In its final pricing practices guidance, the FCA requires a firm to consider whether any redress should be made when it identifies a breach of the pricing rules. This could have far-reaching ramifications for the sector. Lucy Freeman looks at what impact this could have on non-investment insurance distributors.
In May 2021, the FCA published policy statement PS21/5 outlining new rules on general pricing practices. The FCA believes some consumers have been harmed by paying very high prices over a long period and by practices that have discouraged them from shopping around. These rules are designed to reduce harm for consumers and secure an appropriate degree of protection for them. They apply to both insurers and insurance intermediaries, with a primary focus on home and motor business. The implementation date was extended from October 2021, and the rules came into force on 1 January 2022 for the insurance industry.
What are the new rules?
In brief, firms are required to regularly review the insurance products they offer to assess whether they remain consistent with the needs of the target market, whether they provide fair value, and whether the distribution strategy remains appropriate.
The FCA requires that when reviewing whether an insurance product provides fair value, firms must consider any impact the distribution arrangements have on the value, including ancillary products such as retail premium finance.
The risk of redress claims
Should firms breach the requirement to provide fair value, PROD 4.2.37C provides that they “should consider what may be necessary to provide appropriate mitigation and/or remediation of the harm including whether redress should be made. The firm should contact any affected customers where this is necessary to inform them of the issues and of the actions being taken”.
The concept of redress is also extended to the ‘distributors’ of insurance products in PROD 4.3.11B (7). In addition to potentially providing financial redress, the FCA outlines the need for firms to repair harm where fair value was not provided.
That redress has been explicitly mentioned by the FCA is significant. This has not been picked up on by much of the market commentary surrounding these rules, and yet I believe it could have a considerable impact on the sector – as has been seen in the high-cost short term lending sector, for example.
How will redress claims arise?
Examples of practices that I believe might be questioned in respect of their fair value include short term payment policies. In these products, it's common for a consumer to receive only 50% of their premium back if the policy is cancelled after one month, or 30% it is cancelled after two months etc. It may be difficult to prove to the FCA that a firm has earned 50% of the premium in the first month, even though they were due to carry the risk for a longer period.
Products that have significant ‘change fees’ also need to be carefully assessed in light of the fair value test. Firms will need to link the cost of any change fee charged to the consumer to the actual cost of making the change. They should be able to demonstrate they are not trying to make a profit out of change fees.
How can firms minimise redress risk?
To minimise any redress risk, firms should ensure that they have a business explanation for what they are charging for certain products. In addition, firms should ensure transparency at the outset of their quotes to customers to enable customers to make an informed decision.
As any claim for redress is likely to begin with a customer complaint, firms should ensure that complaints teams are appropriately prepared and supported to offer crystal clear explanations of why they believe the firm has, or has not, been fair – with supporting evidence where available.
The FCA may also consider requiring firms to undertake redress through its supervisory and enforcement activities. To defend against this, firms must ensure that they have a robust audit trail in place to evidence their compliance with the relevant rules. It will be particularly important to demonstrate that renewal pricing has not exceeded equivalent new business pricing.
What will FCA enforcement look like?
Questions remain as to how these rules will be enforced. How will fair value be measured? At what point should redress be considered? If ‘harm’ has been repaired where fair value was not provided, is redress still necessary?
Given that firms had little time to implement the rules outlined in PS21/5 (the final rules were published in May 2021 and were enforceable from 1 January 2022), we expect that there will be some high-profile enforcement cases in this area that may shed light on the above questions.
The impact of redress claims
Should redress payments to consumers be necessary, the impact on a firm can be considerable. There's a risk that claims management companies (CMCs) could become involved, which can create significant issues due to the volume of complaints that they can issue to firms over a very short period. For example, the mis-selling of PPI is estimated to have cost the industry over £53 billion, and high levels of redress claims generated by CMCs has contributed to the demise of several firms in the high-cost short term credit sector.
Insurers and insurance intermediaries should be aware of the impact that many claims can have on resources and liquidity. The consequences of such claims are much wider than any redress payments that need to be made. The costs involved in the claims management process, including system and platform developments and training/personnel required to look back at records to adjudicate claims are significant.
A firm will need to ensure that its complaints teams are ready to respond adequately to any future complaints that the firm may receive with respect to fair value. This is particularly so given that dissatisfied customers can escalate their complaints to the Financial Ombudsman Service (FOS) within six months of their decision, resulting in a case fee of £750 per complaint payable by the firm in addition to any monetary redress that may be awarded.
Finding the right balance
When reviewing and monitoring their pricing models, firms need to be aware that the possibility of redress has entered the insurance market. There's a tight line to walk here, especially in lower margin business lines. Management must ensure fair value is achieved while still writing profitable business or risk the need to ‘repair harm’ and potentially face damaging redress claims.
Alex Ellerton, Head of our Regulatory Practice, says "the redress requirements included within these rules only increase the risk for firms dealing with what is already a complex and far-reaching regulatory change programme. This highlights the need for firms to be both backwards and forwards looking when undertaking product pricing reviews.