A new regulatory regime will take effect in the UK next year Jonathan Davies discusses the key issues.
With effect from 14 January 2005, insurance mediation will be a regulated activity in the UK. From that date it will be a criminal offence to undertake insurance mediation activities in the UK unless authorised to do so by the FSA.
What is insurance mediation?
The definition of insurance mediation laid down in the UK legislation is very wide. It covers arranging contracts of insurance, advising on contracts of insurance, assisting in the administration and performance of contracts of insurance and dealing in contracts of insurance. 'Arranging' covers negotiating the terms of a contract of insurance on behalf of the proposed insured, assisting in the completion of the proposal form and introducing a customer either to an insurer or a broker to take out a contract of insurance. 'Dealing' covers agreeing, either on behalf of a policyholder to buy an insurance policy, or on behalf of an insurer to issue an insurance policy. Thus, as well as brokers, the activities of managing general agencies and all other coverholders will fall within the scope of regulation.
The scope of regulation in the UK is wider than under the EU Insurance Mediation Directive. The EU directive only covers insurance mediation, that is the activities classically performed by brokers standing between policyholders and insurers. In order to ensure a level playing field, the UK government has extended the regulation so it also applies to insurers when they undertake the activities of selling insurance policies. Insurers then become subject to all the FSA's conduct of business rules on giving suitable advice and product disclosure. Where policies are arranged through intermediaries, this burden falls to the intermediary. It is possible that some insurers may, as a result of the new regulations, limit their activities so they only arrange policies through intermediaries.
The width of the definition, in particular, of 'arranging' goes far beyond the traditional activities of insurance brokers. The FSA has published guidance on the extent of the regulated activities. Virtually any involvement in the chain of arranging re/insurance policies beyond a mere passive display of advertising literature will be a regulated activity.
Numerous businesses at present carry on some incidental insurance, for example, arranging insurance policies to cover products they supply. Professionals and businesses ranging from vets and dentists offering the sale of pet and dental insurance, surveyors managing properties and arranging their insurance and businesses offering warranties on goods that they sell are likely to fall within the scope of regulation. The FSA has launched a major advertising campaign to encourage relevant businesses to become authorised, and has expressed concern that the number of secondary insurance intermediaries applying for authorisation is significantly fewer than anticipated.
It is likely that some firms which previously undertook incidental insurance activities will now cease these activities because the burden and cost of authorisation cannot be justified by the profits from such insurance activity. This may mean some insurers will see a diminution in business whilst the insurance buying public may find it more difficult to obtain insurance. It is also feared that many businesses have simply not appreciated they will require to be authorised and the FSA may become involved in widespread enforcement activity to clamp down on unauthorised insurance mediation soon after the new laws come into force in January 2005.
Appointed representative exemption
The UK regulatory framework allows firms, whether insurers or brokers, to appoint 'appointed representatives'. Appointed representatives can carry on regulated insurance mediation activities on behalf of their principal without themselves being authorised. Many firms, particularly those who arrange policies with only a limited number of insurers, may perceive appointed representative status as a way to avoid the need for authorisation. Insurers, fearful of loss of business, may be panicked into agreeing to appointed representatives.
However, appointed representative status is a high risk strategy for the principal. Under Section 39 of the Financial Services & Markets Act 2000, the principal is responsible for everything done by the appointed representative. This would cover civil claims for mis-selling and other negligence, potential disciplinary action by the FSA and liability if premium or claims monies are stolen. Insurers and brokers must be careful therefore not to choose appointed representatives without careful due diligence of the proposed representative's suitability and systems and controls.
Policing the perimeter
The FSA will be monitoring for firms carrying on regulated activities but who have not obtained authorisation. However, the FSA rules transfer much of the burden of removing unauthorised activities from the market to insurers. The FSA rules require that before any firm uses the services of an intermediary they must check the FSA register or its equivalent in any other EEA nation to ensure the person is authorised. Thus, insurers may not accept risks from unauthorised intermediaries. Moreover, firms must take reasonable steps to ensure that no one else in the distribution chain in respect of any insurance risk is conducting unauthorised insurance mediation when required to be authorised.
Insurers will require their brokers and other introducers to certify that there are no unauthorised intermediaries involved in the production of business. Unauthorised intermediaries are likely to find it impossible to place their risks.
