On 21 April 2023, the Financial Conduct Authority (FCA) published a consultation paper (CP23/8) (CP) on proposed rule changes to address issues identified within the multi-occupancy building insurance market which are leading to poor outcomes for leaseholders.
Over the past few years, the cost of building insurance to residential leaseholders and other property owners of multi-occupancy buildings has increased significantly across the UK. These cost increases have been driven, in large part, by properties with flammable cladding or other material fire safety risks.
This led to a request from the Secretary of State for Levelling-Up, Housing and Communities for the FCA (in consultation with the Competition and Markets Authority) to review the market.
The resulting FCA report on insurance for multi-occupancy buildings released in September 2022 (the September Report), identified certain disadvantages in the insurance market for leaseholders. In particular, the FCA recognised that leaseholders are not classified as customers within the rules, meaning there is no express requirements for insurance firms to consider their interests when designing and distributing policies.
Consultation Paper (CP23/8)
In light of the feedback provided by the September Report, the FCA, in its latest CP, has proposed rule changes with the following aims.
- Protect the interests of leaseholders: The FCA wants the interests of leaseholders (and others in similar positions) to be properly considered when firms design their products. This is because the freehold property owner is typically the policyholder and insurers / brokers consider them to be their ‘customer’. Whilst the leaseholders often have the ultimate insurance bill passed to them (through service charges, lease agreements or otherwise), they often do not have any role in policy negotiation and purchase. In turn, this reduces the incentive on freeholders to select a policy in the best interests of leaseholders, because they are able to recover their costs regardless.
- Fair Value Pricing: The regulator aims to achieve prices that are fair value to leaseholders as well as freeholders. This reflects certain evidence that policies are selected on the basis of commission rather than the product quality.
- Fair Remuneration: The FCA is also seeking to ensure that remuneration of all parties involved in insurance distribution has a fair relationship to the benefits provided to leaseholders. Currently, it considers the level of commission to be high and disproportionate to increases in service costs.
- Transparency and disclosure: The CP aims to ensure that leaseholders have sufficient information to challenge poor practices and unfair costs passed on to them. According to the FCA, the current lack of transparency and disclosure from both the insurance and property sector means that leaseholders often find it difficult to get information they are currently entitled to, due to the time and costs involved.
This consultation, therefore, has application to regulated insurers and intermediaries and will be of interest to industry groups and trade bodies, unregulated firms involved in multi-occupancy buildings (e.g. managing agents), freeholder owners who are landlords of multi-occupancy buildings and leaseholder representation groups and individual leaseholders.
The FCA has proposed the following changes to the Handbook.
- Insurance Conduct of Business Sourcebook (ICOBS): The FCA has proposed that the requirement to act honestly, fairly and professionally in the customer’s best interests be extended to the benefit of all policyholders and policy stakeholders i.e. the scope of the proposal goes beyond leaseholders. In addition, the CP introduces leaseholder focused information disclosure obligations in a new section ICOBS 6A. This includes a requirement that the customer (i.e. freeholder) is provided the following disclosures by the intermediary in direct contact with them or the insurer (where there is no intermediary); along with a clear message that the freeholder should pass this onwards to leaseholders.
- Disclosure obligations
- Summary of the policy (to be provided by insurer): to include main benefits, coverage and exclusions of the policy, duration and insured sum (in total and per building). This can be achieved through a bespoke document or existing Insurance Product Information Document (IPID) or Policy Summary.
- Pricing information (to be provided by insurer): provide clear pricing information to help leaseholders understand the policy premium breakdown, per building level as well as any relevant tax.
- Remuneration (to be provided by intermediary): insurance intermediaries to disclose the total remuneration received for arranging the insurance, including both commission paid by insurers as well as remuneration paid to other parties e.g. unregulated Property Managing Agents (PMA) / freeholders.
- Potential conflicts of interests (to be provided by intermediary): extend the existing requirement in ICOBS 4 to require intermediaries to proactively disclose potential conflicts to leaseholders.
- Alternative quotes (to be provided by intermediary): intermediaries to be required to disclose the number of alternative quotes they have obtained and an explanation of why the proposed policy is recommended / in the interests of both the freeholder and leaseholder.
- Timing: all of the above information should be disclosed promptly after the conclusion of the contract.
- Leaseholder queries: insurance firms should respond to queries from leaseholders where the freeholder has failed to pass on this information. In particular, the FCA clarifies that the freeholder’s consent to this direct provision of information is not necessary where FCA rules already provide for this disclosure being intended for leaseholders.
- Large risks: applicable to all multi-occupancy insurance contracts, including those which meet the definition of contracts of large risks.
