Poor culture and controls, complex terms and conditions and large back-books among key risk areas

The Financial Conduct Authority (FCA) has published its Business Plan for 2014/15 on March 31. The plan confirmed that the regulator would be undertaking a review of practices relating to legacy/historic business. News of this review caused significant market disruption when it was leaked in a newspaper article on March 28 and the FCA continues to deal with the fallout of its handling of this announcement.

According to the business plan, the FCA will assess whether long-term insurers are operating historic products in a fair way and whether they have ‘adopted strategies’ that exploit existing customers. The FCA is concerned about firms taking advantage of customer inertia by making it difficult to switch or by being vague about the pricing of existing products or the availability of other products. The root of the problem seems to be the fact that some customers pay more due to an inability to switch to other contracts (e.g. because of exit charges). It appears that the FCA is concerned that some firms may be using “the value they get from existing customers to support low rates and introductory offers for new customers”. The FCA has said it will review 30 firms and work is expected to start in the summer, however, the precise scope and purpose of the investigation remains uncertain.

In addition to the review of legacy products, the FCA confirms that it will continue to carry out market studies and thematic reviews to investigate issues it is concerned about. For the general and life insurance sector, the following areas will be subject to investigation:

• wholesale activities, specifically the connection between retail and wholesale participants in general insurance markets. In particular, the FCA will consider the impact on personal lines and small commercial customers who buy products provided by wholesale firms;
• commercial claims. Further to its retail claims work, the FCA will consider whether commercial customers’ expectations are met in the claims process and where poor behaviour could have a wider impact on trust in the market;
• cover holders. The FCA will look at distribution chains in wholesale markets, through to the impact on retail and small commercial customers. Key risks in complex distribution chains, such as product design, sales and post-sales handling will be reviewed. The regulator will also aim to improve how intermediaries manage conflicts of interest;
• premium finance. In line with its new consumer credit remit, the FCA will review firms’ sales practices and disclosures in premium finance sales;
• client money. New rules (CASS 5A) covering how intermediaries should deal with client money will be published. The FCA will also conduct thematic work in this sector, in particular the extent to which firms are currently holding client money without the appropriate permission and protections;
• retail investment advice. The FCA will look at whether investment advisers are carrying out appropriate due diligence to ensure suitability of products and services; and
• managing the performance of staff. This will be a cross-sector study into how firms manage the performance of sales staff (e.g. financial incentives and sales targets) and mis-selling risks.

Ongoing thematic work and follow-up to FCA investigations into with-profits governance, packaged bank accounts, mobile phone insurance, motor legal expenses insurance and annuities is scheduled for 2014/15.

As well as announcing sector specific thematic work, the business plan identifies seven key forward-looking areas where potential risks to the FCA’s objectives may arise. Some of these areas will be addressed (such as product back-books), whereas others will be monitored over time and action taken where necessary. Detailed analysis of these risk areas is provided in the FCA’s Risk Outlook 2014. In summary, the forward-looking areas of focus are:

• technological developments may outstrip firms’ investment, consumer capabilities and regulatory response;
• poor culture and controls continue to threaten market integrity;
• large back-books may lead firms to act against their existing customers’ best interests;
• retirement income products and distribution may deliver poor consumer outcomes;
• the growth of consumer credit may lead to unaffordable debt;
• terms and conditions may be excessively complex; and
• house price growth that is substantial and rapid may give rise to conduct issues.

Whilst there is currently no action planned, it is worth noting that the FCA will be monitoring product terms and conditions. There is, according to the FCA, a risk that market conditions may increase the disparity between what firms can viably offer consumers and what consumers need from financial products. Specifically, the regulator will monitor the risk that consumers may misunderstand the degree of protection they have, obstacles to exit a product or service that were unclear at the point of sale, complex terms and conditions that make it difficult for consumers to compare products, costs, risks or exclusions, and any tension between “explaining complex terms and conditions clearly in plain language and the extra length this gives documents”, for example, in insurance contracts.

The timetable for current and planned thematic work and market studies is as follows:

Q1 2014: general insurance add-ons, retirement income study, review of post-RDR adviser charging and service disclosure, PPI redress, financial incentives, complaints handling and resilience against cyber attacks;

Q2 2014: fair treatment of long-standing customers in life insurance, RDR post-implementation review, cover holders, managing the performance of staff and visibility of resilience and risks at board level;

Q3 2014: premium finance, motor legal expenses insurance, commercial claims, protection of client money by small firms, packaged bank accounts and effective due diligence for retail investment advice; and

Q4 2014: governance of with-profit funds and mobile phone insurance.

View FCA Business Plan 2014/15, 3 April 2014

View FCA Risk Outlook 2014,  3 April 2014