Guilty: The FSA on trial

Tim Oliver, the vice-president of the Forum of Insurance Lawyers; Grant Ellis, chief executive of the Broker Network, the UK’s largest broker network; Barbara Bradshaw, chief executive of the IIB; and Steve White, Biba’s resident regulation expert, pictured left to right, joined Insurance Times deputy editor Ellen Bennett to debate five charges against the FSA, which has been regulating brokers since 2005.

This came against the background of Conservative leader David Cameron’s recent pledge to abolish the FSA if he is elected to power, and widespread criticism of the body for failing to prevent the collapse of Northern Rock and Bradford & Bingley, and the ensuing financial crisis.

Closer to home, the regulator has been making headlines with its plans to hike charges for brokers; the huge fees it paid for the inquiry into commission disclosure, as revealed by Insurance Times; and its ongoing insistence that brokers cross-subsidise insurers and banks under the controversial Financial Services Compensation Scheme. The panel was chaired by Oliver.

Charge 1 The FSA has been too soft on the banks and failed to fulfil its statutory function to protect consumers by not properly regulating insurers.

Verdict Guilty

Testimony There was a consensus among the panel that the FSA could and should have done more to prevent the banking crisis. “It could have done much more,” Ellis said. “It was common knowledge in City at the time that Northern Rock was going to go bust. Why was it a surprise to the FSA?” Bradshaw added: “It should have been looking a lot closer.” The panel agreed that it was not intentional, but suggested that the FSA simply failed to understand the implications of the banking models that were being used.

There was more sympathy for the authority when it came to insurers. As the panel pointed out, there has not been an insurer collapse since Independent in 2001 – and there was little the FSA could have done to have prevent that.

Certain overseas insurers that offered low-cost policies in the UK were mentioned but, again, the panel felt there was little the FSA could do to stop them operating here. “I’m not convinced there’s a case to answer on not having regulated insurers properly,” Ellis said. “But that could be entirely down to luck.”

There were more detailed criticisms with regard to payment protection insurance (PPI), which is largely sold by banks. As White pointed out, there were 35,000 complaints to the Financial Services Ombudsman last year about the mis-selling of PPI, 95% of which were upheld in the customer’s favour. “It is systematic mis-selling which is still going on because the FSA will not bang heads together and sort it out,” he said. “It’s simple: if it finds a bank mis-selling, it can stop it doing so – but it hasn’t done it.”

The FSA has intervened in the PPI market in another way, however, recently writing to a number of leading insurers and brokers telling them to stop hiking premiums, in the interests of treating customers fairly.

The move invoked the ire of the broking profession, which argues that the FSA is overstepping its remit – a charge that came up time and again during the discussion.

“It’s fundamentally an example of it getting involved in pricing,” Ellis said. “The authority is talking about us writing to consumers to say the premium shouldn’t have been increased so here’s the money back. It is fundamentally undermining one of the principles of insurance: that you don’t end up in a better position having claimed than you would have done had you not had to claim. There’s a whole raft of things where the FSA is reacting to something. There’s a consequence in what it is doing that it doesn’t understand.”

There was some debate on this point, with White agreeing that the FSA should not get involved in pricing, but suggesting that broker commission on PPI policies was too high.

Overall, the panel agreed that the FSA had been too soft on the banks. “It comes heavy-handed on things that don’t matter and misses the things that do,” Ellis said.

Charge 2 The FSA has made brokers liable for the failure of a bank or insurer under the Financial Services Compensation Scheme (FSCS).

Verdict Guilty

Testimony If a bank or insurer fails, brokers are liable to pay compensation under the FSCS – a unique position in Europe which has provoked fury in the industry. “It’s totally unfair,” said White. “We are not at all to blame for the failure of the banking sector. Indeed, a lot of intermediaries have been heavily disadvantaged by what’s going on in the banking sector, from a business perspective, yet here they are potentially having to put their hands in the pockets for the failure of Bradford & Bingley.” Bradshaw added: “Brokers have lost business to the banks, and yet they are having to pay for their failures. It’s a double whammy, through no fault of their own.”

