In its 2017/18 Business Plan, released on 19 April 2017, the FCA set out its intention to undertake a market study of the wholesale insurance market. According to its Sector Views, the FCA divides the General Insurance and Protection (GI&P) sector into three sub-sectors, including wholesale, which meets the insurance needs of large, complex businesses. This article identifies the scope of the planned market study to apply to the latter category of Wholesale – insurance for large, complex businesses including multi-nationals.
Page 78 of the 2017/18 Business Plan: “We want to ensure that the wholesale insurance market is working well and fosters innovation and competition in the interests of a diverse range of consumers. We will conduct a market study to assess how effectively competition is working in these markets, including how firms create market integrity and conduct risks. Following the publication of this market study, we will consider appropriate remedial actions.”
According to its Sector Views, the FCA divides the General Insurance and Protection (GI&P) sector into three sub-sectors: Retail; Commercial, which is insurance for smaller businesses such as sole traders, micro-businesses, and small-to-medium sized enterprises (SMEs); and Wholesale, which meets the insurance needs of large, complex businesses.
Accordingly, we identify the scope of the planned market study to apply to the latter category of Wholesale – insurance for large, complex businesses including multi-nationals. FCA comments that this sub-sector is of ‘global significance’ and ‘underpins the functioning of global aviation, marine and energy markets, and provides alternative and reinsurance cover to international markets.’
In this sub-sector, product offerings are often bespoke; multiple classes of business are offered, with thousands of sub-classes that operate as their own markets, with distinct legislative, technological and macro-economic drivers.
One example which the FCA cites in its Sector Views as increasing in prominence is cyber-insurance; given the FCA’s identification of ‘technological change and resilience’ as a cross-sector priority linked to its market integrity statutory objective, it would be both consistent and efficient for the FCA to focus on this market within the study.
Finally, the FCA includes reinsurance products in the wholesale sub-sector.
- The Wholesale sub-sector characteristics
The wholesale market is ‘fragmented’, though large firms dominate.
There are nine key global firms (based in London) in the pure reinsurance market.
Certain sub-classes or specialty lines may be fairly concentrated due to the specialised underwriting they require.
The Lloyd’s market is a significant source of income for the top insurers.
Most business placed at Lloyd’s is via brokers facilitating the risk transfer process between policyholders and underwriters.
- FCA’s view of the Wholesale sub-sector
Across the GI&P sector, profit margins are being squeezed as a result of intense competition around headline price for new business, competition from intermediaries for parts of the value chain, and adverse market conditions.
This has driven some responses from providers which may be cause for concern, e.g., reducing service level, dual pricing, add-ons. For intermediaries, commission from insurance providers as a common element of the remuneration structure also needs to be handled appropriately.
The FCA observes that downward pressure on premiums, low investment returns and Lloyd’s own initiatives to modernise are influencing the shape of the Lloyd’s market.
Some wholesale brokers are seeking to diversify via entry into the commercial market with products such as cyber; some are also acquiring commercial brokers to gain market share.
Driven by the introduction of a new framework for insurance-linked securities, hedge fund and pension fund investment in the sector are bringing new capital into the sector, driving premiums down.
The presence of vertically integrated value chains, including arrangements between brokers and Managing General Agents (MGAs) has concentrated positions in the value chain. The FCA notes that the largest brokers hold a large proportion of business accessing the London Market.
The FCA comments on complexity in the distribution chain, where chains which span multiple jurisdictions introduce challenges for compliance with, for example, sanctions regimes, anti-bribery and corruption legislation, etc.
The FCA has seen evidence of poor oversight of third party providers, outsourcers, and appointed representatives across the Sector.
Even for sophisticated customers like large businesses and multi-nationals, products are becoming increasingly complex; there is high reliance on brokers to access the product and service information they need to make decisions.
Technological change has increased potential for exposure to risk both for firms in the sector and for their customers. Innovation, such as driverless cars, may ‘transform liability potential for reinsurers.’
- Current position
We understand that:
The FCA intends to begin work in earnest on the market study in the Autumn.
The FCA is developing the scope and terms of reference for the study. It will consult with both LIIBA and individual firms on this.
