FCA launches discussion on how its rules apply to commercial insurance products

What does this mean?

The FCA notes many of its current insurance rules stem from the EU’s Insurance Distribution Directive (IDD), implemented in 2018. At the time, the FCA implemented the IDD by introducing new rules on product governance through the Product Intervention and Product Governance sourcebook (PROD). These rules were later enhanced by the pricing practices remedies, which require firms to provide fair value to customers. 

The introduction of the Consumer Duty has further reinforced the FCA’s rules in PROD, and focuses on firms delivering good customer outcomes. In addition to consumers, most of these rules also apply to businesses where the insurance contract would not fit under the FCA’s definition of ‘contracts of large risks’. The FCA has been engaging with industry stakeholders to understand the challenges it faced when implementing PROD and Consumer Duty rules. In light of this engagement the FCA presents options in DP24/1 to consider areas where it can reduce regulatory requirements and costs on firms, while maintaining protection for small and medium enterprise (SME) insurance customers. 

Definition of ‘contracts of large risks’

The FCA explores how some of its rules designed for consumer protection extend to certain commercial customers. Current rules differentiate consumers (acting outside their trade or professions) from commercial customers based on the ‘contracts of large risks’ definition. 

Commercial customers range from small businesses to large corporations. Small businesses often lack insurance expertise and resources, which makes them similar to consumers in their need for protection. Larger corporations usually have the expertise and financial power to negotiate, and require less regulatory intervention. 

Industry feedback to the FCA highlights inconsistencies in definitions across various rules (for example, FCA Glossary, Dispute Resolution: Complaints sourcebook (DISP) and the Perimeter Guidance Manual), which can complicate customer categorisation and create regulatory cost burdens. Some product-specific rules lead to unnecessary protections and thus potentially additional expense for large corporations.

DP24/1 outlines potential amendments to the ‘contacts of large risks’ definition to better differentiate between larger commercial customers and SMEs, while ensuring that appropriate levels of protection are maintained. The FCA explores three options with two supplementary options:

• Option one: align the large risks definition with the DISP rules for eligible complainants who can access the Financial Ombudsman Service, removing product-specific rules to simplify the framework and reduce costs.

• Option two: only remove product-specific rules, maintaining the current ‘large risks’ criteria but ensuring consistency across all insurance products.

• Option three: develop a new definition specific to the insurance market, although this may not resolve all inconsistency issues.

• Supplementary option one: define all SMEs with 0-1 employees as consumers due to their similarity to individual consumers in terms of financial expertise and negotiating power.

• Supplementary option two: address challenges with policies that have multiple named or unnamed policyholders through guidance or rule amendments.

Co-manufacturers of insurance products 

PROD rules outline the requirements for firms on the approval, maintenance, operation, review, and distribution of insurance products. The FCA explains that industry stakeholders have raised several issues with the current PROD rules for co-manufacturing arrangements, questioning the need for each co-manufacturer to separately approve the product, the efficiency of the current responsibility sharing mechanisms, and interactions with distributors (sometimes distributors are approached separately by each co-manufacturer for information). 

The FCA explores three options to address industry concerns in this area:

• Option one: a single 'lead' insurer would handle compliance with PROD 4.2, with others providing necessary data.

• Option two: co-manufacturers can decide whether to appoint a lead or share responsibilities. 

• Option three: additional FCA guidance on current rules to provide clarification and prevent misunderstandings.

Additionally, the FCA recognises the issues with ICOBS customer disclosure rules in multi-insurer arrangements, which can lead to multiple insurers sending separate disclosure documents to customers. DP24/1 asks for feedback on rules changes to designate a 'lead' firm responsible for collating and sending all disclosure information when no intermediaries are involved.

Bespoke products exclusion

While ‘bespoke contracts’ is not a defined FCA term, the FCA explains it considers the bespoke products exclusion to be the adaptation of an existing insurance product for an individual customer, which is not considered manufacturing under PROD rules.

The exclusion currently applies only to intermediaries. The FCA recognises many firms are not using this exclusion due to misinterpreting that it applies only to entirely new contracts as bespoke.

The FCA’s options in this area aim to reduce unnecessary work and costs for firms by clearly defining and expanding the bespoke contract exclusion (to include both insurers and intermediary co-manufacturers).

What do firms need to do?

Following changes to PROD and the coming into force of the Consumer Duty, the FCA had indicated its intentions to explore how it can make its rules designed for retail consumers and SMEs to apply more proportionately to large commercial customers. DP24/1 marks the FCA’s first step to achieve a better balance in its rules. 

As the FCA is in the initial stages of potential policy changes in this area, firms may want to start considering how they currently differentiate their SME and large risk customers under the FCA’s various rules, and if they are comfortable with existing policies and processes. 

The FCA makes clear that it considers some firms are misunderstanding or misinterpreting its rules. Firms should consider these areas to understand if this concern applies to them. One example of potential misunderstanding the FCA provides is how its rules apply to co-manufacturer arrangements where one firm can collate and analyse all the relevant fair value data, and produce a report to be shared with other co-manufacturers who can rely on this data to approve fair value. 

Firms with SME and large risk customers should review DP24/1 and consider engaging with the FCA to help shape the FCA’s policy in this area.

Next steps

DP24/1 closes on 16 September 2024. The FCA will consider the responses it receives and then decide whether it should consult to make changes to its rules and guidance.