The Financial Conduct Authority (FCA) has published the results of a thematic review undertaken as part of the regulator’s 2015/2016 Business Plan – TR16/6: Principals and their appointed representatives in the general insurance sector. The review has identified a number of significant shortcomings in relation to principals’ understanding of their regulatory obligations towards appointed representatives (ARs). The thematic review has found that failures in the control and oversight of ARs risk serious detriment to the principals’ customers.
There are approximately 20,000 appointed representatives operating in the UK of which about a quarter operate on behalf of the insurance sector (whether intermediaries or insurers). Importantly, the relationship of the AR to its principal is one of agency: the principal has full responsibility for the acts of its AR and must have effective systems in place to ensure that the AR acts as intended without causing customer detriment. The thematic review undertaken by the FCA sought to assess whether ARs were sufficiently controlled by their principals and were supported by sufficient resources. The review focused on the UK general insurance sector.
The FCA’s review took a sample of 15 principals using a risk-based approach to represent a diverse range of business models, products, sales methods and sizes of AR networks. These principals collectively had 783 ARs. The FCA visited 14 of the principals and 25 of the ARs in the review.
What was the outcome of the thematic review?
Business model and risk management. Almost half of the principals in the sample were unable to demonstrate that they had considered and had understood the nature, scale and complexity of the risks arising from their use of ARs. Accordingly, this failure to understand and control these risks resulted in some ARs conducting activities outside the principal’s core areas of expertise and without the principal having the ability or resource to oversee what the AR was doing.
The FCA found that these principal firms were unable to consistently demonstrate that they had met the regulatory requirements to take reasonable steps to:
- Consider how the appointment of ARs would impact their business model and core activities;
- Understand the nature, scale and complexity of the risks arising from the activities of their ARs; and
- Put in place appropriate risk management frameworks to identify and manage risks to their business and customers.
Governance. Principles were unable to demonstrate how they had met their obligations to consider the solvency and suitability of the AR on appointment. When entering into contractual agreements, principals had failed to set up a suitable operational framework by which they could oversee their ARs. In many instances, the FCA found that AR contractual agreements were not compliant with regulatory requirements. The FCA also found that principals had not always correctly categorised ARs and had not met the requirements of the approved person regime.
Customer outcomes. The FCA found that in a third of the firms in the sample, there was evidence of potential mis-selling and customer detriment as a result of AR’s actions, with most of these issues not previously identified by the principal. For example, the FCA found examples of customers buying products that they may not need, under which they may be ineligible to make a claim, or without being provided with enough information to make an informed choice about a purchase of cover (clearly, breaches of FCA rules). Amongst the ARs of one firm there was significant evidence of mis-selling leading to actual customer detriment as a result of poor sales practices. The FCA also observed potential customer detriment arising from shortcomings in principals’ understanding and application of the client money rules.
What happens next?
The FCA has taken early intervention actions in relation to five of the fifteen principal firms in the sample. The actions include agreeing the imposition of requirements on regulatory permissions, requiring principals to cease sales activities and commissioning two section 166 (skilled persons) reports to assess whether detriment has been suffered by customers from mis-selling and consider the adequacy of systems and controls. The FCA is also considering the need for customer redress.
What are the regulatory expectations of principals?
The FCA expects the principals of ARs to be able to demonstrate that they comply with regulatory obligations to:
- Consider the impact of ARs on their business model and ability to meet regulatory thresholds;
- Assess the solvency and suitability of any AR;
- Take steps to put in place appropriate risks management frameworks to identify and manage the risks that the AR may present to the principal’s business;
- Have adequate controls in place to manage those AR activities for which the principal is responsible;
- Put into place compliant contractual arrangements with the AR; and
- Have adequate resources in place to monitor and enforce compliance with regulatory requirements.
A ‘Dear CEO’ letter will be sent by the FCA to the chief executives of principal firms with ARs in the general insurance sector setting out expectations and actions that the regulator will expect the firm to take to address the issues identified in TR16/6.