The panel agreed that, when the FSCS was introduced in its current form, there was no expectation of a bank collapse – then the worst-case scenario hit. Was the FSA aware of the risk? asked Oliver. Bradshaw said:?“It knew damn well, because we told it. It just completely ignored us.”

The panel pointed out that brokers did not know how much they could be liable, making it difficult to plan their finances. “You don’t know what you could be on the hook for – it’s like being a Lloyd’s Name,” said Bradshaw. Ellis added: “The smallest businesses are going to be the worst affected.”

Could things change if the FSA were abolished? “It would be in the hands of the government to do that, and one would hope that if we abolished the FSA, some of its more unusual decisions would be overturned,” said Ellis.

The FSA turned down an invitation to attend the debate, but a spokesman said later that the authority would start another comprehensive review of the

FSCS funding model this year. It would cover:

• the structure and composition of the classes in the funding model;
• the annual thresholds each class could be asked to pay;
• the allocation of levies and the limits that apply to different types of levy;
• the method of apportionment of levies to individual firms, including considering the case for risk-based levies; and
• the treatment of new entrants to the industry and those firms leaving the industry.

Charge 3 The FSA has raised charges at a time when all businesses are trying to control costs.

Verdict Guilty

Testimony Earlier this year, the FSA hiked its charges to fund its expansion, primarily in the regulation of banks. “Brokers are trying to control their costs at the moment. They look at everything, and they see this spiralling cost and there’s absolutely nothing they can do about it,” said Bradshaw. Ellis said: “The authority is not answerable to anybody either. If it was a cost it had to justify, then you would have some lobbying opportunity, but there is none. This is what concerns me about professional regulators – they have a vested interest in increasing their sphere of influence. It becomes an industry in its own right, rather than a supporting component of an industry that already exists.”

Oliver asked whether there was any evidence of “regulatory landgrab” on the part of the FSA. “Is it raising these charges to stretch into other areas, or is it simply an increase in its workload?” he said.

White said it was a significant increase in workload. “We have an over-burdened, disproportionate financial services regulator. Most of our European peers have an insurance regulator – we don’t. We have a financial services regulator. We were shoehorned into something that was created for someone else. And that was the Treasury’s decision.”

Bradshaw said people abroad were appalled. “Nowhere else is there just one regulator. People can’t believe that we’re all in the one group; they just can’t understand it.”

Ellis added that regulators needed individual specialisms, and moving staff from one discipline to another added to the FSA’s problems.

Oliver put the case for the defence: “If I’m a consumer, I want to see the FSA all over the banks.

I don’t want to see a light touch, I want to see it recruiting the best staff and sorting things out. Isn’t it inevitable, then, that the cost of regulation will go up?”

“Absolutely,” replied White. “But then you look at how those costs are applied. What is the regulator spending its time on? It’s not general insurance intermediation – and yet some of our members were staring down the barrel of 100% fee increases this year.”

After the debate, the FSA spokesman said the financial services industry was facing unprecedented challenges and that it had “a central part” to play in addressing those challenges and providing leadership on the future shape of regulation.

“We are focused on ensuring firms are soundly run in these difficult times and consumers are protected. We need additional financial resources to meet these priorities and this has meant higher fees for regulated firms in 2009/10.”

But he said there would be no increase in fees for the smallest firms, including brokers. “We have been careful to ensure, as far as possible, that firms requiring the most regulatory work and engagement pay proportionately.”

Charge 4 The FSA spent £800,000 on an unnecessary and time-consuming review of commission disclosure.

Verdict Not Guilty

Testimony Information released to Insurance Times under the Freedom of Information Act showed that the FSA’s review of whether commission disclosure should be mandatory cost £800,000. Many brokers feel that disclosure is a pointless debate, given that commercial customers have shown very little interest – and already have the right to ask their brokers what commission they are being paid. The panel broadly supported this view. “The FSA has a fundamental view that commission is wrong, and it comes right through the whole sector,” Ellis said. “That to me is absolutely at the heart of why it just does not understand the industry.”

