FSA regulation of the construction industry

An imminent change in the law will have a major impact on the property and construction industries. If you carry on certain activities relating to insurance, you will need to be authorised by the Financial Services Authority. It will be a criminal offence to carry on these activities without the appropriate authorisation.

The regulated activities

There are four new regulated activities. If you carry on any of these activities you will need authorisation from the Financial Services Authority (FSA), the existing regulator of financial institutions such as banks and insurance companies.

Concluding a contract of insurance

As agent you will be carrying on this activity if:

• you purchase insurance on behalf of someone else, so you contractually commit that person to enter into the contract as policyholder. It is common, for example, for a construction company to purchase insurance on behalf of a developer, a finance provider or a sub-contractor who will be named as a policyholder or co-insured under the policy
• you have an arrangement with an insurer or broker which enables you to grant cover, on behalf of the insurer, to someone else – for example, if you have an agency agreement or binding authority with an insurer or broker.

Arranging for someone to enter into a contract of insurance

The scope of this activity is broad and the legal analysis can be complex, particularly where your involvement in arranging the insurance is limited. As a general principle, however, you will be arranging insurance where you act as an intermediary between the prospective policyholder (or their agent) and an insurer or broker and you provide information on the prospective policyholder or their insurance requirements to the insurer or broker. So, for example, you will be arranging insurance for a developer if:

• you submit an application or proposal form signed by the developer to a broker/insurer (if you sign the form yourself, you may be concluding a contract as agent, as described above)
• you provide information on the developer or the developer's insurance needs to a broker/insurer to enable them to prepare a quote or
• you provide the developer's contact details to a broker/insurer so they can contact the developer directly.

Assisting in the administration and performance of a contract of insurance

This relates primarily to activities carried on for policyholders after the policy has been put in place. The principal activity caught is assisting policyholders with claims, but ongoing policy management activities on behalf of a policyholder may also be caught, so, for example, making disclosure under a policy or notifying mid-term adjustments on behalf of a policyholder may bring you within the FSA net. A construction company which completes or provides evidence in support of a claim and submits a claim form on behalf of a policyholder, or which negotiates and agrees a claim on behalf of a policyholder will be assisting in the administration and performance of a contract of insurance.

Advising on a contract of insurance

This activity is less likely to be relevant. A distinction is drawn between the provision of advice and the provision of information (provision of information is not a regulated activity). Advice normally involves some form of recommendation (express or implied). The provision of factual information on, for example, the risks covered by a particular policy or the premium payable under a particular policy would not normally be advice. Also, in order to be a regulated activity, the advice must relate to a particular policy. A recommendation that someone should take out a particular class of cover would not therefore be a regulated activity, nor would advice on the extent of the cover that a client should purchase, unless, in either case, you then go on to discuss a particular policy. Advice that a premium is cheap/expensive etc. would, however, be caught.

Importantly, agreeing to carry on any of the above activities is itself regulated, so companies cannot contractually agree to arrange insurance and then hope to avoid authorisation by delegating actual performance to a broker.

Remuneration

FSA authorisation is only required if you are remunerated for your insurance related activities and you carry on those activities by way of business. Remuneration is interpreted widely and includes:

• direct remuneration, such as receipt of commission from an insurer or broker
• any other commercial benefit which you may receive as a direct result of your insurance activities, for example a reduction in your own insurance premiums, which is granted by an insurer or broker because of the additional business you provide to them and
• any indirect commercial benefit which you may receive as a result of the activities, for example, where you are paid to provide a range of services which include regulated activities related to insurance. An indirect commercial benefit would also be obtained where the insurance activities play a material part in the success of your other activities or provide you with a materially increased opportunity to supply other goods or services, i.e. you win more business because you are able to provide the insurance services, or you would lose business if you were not able to do so.

Consequences of FSA authorisation

If you do become FSA authorised, you must comply with the detailed requirements of the FSA rules. Broadly speaking, these fall into six categories:

• Fees - You must pay an application fee, an annual fee and make contributions to the Financial Ombudsman Service (FSA's dispute resolution scheme) and the Financial Services Compensation Scheme.
• Financial requirements - You must maintain minimum levels of capital and professional indemnity insurance and hold clients' insurance monies (premium and claims) in accordance with FSA's client money rules.
• Insurance Conduct of Business ("ICOB") rules - These are prescriptive rules which govern the way in which you provide insurance related services to your clients.
• Training - The staff involved in insurance activities must be vetted and trained on an ongoing basis to ensure they are competent to perform those activities.
• Systems and controls - You must have documented systems and controls which are appropriate to your business, including controls to ensure compliance with FSA rules.
• Approved persons - At least one individual within your business will need to be individually approved and registered with FSA.

If you fail to meet the requirements of the FSA rules you can be disciplined by FSA which may result in a fine or withdrawal of your authorisation. Approved persons can also be disciplined.

Avoiding FSA authorisation

There are three options. Firstly, you can restructure your operations so you are not carrying on regulated activities – there are a range of possibilities, all of which have implications for the service you can offer.

Secondly, you can restructure your operations so you are not being remunerated for the insurance activities or you are not carrying on those activities by way of business – again, there may be commercial implications and you may lose some income, but this may be preferable to regulation. Any attempt to restructure operations will need to take account of existing as well as future arrangements. If you are currently contractually obliged to perform insurance related activities, the entities to whom you provide those services will have little incentive to agree to a change.

Thirdly, you can become an appointed representative (AR) of an FSA authorised firm (an insurer or a broker). An AR can carry on the regulated activities described above without being FSA authorised. Instead, the authorised firm who appoints the AR accepts responsibility to FSA and to customers for the AR's activities. The principle advantage of being an AR is that you do not need your own FSA authorisation and FSA rules will not apply directly to you. As a result, you will not have to pay application fees, annual fees etc. and you will not have to maintain minimum capital or professional indemnity insurance. Having said that, AR status is not an easy way out of regulation. The firm which appoints you will have to ensure your compliance with FSA rules:

• It will impose a contractual obligation on you to comply with the FSA rules (including ICOB).
• It will impose its own systems and controls on your business which may be more onerous than those which you would otherwise have to implement.
• It will require your staff to be vetted and trained to the required standard
• You will still need to have at least one approved person.
• It will wish to check your processes and business from time to time to ensure that you are operating in accordance with FSA's requirements and your contractual obligations – this is likely to involve visits to your office and a review of your files.
• It may charge you or offer less attractive commercial terms because of the services it is providing to you and the risks involved.
• It may impose restrictions on your insurance activities, for example, if you become the AR of an insurer it may stop you from selling other insurers' policies.

In short, if you become an AR you may lose a considerable degree of control over the insurance aspects of your business.

When does all this happen?

The new law comes into effect on 14 January 2005. However, you really do need to act now because FSA has up to six months to consider an application for authorisation. If you are not authorised when you need to be, you will be committing a criminal offence and insurers/brokers will refuse to deal with you.

For further details please contact Paul Edmondson on +44 (0)20 7367 2877 or at [email protected]