New FCA rules which come into force 1 October 2021 require insurers and intermediaries to demonstrate how a premium finance product offers value for money to the consumer. Bradley Chadwick highlights the impact these pricing guidelines may have on intermediaries who distribute products with premium finance.
On 25 August 2021, the FCA issued a warning to insurance firms stating that many are not ready to implement the new product governance rules that come into force from 1 October. These were published back in May in policy statement PS 21/5 and set out new pricing rules for insurers, and insurance intermediaries, such as MGAs and brokers. These include:
a prohibition on ‘price walking’ for home and motor insurance
a requirement for auto-renewable insurance policies to provide easy and accessible methods for opting out of auto renewal
factors that insurers and intermediaries must consider when determining whether a product offers value for money.
I believe it's this last point relating to ‘value for money’ that is one of the most far reaching for industry players. It also has particular relevance to firms who receive ancillary revenues from premium finance business.
Insurers and insurance intermediaries will now have to carry out detailed assessments to make sure that each of their products provide ‘fair value to customers’, and attest to such. In doing so, firms must consider the following elements, which notably includes the cost of any premium finance, as set out in section PROD 4.2.14E R of the policy document: the individual elements of the expected total price to be paid by the customer. These elements include, but are not limited to, the price paid for:
the insurance product, including any additional features which are part of the same non-investment insurance contract
any additional products, including retail premium finance, offered alongside the insurance product
the distribution arrangements, including the remuneration of any relevant person in the distribution arrangements, and including where the final decision on setting the price is taken by another person”.
Spotlight on premium finance
Customers can be unaware that when they select to pay their premiums monthly rather than in one instalment, they have often bought a premium finance product.
Under the new rules, firms must do more than simply ask the customer to choose between paying monthly or annually. They must give clear information about the cost of any premium finance arrangement and make it clear to the consumer that this makes the contract more expensive. What the impact of this will be on a consumer’s buying habits - and therefore a businesses’ revenues and profit - remains to be seen. But the FCA’s direction of travel and focus on the consumer is clear, and management and other stakeholders should be prepared for this.
In addition, firms’ remuneration arrangements in relation to retail premium finance should not give an incentive to offer retail premium finance with greater costs to the customer where another arrangement better aligned with the customer’s interest is available. The FCA expects firms to undertake regular reviews of their retail premium finance arrangements, considering how they provide a ‘fair outcome for the customer’ and why they selected the arrangement. Where the firm receives a greater level of remuneration compared with other arrangements available to the customer, they will need to consider whether this is consistent with their obligations under the ‘customer’s best interest’ rule.
Demonstrating how premium finance adds value
As mentioned above, the new rules require insurers to undertake a value for money assessment to identify ‘any impact which the distribution arrangements are having on the value including whether the distribution channels remain appropriate’. Further, ‘a firm must not use a distribution channel unless it is able to demonstrate clearly that the channel results in fair value to customers in the target market’.
While information on what profit is being made from premium finance will need to be disclosed to the customer, it now also needs to be provided to the FCA. The emphasis will be on both insurers and intermediaries to demonstrate how premium finance related charges add value to the end consumer. It remains to be seen how the FCA views value for money in premium finance, but what is clear is that if businesses are making substantial amounts from premium finance versus insurance products, this will become apparent to both the FCA and the customer - both of whom have the ability to impact the business.
Crucially, industry players may need to think through what the consequences would be to their business model should the FCA view that their premium finance related charges are not adding value to the end consumer.
What do these rules mean for insurers and intermediaries and their lenders?
For some insurance intermediaries, revenues made from selling premium finance to customers can be a significant portion of their overall income - firms may make little money from the insurance product or its distribution, instead capturing margin in a premium finance add-on.
FCA research conducted in 2019 showed that in the context of motor and home insurance for example, 11% of insurers revenues comprised of non-core revenue, of which up to 48% related to premium finance. At that time, average premium financing revenue per policy ranged from £3 to £110 in motor and between £3 and £32 for home insurance.
Insurers and intermediaries need to be aware that if a key part of your revenue derives from premium finance, and that the end cost to the customer is not considered to add value to that consumer, this will come under increased focus by the FCA. This may lead to some headwinds on the horizon and management should start to look at how they can mitigate this.
Equally, lenders and investors to insurers and intermediaries should think to undertake due diligence on this issue. Lenders and investors would be advised to understand what proportion of any counterpart’s revenue derives from premium finance, and if this ancillary business were reduced, how it might affect their ability to repay any loan.
Consider asking for regular disclosures from your borrowers, stripping out premium finance related income, to enable stress testing of forecast information to assess realistic credit quality.
The FCA regulation timeline is challenging
The changes to the rules on pricing, auto-renewal and data reporting come into effect on 1 January 2022. However, the rules on premium finance disclosures and product governance take effect from 1 October 2021, and the FCA has said in their recent warning that any firms who are not fully meeting requirements and expectations have significant work to do to comply by 1 October.
The regulator indicated that firms should prepare implementation or project plans when approaching the guidance. This will enable them to evidence or track whether they have successfully completed reviews of their product governance arrangements, or made necessary changes to their systems and controls.
The FCA has also stated that they intend to take a more interventionist approach in the future regarding the rules set out in PS 21/5, to ensure that firms provide suitable quality at a fair price to their consumers.