The focus of the study will be on intermediation.
The study will be carried out under the FCA’s competition powers.
The FCA hopes to be in a position to produce an interim report within six months of the formal start (end Q1 2018), but this is dependent on findings.
The study will be carried out by a dedicated team of people.
We understand that there are 27 ‘fixed’ firms and 5,700 ‘flexible’ firms in the GI&P sector. The selection of participating firms may draw from both ‘fixed’ and ‘flexible’ portfolios. Any firm in the ‘fixed’ portfolio is likely to be under consideration for the market study. Contributing factors for selection may include:
- The FCA’s existing view of the firm.
- Whether the firm is active in a class of business which the FCA has selected for a case study (assuming case studies are part of the market study).
- What other regulatory engagement the firm has ongoing or in plan with the FCA or other regulators.
- Intelligence gathered from the FCA Contact Centre or other sources.
- Consideration of the firm’s own regulatory returns/annual reports and accounts.
- Potential areas of focus for the market study
Based on the commentary in the Business Plan and Sector Views, the following aspects of the wholesale insurance business will be considered. We understand the FCA has indicated that its focus will be on intermediation. While this appears to imply brokers, it is likely that the FCA will look at the entire chain.
Conflicts of interest and inducements: Conflicts of interest are a perennial concern for the FCA. In the case of the wholesale sub-sector, this is likely to include a focus on relationships between parties in the distribution chain, including the transparency of those relationships and remuneration structures to customers. Participating firms should consider how they communicate these relationships and remuneration structures to customers in a way which is ‘fair, clear and not misleading’. They should also consider whether the structures are, of themselves, fair or whether they may restrict choice if they direct business to insurers who pay for services rather than to those who offer greater value or suitability.
Governance structures: Boards and Board committees should meet the FCA’s expectations, including in terms of balance of INEDs to Executives, parent company influence on subsidiaries, etc. Participating firms should be able to provide a clear organisational structure which identifies regulated entities, and (for insurers) a clear Senior Managers map with relevant responsibilities or (for intermediaries) a clear identification of Approved Persons with relevant responsibilities. The FCA is also likely to be interested in MI, escalation processes, underwriting authorities, delegated authorities matrices, etc.
Product development/governance: Oversight of product development, including underwriting, should be robust to ensure that products meet quantifiable customer needs. Ongoing monitoring of products should identify any distribution anomalies (e.g., products being sold outside the target market, etc.). The FCA commented in its Sector Views that there is a risk of products being developed which suit a particular provider as opposed to offering the best suitability and value to the customer. Participating firms should consider how they can evidence suitability and value.
Cyber-resilience/innovation: The FCA notes in the Sector Views that market modernisation may give rise to operational resilience challenges where single points of failure are created, e.g., where many brokers use a single software house, or a ‘concentration risk’ is created. The FCA also comments that market modernisation may make market entry more difficult for those not able to meet market standards; by extension this may be understood as a perceived damper on competition. Participating firms may not be able to speak individually to this point on competition, but industry organisations should be able to form a position if there is some consensus.
Multi-jurisdictional chains: The global nature of the sub-sector exposes it to potential breach of sanctions and other legislative requirements. The FCA will be interested in how participating firms manage this risk, e.g., onboarding and ongoing monitoring.
Solvency: The FCA can be expected to look at compliance with Solvency II requirements by participating firms, most likely as part of a desk-based review.
Profitability/stability/strategy: The FCA is likely to look at the source of profit of individual firms participating in the market study, the stability of participating firms and the sector, and participating firm’s strategies. It is likely that some form of desk-based review of Annual Reports and Accounts will be undertaken; where it is unable to discern enough information to determine how the firm is making money, it will request more information from the firm.
Permissions: As part of desk-based review work, the FCA can be expected to review participating firms’ permissions against the activities which those firms are undertaking.
Client assets: As part of desk-based review work, the FCA may look at participating firms’ arrangements to safeguard client assets, and review firms’ CASS returns.
Claims handling: In common with the approach it takes in other sectors, the FCA is likely to look at claims handling processes.