Insurance updater - Europe

Publication April 3, 2014


This week the FCA announced plans to broaden its reviews to as yet ‘unvisited sectors’, meaning firms can expect regulatory scrutiny of wholesale activities, commercial claims and distribution chains over the course of 2014/15. A compromise position appears to have been reached allowing mutuals to continue to write non-profits business. In another step towards Solvency II implementation, EIOPA is now consulting on the first set of implementing technical standards.

Thematic work into commercial claims, wholesale distribution, incentives and life business outlined in FCA business plan

Poor culture and controls, complex terms and conditions and large back-books among key risk areas

The Financial Conduct Authority (FCA) published its Business Plan for 2014/15 on March 31. The plan confirmed that the regulator would be undertaking a review of practices relating to legacy/historic business. News of this review caused significant market disruption when it was leaked in a newspaper article on March 28 and the FCA continues to deal with the fallout of its handling of this announcement.

According to the business plan, the FCA will assess whether long-term insurers are operating historic products in a fair way and whether they have ‘adopted strategies’ that exploit existing customers. The FCA is concerned about firms taking advantage of customer inertia by making it difficult to switch or by being vague about the pricing of existing products or the availability of other products. The root of the problem seems to be the fact that some customers pay more due to an inability to switch to other contracts (e.g. because of exit charges). It appears that the FCA is concerned that some firms may be using “the value they get from existing customers to support low rates and introductory offers for new customers”. The FCA has said it will review 30 firms and work is expected to start in the summer, however, the precise scope and purpose of the investigation remains uncertain.

In addition to the review of legacy products, the FCA confirms that it will continue to carry out market studies and thematic review to investigate issues it is concerned about. For the general and life insurance sector, the following areas will be subject to investigation:

  • Wholesale activities, specifically the connection between retail and wholesale participants in general insurance markets. In particular, the FCA will consider the impact on personal lines and small commercial customers who buy products provided by wholesale firms.
  • Commercial claims. Further to its retail claims work, the FCA will consider whether commercial customers’ expectations are met in the claims process and where poor behaviour could have a wider impact on trust in the market.
  • Cover holders. The FCA will look at distribution chains in wholesale markets, through to the impact on retail and small commercial customers. Key risks in complex distribution chains, such as product design, sales and post-sales handling will be reviewed. The regulator will also aim to improve how intermediaries manage conflicts of interest.
  • Premium finance. In line with its new consumer credit remit, the FCA will review firms’ sales practices and disclosures in premium finance sales.
  • Client money. New rules (CASS 5A) covering how intermediaries should deal with client money will be published. The FCA will also conduct thematic work in this sector, in particular the extent to which firms are currently holding client money without the appropriate permission and protections.
  • Retail investment advice. The FCA will look at whether investment advisers are carrying out appropriate due diligence to ensure suitability of products and services.
  • Managing the performance of staff. This will be a cross-sector study into how firms manage the performance of sales staff (e.g. financial incentives and sales targets) and mis-selling risks.

Ongoing thematic work and follow-up to FCA investigations into with-profits governance, packaged bank accounts, mobile phone insurance, motor legal expenses insurance and annuities is scheduled for 2014/15.

As well as announcing sector specific thematic work, the business plan identifies seven key forward-looking areas where potential risks to the FCA’s objectives may arise. Some of these areas will be addressed (such as product back-books), whereas others will be monitored over time and action taken where necessary. Detailed analysis of these risk areas is provided in the FCA’s Risk Outlook 2014. In summary, the forward-looking areas of focus are:

  • Technological developments may outstrip firms’ investment, consumer capabilities and regulatory response.
  • Poor culture and controls continue to threaten market integrity.
  • Large back-books may lead firms to act against their existing customers’ best interests.
  • Retirement income products and distribution may deliver poor consumer outcomes.
  • The growth of consumer credit may lead to unaffordable debt.
  • Terms and conditions may be excessively complex.
  • House price growth that is substantial and rapid may give rise to conduct issues.

