is July 4. The CMA is required to publish its final report by September 27, 2014.

For further information:

CMA Private Motor Insurance market investigation

EIOPA publishes quarterly risk update

The European Insurance and Occupational Pensions Authority (EIOPA) has published its risk ‘dashboard’ for the first quarter of 2014. In summary, the report highlights that:

  • Market risks remain a concern as deflationary tendencies continue across Europe with the result that policy interest rates remain low.
  • Both unemployment and government debt remain high across the EU. Emerging geo-political risks and developments in global financial markets may have the potential to have a negative impact on European economic conditions.
  • Insufficient implementation of structural reform in the Euro area may impact export growth.
  • Liquidity and funding risks remain in the market as lapse rates have increased in some Member States. More illiquid assets are making their way into investment portfolios (i.e. commercial mortgages, private placement bonds, asset-backed securities).
  • Credit risks have not reduced since the last quarter. Public and private indebtedness remains high.
  • The industry still faces challenges in terms of profitability as interest rates remain low.
  • Contagion risks from banks and sovereign states remain an issue in the European market although rating outlooks for the Member States with large insurance groups are either stable or positive.
  • Insurance risk is not a major concern at present. Competition between reinsurers increases and is expected to have an effect on profitability and solvency.

For further information:

EIOPA Risk Dashboard June 2014 – Q1 2014 data

Scottish independence

On September 18, 2014 Scotland will hold a referendum on whether Scotland should be independent. Although a ‘yes’ vote would not legally require the UK government to recognise Scottish independence, it would clearly be a very difficult position politically, if the UK government were not to then work with the Scottish government towards a negotiated independence.

How might independence influence insurance business in Scotland?

Currently, the UK has a successful domestic market for financial services including banking, insurance, asset management and other financial services. Scotland shares a significant proportion of this UK domestic market and has an international reputation for its skills in banking and finance. Indeed, some of the UK’s most well-known financial services brands began their life in Scotland and over £300 billion of funds are managed in Scotland. In 2010 financial services and insurance contributed £8.8 billion towards Scotland’s economy, accounting for more than 8 per cent of Scotland’s onshore activity. Furthermore, 24 per cent of employment in the UK life and pensions sector is based in Scotland.

Should Scotland vote ‘yes’ on September 18, what might we expect to happen to the insurance sector in the UK? Read our Insurance Q&A on Scottish independence


Recent publications

Subscribe and stay up to date with the latest legal news, information and events...