FSA regulation of general insurance - the scope of the new regime

The Government has published draft legislation to implement the Insurance Mediation Directive ("IMD"). This legislation will give the FSA greater powers over general insurance, protection and critical illness policies. As expected, IMD will be implemented using the existing regime for financial services regulation in the United Kingdom. The Regulated Activities Order ("RAO") currently sets out the activities for which FSA authorisation is required. This Order will be extended to include new general insurance activities.

Broadly speaking, the RAO defines the scope of regulation by reference to regulated activities and regulated investments. If you carry on a regulated activity in the UK in relation to a regulated investment then, subject to certain exceptions, you require FSA authorisation. All contracts of insurance (life and general) are regulated investments under the RAO. All insurers therefore require authorisation. Intermediaries, however, do not currently require authorisation if their activities relate to general insurance, protection or critical illness contracts (only life intermediaries are currently caught). This will change so that general insurance intermediaries will, in future, need to be FSA authorised.

The new regulated activities

The following (non-exhaustive list of) activities will require authorisation from FSA, whether carried on in relation to life or general insurance.

Dealing in contracts of insurance as agent – it does not matter whether you are acting as an agent for the insurer or the insured. Underwriting agents, coverholders and the like will be caught as well as intermediaries who complete contracts of insurance for customers.

Arranging insurance contracts – this activity will catch most intermediaries. It covers (i) arranging for a person to enter a particular insurance contract with an insurer, or (ii) making arrangements with a view to another person who participates in those arrangements buying an (unspecified) insurance contract.

Introducing a potential policyholder to an insurer or an intermediary may fall into the second category. An introducer will be caught if he is remunerated for the introduction unless he is able to rely on an exclusion for the provision of information on an incidental basis in the context of another professional activity. This exclusion may, for example, apply to lawyers, accountants, doctors, dentists, car mechanics and retailers. The exclusion is, however, restricted to the supply of information and an introducer cannot rely on it if he provides advice on the insurance product (see below) or he in any way negotiates with the insurer over the terms of the policy.

Advising on insurance contracts – advice on a particular insurance contract will be regulated. Generic advice, such as advising someone to take out some form of private medical insurance, will not be regulated. This distinction between generic advice and advice on a particular contract reflects the current position in the RAO for other regulated investments.

Managing insurance contracts – the Government has tried hard here to include the IMD activity of "assisting in the performance and administration of a contract" within existing financial services terminology. At present, managing investments catches the activities of fund managers. It is not immediately apparent what managing insurance contracts may cover. It is, however, designed to catch post point of sale activities. FSA will provide further guidance on the precise scope of this in due course. It is relevant to note, however, that the activity catches people who assist in the administration and performance of a contract. An outsourcing provider who sends out renewal notices is therefore unlikely to be caught: it may be assisting in the administration of the contract but will not be assisting in the performance. Further, claims handling by intermediaries on behalf of insurance companies, expert appraisal and loss adjusting are specifically excluded, although the precise extent of this exclusion is currently unclear.

In order to ensure a level playing field, the Government intends to regulate each of the above activities whether carried on by insurers or intermediaries/others (even though the IMD does not require the activity to be regulated when carried on by insurers' employees).

FSA authorisation is, however, only required if the regulated activities are carried on by way of business. Whether a person is carrying on activities by way of business will depend on all the circumstances. Relevant factors include remuneration (a key, but not essential element), the frequency with which the activity is carried on, the nature of the activity and whether the person is acting in the course of a trade or profession.

Excluded contracts of insurance

The IMD excludes from regulation mediation activities relating to insurance contracts for risks outside the European Community. However, in the UK's current life regime, if mediation takes place in the UK, authorisation is required irrespective of the location of the risk so, for example, a financial adviser based in the UK who arranges life cover for a US resident will require UK authorisation. The Government proposes to apply the same approach to general insurance with one important exception: mediation activities in relation to contracts for large risks situated outside the EEA will not be caught [1]. In reality, of course, few, if any, insurers or intermediaries situated in the UK will be involved in non-EEA large risks only. The practical consequences of this exemption are therefore hard to define. It is, however, possible that FSA rules governing mediation activities will not apply when those activities relate to large risks situated outside the EEA.

Certain activities carried on in relation to travel and extended warranty insurance may also be excluded. Travel insurance sold as a stand-alone product will be regulated. Travel insurance sold with a holiday which meets certain conditions may, however, be excluded. The Government is considering three options in respect of this type of sale: no statutory regulation, full FSA regulation and industry-specific regulation. Under the latter option travel agents and tour operators selling travel insurance with a holiday would not require authorisation provided they were subject to a suitable ABTA Code which would be certified by FSA. The tone of the Government's consultation document suggests this is its preferred approach, although the exemption seems difficult to justify on any logical basis.

Extended warranty products which meet certain criteria may also be excluded. The Government proposes that all extended motor warranties which are contracts of insurance should be regulated. In respect of other goods, the Government intends to reconsider the issue once the conclusions of the Competition Commission's investigation into extended warranties on domestic electrical appliances have been published.

Avoiding authorisation

In general terms, only persons authorised by FSA are able to carry on regulated activities. However, an important exemption exists for appointed representatives who may carry on regulated activities without themselves being authorised. An authorised person must, however, accept legal and regulatory responsibility for the conduct of all regulated activities carried out by the appointed representative. The existing appointed representative regime will apply in a modified form to all insurance mediation activities. Limitations on the regime will be set by FSA and it is not yet clear, for example, whether an intermediary who sells the products of a number of insurers can become the appointed representative of each of them.

It will be interesting to see what effects the appointed representative regime will have on long distribution chains for personal lines insurance. The insurer at the top of a chain may be prepared to accept responsibility for the activities of the intermediary immediately below it in the chain, with whom it deals on a regular basis and over whom the insurer can exercise a degree of supervision or control, but it is less likely to accept responsibility for intermediaries further down the chain. The appointed representative cannot accept responsibility for the next person in the chain, so it seems likely that everybody in this type of chain will need to authorised in their own right or such chains will disappear.

European passport rights

Once authorisation has been obtained, the authorised person can exercise passport rights granted by the IMD to carry on mediation activities in other European Member States without becoming separately authorised by the regulators in those States. A simple notification process is all that is required. It is, however, possible that insurers and intermediaries will need to comply with conduct of business rules applicable in the relevant jurisdiction when doing business overseas.

In conclusion, the recent Treasury paper defines the perimeter of the new regulatory regime. However, a lot of questions remain unanswered. More detail should be provided in coming months as FSA produces consultation papers to explain how it proposes to regulate insurance mediation activities. In November, FSA will start consulting on its high level rules and the conditions which must be met before authorisation will be granted. In the second quarter of 2003 it will consult on conduct of business rules governing the day to day activities of general insurers and intermediaries. The authorisation requirement will not come into force until October 2004, but the process is now underway. Everybody involved in general insurance will need to consider how the new regime may impact their business. Experience from N2 (the date when FSA introduced new rules to govern other financial services) suggests that those who fall behind with their thinking now will find it difficult to catch up and may, ultimately, prejudice their chances of obtaining FSA authorisation.

For further information, please contact either Nick Paul at [email protected] or on +44 (0)20 7367 2806 or Paul Edmondson at [email protected] or on +44 (0)20 7367 2877.

Footnote

[1] Large risks include railway stock, aircraft, ships, goods in transit, aircraft and shipping liability; risks related to credit and suretyship where the risk relates to the commercial or professional activities of the policyholder; and risks relating to land vehicles, fire, property damage, motor vehicle and certain financial loss where this policyholder meets specified criteria as to assets, turnover and employees