On 12 December 2001, the Government announced the Financial Services Authority (FSA) was to be made responsible for the regulation of mortgage advice and general insurance broking from 2004.
The decision represented an unexpected u-turn and nearly two months later, the 14,000 intermediaries whose businesses will be affected by the decision are still trying to work out what the implications are likely to be. The honest answer is that at this stage, nobody really knows.
What we do know is that the FSA is committed to a wide ranging consulting exercise with all ‘interested parties’ prior to the new regulatory regime being introduced.
We also know the Government expects regulation to bring in greater protection for consumers and through simplifying the regulatory arrangements, lower costs for intermediaries.
These are both laudable objectives and one can only hope they are achieved. The more cynical among us may question whether the new regime will lead to lower compliance costs. Experience suggests that away from Westminster, regulation usually leads to more, not fewer, burdens for businesses to deal with.
The Government had been signalling for some time it wanted to see higher standards and good practice across the general insurance industry. Like it or not, there is deep scepticism among the public and therefore among politicians about the quality of the advice provided by the financial industry as a whole. Too many people have had their fingers burnt as a result of previous mis-selling scandals.
Since 1998, Government policy had been to look to voluntary self- discipline rather than statute to regulate the sale of general insurance products. This led to the formation of the General Insurance Standards Council (GISC) in 1999.
By January 2002, the GISC had recruited over 6,000 members, ranging from large insurers to small brokers who in total handle over 90% of the general insurance business conducted in the UK. Not without its critics, the self-regulatory regime developed by the GISC has undoubtedly played an important role in raising industry standards and providing important protection for consumers.
From the beginning the majority of the industry supported the formation of the GISC as well as the framework and policies that it introduced. However, the GISC ran into difficulties trying to impose one particular condition in its rulebook. Rule F42 stated GISC members could only conduct business with other members. This Rule was challenged and found to be anti-competitive by the Office of Fair Trading, because it would have forced all intermediaries to join the GISC if they wanted to continue selling general insurance products.
The ongoing public wrangle which followed did not reflect well on the organisation or the industry; with hindsight it must have raised doubts within the Government about whether self-regulation would work in the long run. However, this was not the only factor which would have influenced the Government’s decision to appoint the FSA as the future regulator.
Since the GISC was formed, the European Union has drafted the Insurance Intermediaries Directive. This will require insurance brokers in each EU country to be regulated by a single statutory body. In addition, in the banking services sector, the DeAnne Julius Review proposed that mortgage advice should be regulated. As many insurance brokers also give mortgage advice, once the Government had decided to accept the DeAnne Julius recommendation, the die was cast.
Until 2004 however, the standards covering the sale of general insurance products will continue to be set and monitored by the GISC. The first meeting between the FSA and the GISC took place on 8 January 2002 to discuss how the transition to statutory regulation will be managed. The FSA has made it clear that it considers the best interests of consumers and the financial services industry will be served by the GISC continuing to be an effective organisation.
Publicly, Ruth Kelly MP, economic secretary to the Treasury, endorsed this view when she stated the FSA’s authorisation process would give due credit to firms that are members of the GISC or other comparable organisations. What this means in practice we do not yet know, but the underlying message for intermediaries is clear. If you are not a member of the GISC, you should join immediately. Time and money spent now, ensuring your business complies with current GISC standards and developing a track record of regulatory compliance, will undoubtedly pay dividends later.
The GISC is also having to adapt to the Government’s decision. In early January, its Board decided not to proceed with its application to the Office of Fair Trading to obtain an exemption for Rule F42 under the Competition Act. As a result, GISC members will be able to continue to do business with non-members until the organisation is wound up. It seems reasonable to assume that this will occur once the GISC has handed its responsibilities over to the FSA.
Retaining the rulebook
It will be interesting to see how much of the GISC rulebook is retained. The FSA has indicated that regulatory regime will be designed in a way which ensures the requirements placed on each firm are appropriate for the level of business they conduct. Rather than a flat fee paid by all, this suggests fees will be higher for larger firms.
The FSA also has to decide how they are going to interpret the EU’s Insurance Intermediaries Directive. Distribution channels for general insurance products in Europe are different to those in the UK. In France and Spain, the sale of insurance products is concentrated in the hands of the larger insurers, who sell direct to the public through local offices.
In the UK, the market has evolved differently. Consumers tend to purchase policies through intermediaries ‘ not directly from insurers.
The EU Directive will only be applicable to those companies whose main business is the sale of general insurance products. Companies where insurance does not constitute a significant element of their business will not be regulated. While the EU Directive may work for most European states, where sales are concentrated in the hands of a small number of specialist companies, in Britain ‘ where general insurance products are sold by a wide range of organisations ‘ implementation could lead to some serious anomalies.
A bank, for example, could argue that as the sale of insurance products represents a small element of its overall business, the Directive should not apply to it. Equally, a travel agent could claim that its sales of travel insurance policies fall outside the remit of the Directive whereas a broker selling an identical policy would be required to fully comply with the Directive. The FSA must ensure there is a level-playing field and that regulation is based upon the type of product being sold, not the organisation selling it.
Black and white
Whatever form the regulatory regime introduced by the FSA takes, it seems reasonable to expect it will be much more definitive than the one the GISC was developing. Intermediaries that break the new rules will face much heavier fines and if customers believe they have been given poor advice, intermediaries must also be prepared to have the case reviewed by the Financial Services Ombudsman if things go wrong.
It is hard to believe, despite the Government’s claims, that the new regime will lower regulatory costs. Large organisations will find it easier to bear any additional costs but lone operators may find the investment required to comply with the new regulations punitive. This is likely to lead to changes in the structure of the general insurance market. The number of active intermediaries will fall. Older brokers may choose to leave the market rather than gear their businesses up for the new regime. Others will look to join networks or user groups who will handle all compliance issues and any subsequent claims ‘ leaving them free to concentrate on other areas of their business.
Regulation by the FSA is being introduced because the Government wants to raise standards and ensure the consumer is properly protected. This has to be welcomed. The danger is that if the FSA is not properly resourced or if it is too heavy handed, it may stifle innovation and ultimately reduce consumer choice. The Government, however, probably thinks this a small price to pay to reduce the chance of any future mis-selling scandals.
Change is always a difficult process to manage. The bottom line is that intermediaries will have to adapt to whatever new regulatory regime emerges. The Government has made a decision that will undoubtedly have far-reaching consequences on the sale of general insurance products. Whatever we think, there is no turning back.
David Quick is managing director of CETA
The GISC rulebook will be recognised by the FSA, so becoming a member now may stand advisers in good stead with the new regulator.
It is likely that the EU’s Insurance Intermediaries Directive will only apply to companies that have general insurance sales as their main business.
Advisers may turn to networks for general insurance transaction as small companies could struggle to meet new regulatory costs.