Steve Southall and Mark Leather assess general insurance regulation one year on

In the run up to regulation, the relationship between the general insurance industry and the FSA could have been described as something akin to a blind date. Neither party being too sure of what to expect from the other and both looking to establish some form of trust before taking things further.

The relationship is now a year old, so how has it changed?

In the public arena both sides stand accused of some early indiscretions. The FSA of "gold-plating" the Insurance Mediation Directive (IMD), and of adding "unnecessary" cost, to the industry.

Equally, the industry, has been slow to reform its traditional practices in terms of delivering contract certainty, to recognise and manage conflicts of interest and, in places, of failing to properly implement the FSA rules, notably in relation to disclosure documentation, client money and the sale of payment protection insurance (PPI).

Those who claim that the FSA has "gold plated" the IMD often argue that general insurance regulation was a solution looking for a problem - citing both the lack of evidence of significant customer detriment in the market and the fact that customers could always take their business elsewhere as arguments for a lighter regulatory touch.

Customer detriment
While it is unfair to tar the whole market with the same brush, the Spitzer findings and PPI are examples of the sort of customer detriment that opponents of regulation have suggested did not exist in general insurance.

Equally, while the competitive nature of the market does encourage fair treatment of customers, the 'like it or lump it' approach to customer management hardly seems a good basis for dealing with customers or enhancing the reputation of the market.

Overall, in our view, the reality is of progress but with more work to do. The industry has put considerable effort into implementing and following the new rulebook.

Given the breadth of regulatory obligations, it is not surprising that there are some issues currently viewed as "could do better".

There is no doubt that regulation has extended good practice to the intermediary market in areas such as corporate governance, risk management and the control environment.

It is true that it has cost the industry time and money to improve standards in these areas, but the benefits will be felt over the longer term through more efficient and effective business management. The market as a whole will benefit.

The relationship faces further tests this year. The industry faces ongoing 'Dear CEO' issues, covering conflicts of interest, client money, disclosure documentation and PPI. Each of these offers a different challenge.

Disclosure documentation and PPI are likely to have the highest public profile. While disclosure documentation should be resolved quickly, by addressing the issues raised in the FSA's letter, PPI is likely to be a longer running saga with greater potential reputational risk to the insurance market.

The FSA will undertake further themed visits to test compliance and will be investigating those firms where it found particularly serious problems. The FSA has indicated that enforcement action is a real possibility with the adverse publicity it will bring both for the firms concerned and the industry as a whole.

The fact that many of the PPI problems highlighted by the FSA sit with the distributors rather than the manufacturers of the PPI may well be lost on the general public, but should be a lesson to the industry as a whole.

The Office of Fair Trading study will prolong the public examination of the market with previous studies taking over 12 months to complete.

Disclosure documentation and PPI may have the highest public profile, but conflicts of interest has the potential for the greatest impact on the market, as Spitzer has already demonstrated. The Spitzer inquiry has acted as a driver towards more transparency in terms of remuneration, but the FSA is keen for the market to look at conflicts of interest from a wider perspective.

We have identified over 100 potential conflicts within a "typical" intermediary business suggesting that this will be a more complex issue than firms may have thought.

The EU Competition Commission's Spitzer-style enquiry scheduled for early this year will place further emphasis on this area.

In terms of client money the industry still has more work to do. Year-end audit requirements will be an immediate, and ongoing, issue with firms needing to actively demonstrate and gain auditors sign-off on their client money requirements.

In addition to these 'Dear CEO' issues, contract certainty will remain on the agenda with the FSA intending to make a decision on whether to add contract certainty to its regulation of the market.

Whether a market, or a regulatory, solution emerges, the demands of delivering contract certainty, against a background, in some firms, of a reduction in staff numbers and skill-set looks to be another key challenge for the year ahead. The biggest challenge is with insurers. A recent survey of over 100 major insurance buyers by accountants Ernst & Young identified insurer resource and mindset as the two biggest obstacles to achieving contract certainty. Brokers were considered to "be more agile".

As if these challenges were not enough, we think treating customers fairly will be an increasingly important issue in 2006. Having clarified its expectations, through its Building On Progress paper in July 2005, the FSA will move on in 2006 to assessing whether those expectations are being met.

This will include a specific focus on financial promotions (now that the one year grace period has expired) and claims.

While many firms have taken up the challenge of undertaking a gap analysis of their existing approach to customer management, and closing gaps where appropriate, we think the greater challenge will be to meet the FSA's requirement to embed TCF into staff behaviour and culture.

Against these challenges, plans are afoot to lighten the regulatory load. In December the government announced a 10-point action plan to reform the UK regulation of financial services, in conjunction with the FSA's own Better Regulation Action Plan.

Reduce costs
The government reforms focus on steps to improve regulation by enhancing the risk-based approach, improving the regulatory framework to deliver better and more proportionate, principle-based, regulation and to reduce costs to businesses.

The FSA itself will be undertaking its own insurance conduct of business rules (ICOB) effectiveness review, beginning in April, providing an opportunity for the industry to have its say on what has and has not worked.

Clearly potential changes to status disclosure requirements will be a major area of contention. Firms will also see changes to the 'arrow visits' process with a new risk model and the opportunity to comment on a draft Risk Mitigation Programme (RMP) rather just receive a final version as was the case in 2005.

Against these changes, after the rush to be compliant by January 2005, and following a year of practical experience, we expect pressure internally within firms to review compliance functions and processes to ensure that regulatory risk is being managed in an efficient and effective way.

So one year on from that first 'blind date', what are the future prospects for the regulatory relationship? It is a relationship that is going to continue, for better or for worse, for the foreseeable future.

While 2004 or 2005 may have been the high watermark of regulatory effort within firms, the relationship is likely to be more demanding going forward. IT

' Steve Southall and Mark Leather are members of the Ernst & Young general insurance regulatory team

Lessons to be learned
The first year of regulation has shown that there are lessons to be learned.

These include:

  • The FSA places considerable reliance on senior management within firms to ensure that their businesses are compliant. Managing regulatory risk should therefore be a key objective of all executives within the industry
  • It is important to be both compliant and to demonstrate compliance. While firms have sought to comply with the spirit and letter of the rulebook, they have not always fully documented how they are doing so - making it difficult to provide evidence to the FSA that they are compliant
  • As with any business change, new regulation is a complex process requiring business buy-ins and management of a range of levers including people, process and technology. Firms ignore each element at their peril.