[co-author: James Wilkinson]*

This week the FCA has published detailed finalised guidance setting out their expectations of insurance product manufacturers and distributors in relation to product value and distribution arrangements in general insurance.

Background

During 2017 and 2018, the FCA conducted diagnostic work on General Insurance (“GI”) distribution chains. This work found that customers were suffering harm from failures in product design, oversight and distribution. In response, and in order to provide clarity to firms about the FCA’s expectations (in particular on the design and distribution of insurance products and the requirement to act in accordance with the customer’s best interests), the FCA consulted on new non-Handbook guidance. As a result of the feedback the FCA received to that consultation, some revisions have been made to the guidance, which was published in full on 19 November 2019 (the “Guidance”).

The Guidance gives clarity on the FCA’s expectations of firms in the GI and pure protection sector. Particular focus is applied to the value that the product and distribution arrangements present to the customer. All firms who manufacture or distribute general insurance or pure protection products will be affected by this Guidance.

Manufacturers

Chapter 3 of the Guidance applies to firms manufacturing insurance products. The FCA will expect firms to put in place a product approval process, covering product design and review. As part of this process, manufacturers will be expected to consider the “value” that the product presents for its intended customers (“value” is defined by reference to the interaction between the overall costs to the end customer and the quality of the product and services). Firms will be obliged to consider whether their product is compatible with the needs, objectives and characteristics of the target market and whether the distribution strategy is consistent with the identified target market. The FCA explains in the Guidance that they will expect firms to appropriately evidence the conclusions they reach.

If firms fail to ensure that the product (including costs and charges) is compatible with the objectives, interests and characteristics of customers in the intended market, this will likely indicate that the product is poor value. In these circumstances, manufacturers will be expected to make changes to the product or distribution strategy in these circumstances to prevent harm to customers.

Distributors

Chapter 4 of the Guidance sets out the FCA’s expectations of how distributors should consider the impact of their processes on the value the customer receives from the products they offer. In particular, the FCA warns firms to ensure that the remuneration (including fees and charges) that they receive for their insurance distribution activities does not conflict with their duty to comply with the customer’s best interests rule.

The FCA will require firms to continually monitor their products and distribution arrangements to allow them to act if they become aware, for example, of situations where the remuneration they are receiving is unlikely to be consistent with the customer’s best interest rule, because of its impact on the value of a product.

Where distributors identify that a product is resulting in consumer harm, they should inform the manufacturer and, if necessary, amend the way they distribute the product. This might include stopping the use of a particular distribution method, reducing the amount of remuneration they receive or ceasing to distribute the product entirely.

The FCA also highlights in the Guidance the potential for conflict between distributors’ remuneration and the customer’s best interests rule. Firms are advised to be vigilant in situations involving remuneration which incentivises the firm to offer a product which is not consistent with the customer’s demands and needs. Such situations include where:

• a distributor receives a level of remuneration which bears no reasonable relationship to their costs or workload to distribute the product;
• a distributor receives remuneration which incentivises them to propose or recommend a product which either does not meet the customer’s needs, or does not meet them as well as another product would do; or
• a distributor receives a net rate from the product manufacturer, and is able to set their own remuneration by determining the final selling price themselves.

Where firms conclude that their remuneration arrangements conflict with their duty to act in accordance with the customer’s best interests rule, the FCA will expect firms to amend their remuneration arrangements to avoid such a conflict.

Next steps

Firms conducting general insurance and protection business should consider carefully the FCA’s new Guidance, to ensure they meet the FCA’s expectations. In particular, firms conducting insurance distribution activities should review their remuneration arrangements to make sure that these do not conflict with their obligations to comply with the customer’s best interests rule.

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