The mediation of reinsurance is a regulated activity in exactly the same way as the mediation of direct insurance. Although the Conduct of Business Rules do not apply to reinsurance, anyone engaged in reinsurance mediation must be authorised and must comply with the FSA's core principles and prudential requirements (ie capital adequacy rules).
Recent FSA guidance has, however, limited the scope of regulation as it affects reinsurance. Assisting in the administration and performance of a contract of insurance is a regulated activity, and this covers assisting policyholders in the management and collection of claims. Managing claims on behalf of a relevant insurer is, however, exempt, on the basis that the insurer is responsible for complying with the rules in respect of its claims handling. In guidance published in August, the FSA indicated that claims recovery work for reinsurers will be viewed as part of the claims management function. Thus, the exemption from regulation for managing claims on behalf of a relevant insurer extends also to dealing with reinsurance recoveries on behalf of a relevant insurer.
It needs to be noted that this exemption only applies to relevant insurers, defined as insurers authorised in the UK or one of the other EEA nations. Therefore an English or Irish insurer can retain anyone to undertake its claims management and reinsurance collections. But a Bermuda or New York insurer is not a 'relevant insurer' so it does not have the benefit of the exemption and would have to use an authorised firm to manage its reinsurance collections in the London market.
What the rules require
The Financial Services & Markets Act makes it a criminal offence to conduct insurance mediation without being authorised by the FSA. Firms which are authorised are required to comply with the rules in the FSA handbook, and if they fail to do so are liable to disciplinary action by the FSA. The FSA can impose unlimited financial penalties and, ultimately, can withdraw authorisation.
There are three relevant sections of the FSA handbook. The Insurance Conduct of Business rules (ICOB) contain detailed rules on advertising, advising and selling standards (including that all advice must be suitable), product disclosure, cancellation and claims handling. ICOB does not apply to reinsurance or to contracts for the insurance of large risks, including railway rolling stock, aircraft, ships, goods in transit and property and liability insurance where the policyholder has a balance sheet total of EUR6.2m, a net turnover of EUR2.8m or 250 employees. Second, the Prudential Handbook which applies to all insurance and reinsurance mediation firms imposes capital adequacy requirements and requires mandatory professional indemnity insurance.
In addition to the detailed rules, there are 11 FSA principles for business, setting out fundamental obligations applying to all firms in all circumstances, even when there is no directly applicable rule. These core principles include:
1. a firm must conduct its business with integrity;
2. a firm must conduct its business with due skill, care and diligence;
5. a firm must observe proper standards of market conduct;
6. a firm must pay due regard to the interests of its customers and treat them fairly;
7. a firm must pay due regard to the information needs of its clients, and communicate information to them in a way which is clear, fair and not misleading.
It will be noted that principle 6 refers to 'customers' which excludes market counter-parties whereas principle 7 refers to 'clients' which covers everyone with whom the firm deals. Senior FSA personnel have made clear in many recent speeches that they regard the obligation to treat customers fairly as overriding all other rules. Past disciplinary action has been taken in the financial services sector (regulated by the FSA since 2001 and by its predecessors since 1988) based on breaches of the core principles, for example, advertising material not being clear, fair and not misleading or firms not having acted with due skill, care and diligence. The FSA's core principles require firms not to be hide-bound by the letter of the law but to abide by its spirit.
Britain leads the way
The new FSA rules for insurance mediation mean that, when the Insurance Mediation Directive comes into force on 14 January 2005, the UK will be fully compliant with the directive. Almost all of the relevant UK rules have been published for the better part of a year.
Most other EU nations are far less advanced in their implementation of the directive. In particular of the largest EU nations, France, Germany, Italy and Spain will all virtually certainly fail to implement the directive by January 2005. It will fall to the new EU Commission to take action against recalcitrant nations to implement the directive. In the meantime, the FSA has published a special waiver to its rules which would otherwise have forbidden firms dealing with unauthorised intermediaries in any EEA nation. Firms are now permitted to deal with unauthorised intermediaries in those EEA nations which have not yet implemented the directive, as well of course as the world outside the EU.
Jonathan Davies is a partner at Reynolds Porter Chamberlain.