Brokers (and Insurers) – Are you prepared for Product Governance Interventions?

In October 2022, the Product Governance (“PROD”) Rules, implemented by the Financial Conduct Authority, officially came into force for insurers and brokers in the UK. https://www.fca.org.uk/publications/policy-statements/ps21-11-general-insurance-pricing-practices-amendments

The newly introduced rules follow a long line of product governance guidance and interventions from the FCA into pricing levels within the insurance market.  They supersede the “General insurance distribution chain: Finalised guidance for insurance product manufacturers and distributors” (FG19/05), which the FCA withdrew on 1 October 2021.

The PROD Rules apply to brokers and insurers of all general insurers and pure protection products in the UK, with the exception of reinsurance contracts. They were provisionally launched on 1 October 2021 with a one-year transitional period for existing insurance products to enable brokers and insurers to make any necessary changes to avoid falling foul of the enhanced regulations. Therefore, non-compliance from brokers and insurers alike with the new guidelines from 2 October 2022 runs the risk of FCA intervention.

PROD

The rules aim to deliver what the FCA deem to be “fair value products” for all consumers relative to their coverage circumstances. The aims, as quoted by the FCA, are for the rules to overhaul how insurance is presented to firms and consumers alike. They aim to drive competition between brokers and insurers by lowering both the barriers to switching policies and insurance premiums in general.

One misconception about the rules is that the FCA are intending to impose a blanket cap on profit margins. In actual fact, their focus appears to be in addressing the problem of loyal customers having to over-pay for their renewals in both premiums and broker remuneration (so-called “price walking”). The research papers and guidance reports that were the pre-cursor to the PROD rules identified stark differences between the product price for new customers and the price for loyal (ie renewal) customers, and some of their findings were quite stark.

The rules now require that, where an insurer sets a renewal price, this must be no higher than the equivalent new business price (ENBP). The rules also affirm that the ENBP must reflect both cash and cash‑equivalent incentives that are offered to new customers.

As is the way with the FCA, transparency is at the heart of the changes. Brokers and insurers are now required to be transparent about the cover they are selling and how it differs to the other products on the market; not to impose barriers to consumers switching to better deals and; to report to the FCA about compliance/non-compliance with the rules.

With regards to reporting, brokers and insurers will be required to report ‘average prior year premium’ for each reporting category of customers renewing. This will provide an indication of how prices might have changed year on year for renewing customers in-line with price equality ambitions. In any event, insurers and brokers must also report on pricing data wholistically.

FCA Interventions

The FCA have been ambiguous as to the exact measures which will be taken in the event of non-compliance.  However, given the focus that the rules have been given within the FCA, it is likely that misdemeanours will be taken seriously. Considering the strict reporting requirements, it will be straightforward for the FCA to identify those who have fallen short via omission of a report or unsatisfactory findings.

One of the many dangers with this new regime is that the way in which the new rules are interpreted and enforced could skew the market, and produce unfavourable events.  This is specifically noted by the FCA in their guidance; for example, strict enforcement of the rules could make it unprofitable for some providers to operate in the particular market, which in turn might lead to less competition and a rise in prices.  And that outcome would run counter to the overriding purpose or intention of the rules.  The fact that the FCA have identified this risk at an early stage appears to reflect their willingness to adapt their enforcement and intervention stance depending on how things go.  Nevertheless, there is no getting around the need for insurers and brokers to get to grips with this new regime quickly and to avoid attracting any unwanted attention from the regulator.

Practical considerations

As is so often the case, prevention is better than cure.  If not already prepared, it is important for brokers and insurers to get their houses in order to limit retrospective redress.  The rules are reasonably clear in their demands, and so it ought to be relatively straightforward to roll out process changes and staff education.

With regards to ensuring that loyal customers do not fall victim to Price Walking, insurers and brokers will need to review their pricing and remuneration models for products and undertake an analysis of longstanding renewals relative to new business. For Brokers, this will involve ensuring that the difference between the net-rated price and the overall gross price of the products they procure for their clients does not become progressively larger over time, suggesting larger intermediary profit the longer a customer is with the broker. Similarly for insurers, they must set provisions to ensure the difference between the risk price and the net-rated / gross price does not significantly increase, by way of pure insurer profit, for long-term renewing customers.  The overriding suggestion is that insurers should maintain the ENBP

In addition to the above, attention will need to be given to any packages and special offers that are made to attract new customers.  Although it is relatively straightforward to identify differences in monetary amounts, this exercise may prove more difficult when dealing with non-cash incentives.  As of yet, there is no specific formula for calculating the value of non-cash incentives. However as a rule of thumb any benefit with a distinguishable value should be considered as a non-cash incentive for the purposes of reporting under the new rules. In any event, it is important to keep records of all non-cash incentives offered for the purposes of review and or inspection.

With regards to pricing and profits, although one of the ultimate objectives of the rules is to lower premium prices, the main focus seems to be on price inequality between different sets of customers. So there is no restriction on the levels of profit a broker or insurer can make, as long as there is consistency across the customer group as to the margins being earned.  There is nothing to stop differing margins being imposed in differing classes of business, as long as there is consistency within the class.  And as long as renewal prices remain the same as (or lower than) new business prices.

Finally, both insurers and brokers will need to be very clear about the scope of the products they are selling, particularly if the scope of cover is being restricted in any way when compared to market norms or the expiring terms.  Insurers won’t be able to make substantive changes to their products without highlighting those changes, and brokers will need to ensure that they are very clear and precise in communicating those changes (and their possible implications) to their clients.  Written records will be absolutely essential in both cases.

We will endeavour to publish further updates as the rules continue to bed in.  In the meantime, you can view our previous article on broker remuneration here.