Enhancing consumer protection in general insurance: from multi-occupancy building insurance to group policies

Who this blog is for

Board members and senior executives of insurers and intermediaries across the UK insurance industry, as well as property managing agents working across the UK. In particular, insurers and brokers with multi-occupancy building insurance products and group or master policies in their commercial books and those in first line of defence and compliance roles who manage their firm’s product portfolio.

At a glance

• The FCA’s proposed rules in relation to multi-occupancy building insurance expand the definition of customer to include leaseholders as “policy stakeholders”. Whilst the focus of the consultation is multi-occupancy building insurance policies, the wider definition is likely to draw other products into the scope of the proposed rules. For example, the FCA considers beneficiaries under group policies to be policy stakeholders in CP23/8.
• Firms might wish to review their existing product portfolios to determine whether the wider definition of customer will affect any other products in their portfolio. This information will provide firms with the number of products under scope of the new proposals.
• For all products under scope, firms should then consider the required changes to areas of their conduct risk framework to implement the proposals such as product review and approval processes, conflicts of interest, target market definition, fair value assessments and disclosures. It is particularly important that firms consider both the freeholder (property owner) and the leaseholder (responsible for paying the insurance premium through service charges) when considering fair value. More generally any new policy stakeholders identified should be brought into consideration in fair value assessments including beneficiaries in group policies.
• Firms will need to review their remuneration structures and controls to ensure conflicts of interest are appropriately managed and mitigated. Percentage-based commissions might no longer be acceptable in an environment of increasing premiums, especially where there is weak justification in relation to additional services/costs arising in the distribution chain.
• The proposals, if implemented, will have significant implications not only for insurers and intermediaries involved in these types of policies, but potentially for the wider distribution chain including property management agents and freeholders.
• Affected firms should engage with the FCA to clarify areas of uncertainty.

Introduction

In January 2022, the FCA carried out a review of the multi-occupancy building insurance sector at the request of the Department of Levelling-Up and Housing Communities, following a steep increase in prices paid by leaseholders for their building insurance after the Grenfell tower fire in 2017. The review focused on understanding and assessing the factors which affected multi-occupancy building insurance premiums and the impact this had on leaseholders. The FCA made several recommendations in its 2022 report, followed by a Dear CEO letter, and has more recently published CP23/8 which details the proposed rule changes.

The FCA has also published its findings from its multi-firm review of broker remuneration which highlighted extremely poor practices, particularly concerning the inadequacies around brokers’ arrangements and remuneration and the provision of fair value for multi-occupancy building insurance products. Commission rates received in the broker market ranged between 10%-62%, and in some cases, brokers paid more than half of the commission to the freeholder or the property managing agent (PMA) highlighting concerns around conflicts of interest.

The consultation closes on 9 June 2023, with final rules expected in Q3 2023. The FCA is proposing a three-month implementation period from publication of the final rules, which means firms will likely need to be compliant by the end of 2023 or soon after.

In this blog we discuss what the proposed rules changes mean for firms carrying multi-occupancy building insurance and other affected lines of business.

What is changing?

The FCA’s report on insurance for multi occupancy building identified a number of serious issues that resulted in poor outcomes for leaseholders. These included:

• the needs and interests of leaseholders not being considered by firms at product design;
• remuneration practices not being consistent with the interests of the leaseholder;
• policies selected on the basis of remuneration paid to freeholders and PMAs rather than product quality for leaseholders; and,
• a lack of transparency of information and disclosures by firms to leaseholders to allow them to challenge unfair costs.

As a result, the FCA has proposed a number of rule changes. These include:

• Policy stakeholder protection: The FCA is proposing changes to the definition of customers under PROD 4 and the customer best interest rule - ICOBS 2.5 - to enhance the level of protection to leaseholders and equivalent individuals which will include for example group policies’ beneficiaries. These individuals will be known as “policy stakeholders” - a person who “has a contractual or statutory obligation to pay for a part or all of the insurance premium, and, has an interest in or benefits from the subject matter of the insurance”. However, these customers will not fall within the scope of the Consumer Duty (the Duty), as they do not meet the definition of retail customers.
  
• Governance & compliance: Firms will need to ensure they have an appropriate product approval process, with leaseholders and other policy stakeholders defined within their target market. In addition, firms will need to evidence how their products will meet the needs of policy stakeholders, including leaseholders. The FCA’s review of commission practices for intermediaries found evidence of commissions being paid to brokers, freeholders and PMAs that created serious conflicts of interest between those parties and the leaseholders. As a result, firms will need to disclose any potential conflicts of interest, and policy stakeholders’ interests should be specifically considered in the analysis. Firms will also need to consider how their remuneration strategies are consistent with providing fair value to policy stakeholders.
  
• Disclosures (only applicable to multi-occupancy building insurance): The FCA is proposing additional disclosure rules for firms carrying multi-occupancy building insurance business. The intent is to increase the amount of information available to leaseholders and the level of transparency. Disclosures should include: a policy summary, clear pricing information including how the policy premium is made up, the total remuneration received by intermediaries for arranging the insurance including commission paid to freeholders and PMAs, alternative quotes and potential conflicts of interest.

Overall, this is an area where the FCA uncovered significant harm to consumers; the issue has attracted parliamentary scrutiny and it is high on the FCA’s agenda to ensure fair outcomes in the future. The FCA has made it very clear that, where necessary, it will intervene using a range of regulatory tools, including skilled persons reviews, where firms have significant weaknesses in meeting their new and existing regulatory obligations.

