PS174: Prudential and other requirments for mortgage firms and insurance intermediaries

Risk transfer
Risk transfer to insurers to be voluntary. Some agency agreements may enable risk transfer to take place.

FSA's comments: "We didn't feel it would be equitable to make insurers take all of the risk. Where the agency agreement transfers the risk to the insurer, that is a good thing and does work to the benefit of the consumer. But we didn't think we should go beyond that.

Client money segregation
Client money segregation to be achieved through statutory or non-statutory trusts. The non-statutory trust has replaced the voluntary trust in CP174 and permits the intermediary as trustee to lend money out of the fund. Unlike the voluntary trust, the non-statutory trust can be used for commercial and retail money. Where it is used to hold retail money there is a minimum capital requirement of £50,000.

There have been no changes to the statutory trust.

Non-statutory trusts will require good systems and controls and need to be audited. Statutory trusts with less than £30,000 client money a year do not need an auditor.

FSA comments: "It was clear from consultation that we had underestimated the practical problems and costs of segregated accounts. Changes have been made to pick up and address the problems, bring a degree of flexibility and make it closer to market practice."

Capital requirements
Brokers not holding client money and carrying out no other regulated activities will be subject to minimum capital requirements of the higher of £5,000 or 2.5% net annual brokerage income - reduced from 5%.

Brokers holding client money will be subject to minimum capital requirements of the higher of £10,000 or 5% net annual brokerage income. The third option, 5% of average client money balances, has been removed.

FSA comments: "The rules have been simplified, making a clear distinction between those that hold client money and those that don't. People will know exactly where they are.

Professional indemnity requirements
The minimum requirements of ¤1m (£0.7m) single claim and ¤1.5m (£1.05m) in the aggregate have been maintained. But the overriding income multiple has been reduced from three times annual income to 10% of annual income. An upper limit has been maintained but reset to £30m

For firms not holding client money excesses have been reduced to no higher than £2,500 or 1.5% of annual income. For firms holding client money the proposals in CP 174 are maintained - £5,000 or 3% of annual income. Firms will also be allowed to obtain policy excesses beyond this set level where additional capital resources are held.

To provide flexibility, firms will have the option of using a non-group comparable guarantee provided by an authorised firm with a set amount of net tangible assets.

FSA comments: "Few intermediaries suggested difficulties in getting PI cover, but some were concerned that insurers would not discriminate between risks, for instance mortgage, general insurance etc. Responses were positive about the future capacity. PI suppliers said there was sufficient capacity and that they would price the risks separately.

"The changes should allow them to negotiate requirements that are better suited to their risks. We are sensitive to the fact that the PI market is not an unlimited market. We want to provide a greater degree of flexibility to obtain an appropriate policy."

Capital resources - goodwill
Goodwill will not be deducted from capital resources until 14 January 2008.

FSA comments: "We acknowledge that as regulation approaches, consolidation could speed up. Removing goodwill now could hinder that. But goodwill is not a substitute for hard cash. We have offered a transitional arrangement to cover the period of market movement to tide firms over. It will not be extended. Firms should be managing their way out of it.

PS159: appointed representatives
The FSA has dramatically changed its stance on the treatment of multiple principals. The FSA has decided not to prescribe any limits on the number of principals. In CP159, the FSA favoured an approach whereby appointed representatives (ARs) could have only one principal for identified block of 'substitutable' business.

Previously ARs were restricted to advising and arranging insurance. Now they can also deal as an agent (for example, issue cover notes) and deal in the administration of insurance contracts (eg claims handling).

FSA comments: "A significant number of respondents had serious concerns about the proposed product categories and their potential impact on sellers and consumers, potentially leading to a reduction in consumer choice.

"The new approach has been balanced by a tightening up of the requirements for multiple principal agreements."

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