- Disclosure obligations
- Product Intervention and Product Governance (PROD): The CP aims to ensure leaseholders are explicitly taken into account by firms for requirements on product design, approval and distribution and bring certain large risks contracts into scope. This would be achieved by including leaseholders as ‘customers’ for the purposes of the PROD 4 rules, requiring insurers and brokers to specifically consider the position of leaseholders as a relevant part of the target market when designing, pricing and distributing their products. Whilst the main focus is leaseholders of multi-occupancy buildings, the proposal is for these changes to apply where a person has a contractual or statutory obligation to pay for part or all of the insurance premium; or has an interest in or benefits from the subject matter of the insurance, referred to as ‘policy stakeholders’. Whilst the FCA is not proposing that product manufacturers are specifically required to re-approve all relevant products, it expects firms to identify any related issues as part of their ongoing review processes.
- Senior Management Arrangements, Systems and Controls Sourcebook (SYSC): The FCA proposals also introduce requirements for remuneration practices. This includes expanding the scope of SYSC 19.2F (which requires firms to ensure their remuneration practices do not conflict with their duty to comply with the ICOBS’s best interests rule) to include leaseholders and other policy stakeholders. New guidance is proposed to be read alongside these rules, highlighting that firms must consider all remuneration it receives, whether or not it intends to retain that remuneration or make payments out of any such amounts to a third party. Additionally, a firm will be in breach of SYSC 19F.2.2R where it has arrangements to provide incentives, including partial premium refunds or commission-like payments to third parties (including the customer taking out the policy) which may encourage the recipient to use the services of the firm.
Whilst the proposed rule changes build on existing requirements, they may still have significant cost and administrative implications for insurance firms: in terms of new disclosures, the expanded remit of product design and distribution (including both new products and on-going product monitoring) and the introduction of remuneration considerations for all policy stakeholders. The rules could, therefore, go beyond simply protecting leaseholder interests and have a much wider market impact.
FCA letter to the government
The FCA has also published a letter to the Department for Levelling Up, Housing and Communities (“DLUHC”) on 21 April 2023, providing an update on its work and referring to its recommendations in the September Report that:
- the Association of British Insurers (ABI) coordinate with the FCA and government to create a risk pooling solution i.e. the ongoing work to develop and launch a reinsurance scheme to provide reinsurance cover for those multi-occupancy buildings worst affected by cladding and other fire safety issues, which has a planned launch date of summer 2023;
- the British Insurance Brokers’ Association (BIBA) engage with the design of the risk pool to limit commission costs; and
- the government impose legal requirements on unregulated entities that do not fall within the remit of the FCA rules, but which are often remunerated by insurance firms.
In particular, the FCA referred to taking the following actions in light of its findings on remuneration, commission and fair value within the multi-occupancy buildings insurance market: (i) intervention using a range of regulatory tools (including skilled person reports) where firms have significant weaknesses in meeting regulatory obligations (including on fair value); (ii) acting to ensure firms who need to make improvements to fully meet their regulatory obligations address these weaknesses promptly. A Senior Manager Function holder will need to attest and evidence that the firm is delivering fair value consistently; and (iii) an expectation that brokers immediately stop paying commissions to third parties without appropriate justification in line with fair value rules.
In response, the DLUHC welcomes the proposals in the CP and urges the FCA (among other things) to take immediate enforcement action against regulated brokers and managing agents that cannot demonstrate fair value commission (as highlighted by the FCA’s parallel broker remuneration review).
Multi-occupancy buildings insurance – broker remuneration review
In conjunction with this wider review, the FCA has published a report of its findings on multi-occupancy buildings insurance – broker remuneration. This built on the key findings of the FCA’s September Report which identified evidence of some high commission rates and poor practices in the broker market which were not consistent with driving fair value to the customer. The review emphasised the potential harm to leaseholders and the need for brokers to do “significant work” to ensure that fair value is consistently delivered. In particular, the FCA highlighted that these issues could have wider implications and that it expected relevant firms to consider these findings in respect of PROD compliance in general (and not just in respect of multi-occupancy buildings insurance).
This report was followed up by a letter from the DLUHC urging BIBA’s members to consider proposals to address the identified issues relating to commissions and consumer protection.
Timing / Implementation
The FCA has proposed an implementation period of 3 months after the rules set out in the CP come into force. This is on the basis that the changes are building on existing requirements and should, therefore, provide sufficient time to make the required systems and process alterations.
The FCA is asking for comments on the CP by 9 June 2023, with the intention that it will publish a policy statement and final rules in Q3 2023.
To find out more or to discuss any of the implications of the proposals, please contact our insurance team.