In addition, although the Duty does not apply to policy stakeholders, we expect that any evidence of persisting poor outcomes for this group of stakeholders is likely to raise doubts about whether a firm has embraced the spirit of the Duty and therefore attract significant wider regulatory scrutiny. As a result, firms might want to prioritise the necessary work needed as part of their existing product governance, fair value and remuneration reviews whilst adapting to these new requirements to ensure compliance by the implementation date.

What do firms need to do?

Policy stakeholder protection

Whilst the consultation focuses on multi-occupancy building insurance, the proposed rule changes will create a new category of customer (policy stakeholders) which may also affect other types of products beyond multi-occupancy building insurance, group policies being a clear example. Firms will need to review and consider their approach to these customers, ensuring they are able to demonstrate and evidence how they have taken their best interests into account, and that the products offer them fair value. Firms might want to consider:

1. Conducting an assessment of their portfolios to identify whether any additional products beyond multi-occupancy building insurance may also include policy stakeholders. This will inform the scope of business change necessary and whether other lines of business will be affected. For example, some firms operate master or group policies where the insurance premium is charged by way of fees to underlying users of premises or vehicles. In these cases, and depending on the contract wording and other characteristics of the policies, the beneficiaries or insureds might fall under the definition of policy stakeholders. See below: Identifying policy stakeholders.
   
2. Carrying out a legal assessment of the insurance policies identified in 1. above to determine which customers are likely to be construed as policy stakeholders under the proposed rules, given the set precedent.
   
3. Assessing how they should adapt their conduct framework to incorporate the interests of policy stakeholders. This is applicable to policy stakeholder in multi-occupancy building insurance products and any other products where the firm has identified policy stakeholders including group policies. For example, this should include consideration of how policy stakeholders’ best interests are captured in product development, target market definition, product testing and fair value assessments. Firms may also need to consider how the treatment of vulnerable policy stakeholders is considered as part of their value assessments.

Identifying policy stakeholders

Under the proposals, to fall within the definition of a policy stakeholder an individual must have:

• “a contractual or statutory obligation to pay for a part or all of the insurance premium and any other costs connected with the distribution, and
• an interest and/or benefit in the subject matter of the insurance.”

This broadens the protections but leaves some uncertainty as to whether certain individuals are captured or not. The FCA provides the example of a customer purchasing groceries from a supermarket. Their purchase is indirectly funding the shop’s public liability insurance, but they will not be classified as a policy stakeholder, as they have “no interest in the subject matter of the insurance and they are not specifically paying a fee to meet the insurance premium”.

Firms will need to assess whether other products involve consumers that may fall under the definition and therefore be captured within the scope of the proposed rules.

In particular, the extension of certain protections to beneficiaries might affect how insurers treat group/master policies. As an example, these structures can cover scenarios such as:

• warehouse and stock insurance where the policyholder rents warehouse facilities to a number of smaller businesses and charges the insurance premium in fees alongside rent;
• packaged bank accounts, which in return for payment of a monthly account fee may offer beneficiaries travel, gadget and other insurance covers;
• clubs and association insurance arranged for the benefit of members, which may range from those which are arranged to cover minimum legal requirements or an established association standard, but in other cases provide “perks” as a benefit of membership (and may be tied to a membership fee).

Governance and conflicts of interest

The new broader definition of customer under the FCA’s proposed changes, will undoubtedly have an impact on a firm’s governance. Firms might want to consider:

1. Reviewing remuneration policies and procedures to ensure they do not drive poor customer outcomes or create conflicts of interests arising from remuneration paid by authorised firms to brokers, freeholders or PMAs.
2. Assessing whether commission rates are reasonable and consistent with the overall benefits provided to policy stakeholders. For firms which are receiving percentage-based commissions, this could mean they will need to reduce percentage rates if they cannot demonstrate fair value.
3. Ensuring the right controls are in place to analyse and monitor product performance for policy stakeholders.

Disclosures – applicable to multi-occupancy building insurance only

The FCA’s proposed disclosure requirements will drive transparency, meaning that firms will be expected to maintain accurate and readily available information to be made available to leaseholders through freeholders and PMAs. Firms might wish to:

1. Ensure information is appropriately exchanged between the insurer and intermediary/es so the appropriate document(s) can be created to share information with the customer, in this case the freeholder. Insurers should be prepared to be able to deal with queries directly from policy stakeholders in the event the disclosures have not been shared by the freeholder or PMA.
2. Determine the different roles and responsibilities through the chain in respect to policy stakeholders. For example, insurers will be responsible for collating the information for the summary of cover, but the intermediary will have to detail the remuneration disclosures.

Conclusion

The FCA’s proposals could have significant implications for firms offering multi-occupancy building insurance policies and, potentially, other lines of business (such as group policies) where products involve policy stakeholders. To assess the implications, firms first need to review their product portfolios to determine to what extent the proposed expansion of the customer definition may bring additional insurance products in scope of the new regulatory requirements. This will help determine changes required to product review and approval processes, conflict of interest controls and fair value assessments in addition to implementing new disclosure requirements for multi-occupancy building insurance policies.

Firms will be expected to be compliant within three months of the publication of the final rules. Depending on the level of impact on the business, this is likely to be a tight deadline. This means that firms likely to be affected should start performing an impact assessment on their business to enable them to understand quickly what changes will be required. Firms should plan for a robust and swift implementation of the new rules. This is an area of high risk given the very poor outcomes leaseholders had been receiving for many years and the high profile of the review and findings.