Insurance Age has reported that in 2021 there were 145 M&A deals for insurance distributors in the UK, with a value totalling £6 billion. In light of this, I wanted to highlight some recent market changes, including new regulatory requirements to see if these present an opportunity or threat to these deal volumes and valuations and, consequently, to lenders' and investors' exit plans.
While this question is simple for such a large and complex industry, I believe it is still helpful to discuss, notwithstanding that the long-term outlook for insurers and intermediaries remains positive.
Recent market conditions have been favourable for intermediaries. Revenues are up thanks to a hardening market, a post-COVID-19 recovery in trading, and the fact that capacity has not been rationed. However, these tailwinds are starting to meet with both high inflation and the war for talent; both of which are adding costs. In addition, insurers and their distributors are increasingly focusing on ESG, to the extent that some may be required to refine their underwriting requirements and, in some instances, turn away business.
The home and motor insurance pricing practices guidance (PS21/5) which came into force on 1 January 2022, requires insurers and intermediaries to ensure ‘fair value’ in the sale of both core and ancillary products, including premium finance.
For some insurance intermediaries, revenues generated from add-on premium finance can be a significant proportion of their overall income, and it's this income that the FCA has included in both the fair value and reporting requirements. Importantly the FCA has specifically set out that benchmarking and aligning pricing with peers or competitors is not an assessment of fair value. Instead, firms are required to do a more rigorous assessment.
Therefore, if a firm has historically made a substantial proportion of their income from premium finance versus underlying insurance distribution, this will now be apparent to both the FCA and the customer.
How the FCA views fair value in premium finance remains to be seen, but some firms will need to think through the risks and implications to their business model and profitability should the regulator view that premium finance-related charges are not fair to the end consumer. Lenders, investors and sponsors will need to be alive to this risk.
The pricing practices guidance includes the requirement for the distributor, co-distributor and manufacturer to attest compliance with these new rules. Attestation sets a very high standard, and the guidance is clear that while manufacturers are not responsible for other authorised firms’ compliance, the manufacturer is responsible for ensuring the distribution arrangements offer fair value for consumers.
To that end we've seen early indications that insurers will terminate distribution relationships where they have concerns about fair value and the impact on their own attestation. There is a risk, therefore, that attestation may reduce capacity for some intermediaries, and lenders and investors should be aware of this. At the very least it is likely intermediaries will face increased costs due to the focus on quality and fair value necessary for compliance.
The new pricing rules require that a firm considers whether redress should be made in the event of a breach in the pricing rules. No private right of action (PROA) is included in PS21/5, which makes the likelihood of large volumes of complaints less risky. However, given that the FCA has explicitly stated that redress should be a consideration for firms, redress payments and the associated costs could become a larger feature of the market in the future.
In sub-sectors where redress is common (for example consumer credit), it's possible to be liable for products sold before the relevant legislation was implemented, ie, face retrospective remediation.
Investors and lenders should be aware of the impact that redress claims may have on a firm’s resources, liquidity, and salability. On top of any redress payments that need to be made, the costs of the claims management process, including system and platform developments and training/personal required to look back at records to adjudicate claims, can be significant, and could negatively affect EBITDA.
The FCA’s proposed consumer duty is a major piece of legislation designed to set new standards for financial services, including insurers and intermediaries. Arguably, the consumer duty requirements replicate a similar message in the pricing practices guidance in terms of value, pricing and product governance.
Even so, all existing consumer policies and materials could need to be re-worked using the language of consumer duty. The FCA will be seeking attestations from management and undertaking a significant amount of market monitoring to understand how products are being sold. The cost of compliance has been estimated by the FCA to be £2.4 billion in one-off, direct costs.
Lenders, investors, and sponsors should also be aware that some of the requirements set by the FCA’s ‘outcomes’ have the potential to impact a firm’s profitability. Firms need to make leaving, cancelling, or transferring out of a product as frictionless as it is to buy it. There could well be instances where some firms experience significant customer loss, with the corresponding effect on cash inflows and profitability. Firms may need to consider introducing triggers linked to profitability or commission rates to assess whether that product is still delivering fair value for the customer. What impact will it have on a firm should a key and profitably part of their offering be judged not to delivery fair value? How will this impact a business operating in a competitive marketplace?
If you wish to discuss any of the points raised in this article, get in touch with Bradley Chadwick.