What does the FCA’s actions on Gap mean for the future?

It has long been rumoured that the new Consumer Duty regulations would make the FCA more interventionist – and that is proving to be true with the recent regulatory action taken against providers of gap (guaranteed asset protection) insurance.

With insurers agreeing to suspend sales of the product it remains to be seen whether further action will be taken, with fines still a real possibility.

Mathew Rutter, a partner of insurance advisory at international law firm DAC Beachcroft, said this new regulatory landscape has already changed the relationship between the FCA and insurers.

“It puts the onus on firms to work out what they need to do to deliver good outcomes and to meet the FCA’s expectations,” he explained.

“Particularly at this early stage of the Consumer Duty, firms have been very dependent on the FCA to articulate exactly what it expects of them.

“One would expect that dependency to diminish over time, but at the moment we’re seeing both firms and the FCA learning from each other.”

Compliance expert Branko Bjelobaba said that one lesson insurers need to learn is to be much more engaged with their distribution chain, focusing on how brokers are remunerated in relation to the value they are adding for consumers.

“I really do doubt that insurers have effectively engaged with brokers,” he said.

“Insurers should be asking themselves whether they have assessed what it takes for a typical broker to service a typical client and what they are paying them.

“You can’t just lick your finger and stick it up in the air – this requires a precise method of calculation.”

Bjelobaba pointed to the recent furore around commissions for leasehold properties, with some insurers capping commission at 30% to 35%, as another example of the industry getting it wrong.

“That is over and above what any form of commercial insurance pays, and it is still far too generous,” he warned. “We’ve had clear rules that have said your distribution costs should be aligned directly with the costs of the distributors.

“This is where the ABI, Biba and the FCA should have sat down together and worked out an approach that would work sensibly for all parties.”

“The thing I have a concern with the most is distribution where the commission in no way aligns with their costs,” he adds.

And with both the regulator and industry still learning vital lessons about how the new regulations will play out in practice, it is certain that further regulatory action will follow over the course of 2024 and beyond.

Picking targets

The FCA has already highlighted premium finance as one area of concern for future enforcement, while a number of other business lines are also expected to be on the regulator’s watch list.

Insurance DataLab co-founder Dan King said insurers need to be aware of where the regulator may be headed next.

“With the FCA becoming increasingly interventionist, it’s essential that insurers try and stay ahead of the game,” he explained.

“Insurers need to be looking at how their products are performing and how this compares to areas where the regulator has already taken action or expressed concerns about the practices being carried out.”

King said that one area to look at is payout rates, with the latest FCA value measures revealing that gap insurance paid out as little as 4% of premiums in the form of claims when sold as an add-on product.

“The FCA is certainly looking at how much premium is being paid out as claims, as well as how that relates to the level of commission being paid,” he explained.

“We’ve heard that the unofficial threshold for that payout rate may be set at 30%, with business lines falling under that level likely to draw increased scrutiny from the FCA.”

Insurance DataLab’s analysis of the FCA’s value measures found that there are a number of business lines with a payout rate of 30% or less in 2022.

These include motor excess protection – 15% for add-ons and 30% for standalone policies – personal accident cover, which has a 19% payout rate, and home emergency add-ons, with a rate of 26%.

All in all, these business lines with low payout rates account for almost 13.7m policies and are worth close to £690m in gross written premium (GWP).

Many of these products also have claims frequencies at around the 1% to 2% mark, so it is easy to see why the regulator may be taking a closer look.

Favourable outcomes

Rutter said that, with the regulator so focused on analysing the performance of the industry on key metrics, insurers must maintain a steady focus on the measures that can most effectively evidence that they are delivering good outcomes for their customers.

“The key thing is evidencing that the insurer is achieving good outcomes and documenting that evidence,” he noted.

“As far as possible, that evidence needs to be a direct measurement of a good outcome rather than, say, relying on the absence of complaints and assuming that means good outcomes are being achieved.”

However, Rutter said that existing measures and metrics may not be enough and insurers need to be exploring other areas that can be used to evidence these good outcomes.

“Insurers should have plenty of data available to show, for example, how quickly they handle and settle claims, but may not be thinking about that in terms of the Consumer Duty,” he said.

“Insurers need to think about other data that they may need to actively gather and analyse.”

And Rutter said he believes that ensuring proper consumer understanding should be one of the key areas of focus for insurers.

“We expect the FCA to focus a lot on communications – both in formal documents such as policy wordings and also in less formal product literature and communications,” he said.

“Data on customer understanding is harder to obtain, but insurers should be thinking about testing communications and their effectiveness.”

Suitable data

As well as understanding their own performance, insurers also should be aware of what good looks like for their specific area of the market.

While the FCA may be looking for specific products that are not delivering value for their customers – such as they did with gap insurance – they are also expected to be interested in outlying firms that may not be delivering good outcomes, even in well-performing areas of the market.

“It is no longer good enough to know how you are performing on these measures, you also need to evidence it in relation to the wider market,” King said.

“The FCA has said that it will be looking for outliers in the data it assesses, so it is vital that insurers know how they are performing against their peers so they can spot any issues before the regulator gets involved.”

“Prevention is certainly better than cure when it comes to dealing with the regulator.”

Rutter said he was also fearful that the FCA may act with much greater speed when it comes to any future regulatory action.

“It’s important to remember that the FCA’s concerns on gap had been expressed for a number of years and in future we can expect the FCA to move much more quickly,” he noted.

This expected speed of action means that insurers will need to be much more proactive in their approach to compliance.

Rutter explained: “Insurers should not be waiting for direct action as we have seen in the gap market, but should instead be looking to keep one step ahead of the regulator. The main challenge with any principles- or outcomes-based approach to regulation is its ever-evolving nature.

“There may never be a safe place where insurers can say ’there’s nothing more we can do here’.”