There was some discussion about the principles of commission disclosure, with our broker representatives in clear agreement that it would not work. “Take Direct Line,” Ellis said. “It doesn’t pay commission at all; it could use that as a selling point. The fact that its marketing spend is more than the commission paid to most insurance brokers on equivalent terms, would never be disclosed.

“I represent a very large broking business. We have offices all over the UK. We guarantee minimum volumes to various insurers; we negotiate with them at a level where we cascade the information for them; we do sales and marketing on their behalf – but they set the retail price.

“The only way I can be repaid for that investment in cutting their costs, is if they pay me more. So if I go to a customer and say ‘I’m going to earn 20% on this case’, a little broker can say, ‘I’m only going to earn 15%’. That’s not transparent. Why does Asda pay less for a tin of beans than a corner shop? Because it’s invested. Damn right it should pay less.”

But putting these arguments to one side, the panel agreed that the FSA had been forced to look at commission disclosure because of pressure from international brokers post-Spitzer, and from Europe, which is reviewing commission arrangements across the board.

“You need to be realistic,” White said. “The FSA was under a lot of pressure for a long time. The FSA is an expensive regulator, so when it commits to doing something, it costs a lot of money. It was £800,000 over two years, the FSA spends £60m a year on insurance mediation work. £800,000 is a hell of a lot of money and I could have done it a lot cheaper – but £800,000 is not a lot out of £60m.”

There was further criticism of the FSA for the “industry solution” it has implemented instead of new rules. The regulator will return to commercial customers next year and ask if they are aware of their right to ask brokers how much commission they are earning – but none of our panel was clear on how it should do this. Despite this, the panel found the FSA not guilty on this count because it had little choice but to review commission disclosure.

Charge 5 The FSA has failed to add any value to insurance broking in the UK since it started regulating the sector.

Verdict Guilty

Testimony There was a broad acceptance of the need for statutory regulation – but was the FSA best placed to deliver it? “It has played a role in making the industry more professional, of course,” Ellis said. “But the cost to the industry of doing that is far, far too high – and it continues to extend its sphere of influence.” He added that, pre-regulation, the industry tended to act as its watchdog, and pick up the pieces when things did go wrong, with insurers honouring policies where they did not have to, for example.

“It hasn’t added value to brokerages, but has added enormous costs,” Bradshaw said. “Big brokers now have entire regulation departments – it’s become a career option. And the consumer pays for that. If we had a much more specific sector of the regulator, I don’t think it would be that intense.”

Ellis said the authority had not delivered value for money at all. Bradshaw added that it had “too wide a church. It has been been allowed a complete free rein to meddle in anything it feels like meddling in, and has focused on things that have frankly been sideshows.”

The FSA spokesman later said that, in 2007, it “thoroughly reviewed” all the conduct rules that applied to insurance brokers and changed a number – for example, replacing the rules on inducements with guidance on managing conflicts of interest.

“We made other changes to simplify the rules, such as changing the requirements for demands and needs statements to be a copy-out of the insurance mediation directive (IMD). In some cases, we had to retain certain detailed rules for brokers because they were requirements of the IMD and we had no discretion over them.

“We consulted publicly on our proposed new approach and took account of the views expressed to us. In short, we have made significant efforts to ensure our rules strike the right balance between protecting consumers and not placing a disproportionate burden on firms.”

A resounding, damning verdict then: the FSA was guilty as charged, and should be abolished. But what would our panel of experts put in its place? They called for a specific insurance regulator, along the lines of other European countries, with a dedicated intermediary division staffed by experts and accountable to the industry.

“The person in charge would have a significant track record at a senior level in their industry, and would pull together their teams from that industry, rather than professional regulators,” Ellis said. White added: “We want experts; we don’t want Jacks of all trades.”

The panel also felt the regulator should be accountable to the industry somehow, and there should be someone independent, ensuring that it did not extend its own remit. They pledged to lobby for a new form of regulator in the run-up to the general election.

Ellis pointed to the Bank of England as a good example: “It is a bank, it’s got a foot in government, but it sets the rate of interest and as a result is independent of government and political pressure. I can see something like that working very well in this sector.” IT