Whilst there is currently no action planned, it is worth noting that the FCA will be monitoring product terms and conditions. There is, according to the FCA, a risk that market conditions may increase the disparity between what firms can viably offer consumers and what consumers need from financial products. Specifically, the regulator will monitor the risk that consumers may misunderstand the degree of protection they have, obstacles to exit a product or service that were unclear at the point of sale, complex terms and conditions that make it difficult for consumers to compare products, costs, risks or exclusions, and any tension between “explaining complex terms and conditions clearly in plain language and the extra length this gives documents”, for example, in insurance contracts.

The timetable for current and planned thematic work and market studies is as follows:

Q1 2014: general insurance add-ons; retirement income study; review of post-RDR adviser charging and service disclosure; PPI redress; financial incentives; complaints handling; and resilience against cyber attacks.

Q2 2014: Fair treatment of long-standing customers in life insurance; RDR post-implementation review; cover holders; managing the performance of staff; and visibility of resilience and risks at board level.

Q3 2014: Premium finance; motor legal expenses insurance; commercial claims; protection of client money by small firms; packaged bank accounts; and effective due diligence for retail investment advice.

Q4 2014: Governance of with-profit funds and mobile phone insurance.

For further information:

FCA Business Plan 2014/15

FCA Risk Outlook 2014

Mutuals and the way forward

Both the FCA and the Prudential Regulation Authority (PRA) last week published statements in response to the FSA Consultation Paper 12/38: Mutuality and with-profits: a way forward which suggested a way for with-profits mutuals to create a ‘members’ fund’ in which to write or continue to write non-profits business. This issue, and in particular how a small to medium sized mutual could create such a fund without a formal scheme of arrangement, has been under discussion for a number of years now. It would appear to have come to something of a landing point.


The problem for mutuals who are no longer writing significant amounts of with-profits business is that the FCA’s Conduct of Business rules (COBS) effectively require them to go into run-off and to plan for the distribution of their assets over the life of the existing with-profits policies. This is clearly not desirable as many mutuals provide (or at least could potentially provide) other types of insurance policies. Many mutual firms have therefore challenged the FCA rules on the grounds that the FSA/FCA interpretation of the COBS requirements does not reflect the reality of how mutuals operate. Many mutuals have sought to show that just because all of their surplus sits in one fund which supports the with-profits business it does not mean either that other policyholders (or members) have not benefited from distributions from the fund or that all of the fund’s assets should go to the with-profits policyholders on the occurrence of a distribution/winding-up. These arguments have tended to be based on the constitution and operational model of the individual mutual and their practices to date.


Given the differences in the interpretation of the COBS requirements between the FSA and many of the mutuals, in December 2012 the FSA consulted on what is in effect a compromise position. This compromise was designed to offer small and medium sized mutuals a way of creating a members’ fund in which they could continue to write non-profits business. The FSA’s proposal was to allow mutuals to apply for a waiver from the relevant COBS rules. This waiver application would need to explain why the proposals being put forward by the mutual were fair to with-profits policyholders and should be supported by an opinion from an independent expert. The responses to CP12/38 raised two fundamental issues:

  1. whether a waiver was an appropriate way to achieve a permanent variation of policyholder rights; and
  2. how the mutual members’ fund, being a purely notional fund for the purposes of a regulatory rule waiver, would be categorised under Solvency II provisions on ring-fenced funds.

The FCA’s Policy Statement PS14/5 seeks to answer the first question raised by CP12/38 while the PRA’s Supervisory Statement SS1/14 seeks to answer the second question.


The FCA has confirmed that a rule waiver will technically be revocable but has stated that by necessity its long-term nature would be considered as part of the application process.

The FCA has also provided feedback on the original consultation, a summary of its view of the legal position on the rights and interests of policyholders and the text for additional guidance to be added as COBS 20.2 60-61. This guidance sets out the applicable process (in addition to the normal requirements of an application for a rule waiver in section 138A of FSMA). This can be summarised in high level terms as requirements to demonstrate the viability of the proposed non-profits business, the engagement of policyholders and that the waiver would be ‘fair’ to, in particular, the with-profits policyholders. In addition, the firm’s proposals would need to demonstrate that the exercise would not amount to a reattribution, complies with the firm’s constitution and is supported by a report from an ‘approved’ independent expert. The mutual will be required to provide a comparison with a proprietary company to demonstrate that the mutual policyholders will not be at a disadvantage when compared to policyholders of a proprietary with-profits company. In addition the mutual will need to provide an explanation of the support obligations the mutual members’ fund will undertake in relation to the with-profits business and supply details of how policyholder compensation or redress can be paid. Finally, the proposals must demonstrate “how and the extent to which continuing membership rights will benefit with-profits policyholders and other policyholders”.

The FCA makes the point that it expects the independent expert’s views of the existing rights of with-profits policyholders to be supported by independent legal advice and any uncertainty in relation to the legal position should be taken into account by the independent expert. The FCA points out that each application will be dealt with on a case by case basis.  


The main point of interest from the PRA paper, other than to confirm the need for both regulators to be involved in the application process, concerns the applicability of Solvency II ring-fenced fund requirements. These broadly require a notional capital requirement to be applied to ring-fenced funds and require that capital in such funds should not to be available to support any other business undertaken by the insurer. The definition of ring-fenced funds is likely to catch with-profits funds with the result that it is not clear how the mutual member’s fund will be treated under Solvency II. The PRA makes the point that Solvency II is a maximum harmonising directive so it will be unable to provide an exemption from its requirements. The PRA appears to consider that the with-profits fund and the mutual members’ fund could each be ring-fenced (i.e. because the mutual members’ funds would presumably be restricted by obligations in relation to the with-profits fund). The other alternative is that for Solvency II purposes, the two funds could be categorised as part of the same ring-fenced fund (due to the notional nature of the split resulting from the waiver).

Our comments

Both the PRA and the FCA statements appear to provide a framework for such notional splitting of a mutual’s common fund. The approach appears to encourage mutuals to make use of this facility to create a way forward and it is to be hoped that it can work in practice. However, it is fair to say that the uncertainties raised when the FSA’s paper was issued do not appear to have been fully resolved. There are still doubts as to the legal status of a process that potentially compromises policyholder rights under the existing COBS rules and the status of the waiver for Solvency II purposes. For many larger mutuals, given that they will need to incur the expense of an independent expert and potentially lawyers to advise that independent expert anyway, they may gain more from a formal scheme of arrangement to separate their common fund.

For further information:

PS14/5: Mutuality and with-profits funds: a way forward

Mutuality and with-profits funds: a way forward - SS1/14

EIOPA consults on first set of Solvency II implementing technical standards

Six ITS consultations launched as Solvency II preparations gather pace

On April 2, 2014, the European Insurance and Occupational Pensions Authority (EIOPA) issued the first set of Solvency II Implementing Technical Standards (ITS) for consultation. ITS are regulatory tools to assist firms and supervisors’ preparations for the Solvency II approval processes, due to start on April 1, 2015. The Omnibus II Directive grants power to EIOPA to draft these standards.

The consultation papers cover proposed ITS on:

  • Internal models approval processes.
  • Procedures to be used for granting supervisory approval for the use of ancillary own-fund items.
  • The process to reach a joint decision for group internal models.
  • Procedures to be followed for the approval of the application of a matching adjustment.
  • Special purpose vehicles.
  • The supervisory approval procedure to use undertaking-specific parameters.

Responses to all six consultations should be submitted by June 30 using the template provided. EIOPA is expected to submit the final draft ITS for endorsement by the European Commission by October 31, 2014. The second set of ITS is likely to be consulted on late this year or early in 2015. Meanwhile, the Commission’s Delegated Acts containing detailed implementing measures are expected to be made public in the summer.

Firms should review their preparations for Solvency II in light of the ITS consultations. The timetable leading up to implementation on January 1, 2016 is challenging and firms should have a clear understanding of the key dates on the horizon and ensure their preparations for the new regime are well advanced.

For further information:

EIOPA consultation papers

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