Clifford Chance

In a bid to advance its new secondary objective to facilitate the international competitiveness of the UK economy and its growth in the medium to long term, the FCA has been actively considering measures to show that it is taking this objective seriously, whilst balancing its primary objective of ensuring appropriate degree of protection for consumers. In this context, the FCA recently issued a discussion paper (DP 24/1) on 29 July 2024 concerning the regulation of commercial and bespoke insurance business in the UK (the "DP").

The DP has been published following the full implementation of Consumer Duty on 31 July 2024. In effect, the FCA is seeking to establish which rules in the commercial insurance sector could be removed or simplified without compromising on the protection required for small and medium-sized ("SME") enterprise customers. The overall aim is to lower regulatory costs and increase the competitiveness of the commercial insurance sector, which the FCA has stated is worth £15.5bn to the UK economy.

The DP looks at three main points:

1. how should the rules apply to different categories of commercial customers,
2. the rules for co-manufacturers such as subscription market insurers, and
3. how the rules apply to bespoke insurance products.

The FCA has requested feedback on the DP by 16 September 2024.

The Commercial Insurance Market

The concept of a “contract of large risks” has long been used by the FCA as one of the standards for distinguishing insurance for retail customers from commercial insurance. The regulatory protections available in relation to an insurance contract vary significantly depending on whether the contract falls within the scope of “large risks” or not, with contracts outside it being subject to enhanced protections. This reflects the fact that commercial insurers are generally sophisticated and well-resourced businesses and, therefore, as buyers of coverage, they do not require the same level of consumer protection as individuals.

Despite the importance of this classification, the FCA currently does not have a uniform definition for this term and there are certain inconsistencies between the various definitions contained in the Dispute Resolution: Complaints Sourcebook (DISP), The Perimeter Guidance Manual (PERG) and the FCA Glossary. This results in time-consuming and disproportionate efforts from insurers to categorise customers at the time of onboarding and renewal, and the aggregation of SMEs and larger commercial customers into one category from a regulatory protection standpoint. There are also some product-specific rules (e.g. rules relating to sickness policies applying to private insurances arranged by large corporations for their employees) which leads to disproportionate protections and potentially additional expenses for the insurers.

In this context, the FCA is considering whether “contract of large risks” is still the most suitable criterion for determining the applicable regulatory protections and has consequently proposed certain changes in the DP, namely replacing or revising that definition and/or removing the product-specific criteria.

Co-Manufacturers of Insurance Products

Under the current Product Intervention and Product Governance Sourcebook (PROD), when multiple firms are involved in manufacturing an insurance product, the rules apply to each co-manufacturer individually. This leads to duplication of efforts, as each co-manufacturer must conduct its own approval processes, including assessing fair value. This can result in conflicting assessments and inefficient interactions with distributors, who may be approached separately by each co-manufacturer.

In the DP, the FCA proposes simplification of the PROD rules in its application to co-manufactured products, by amending them in one of following ways, to avoid duplication and ensure consistency:

1. designating a single 'lead' insurer as being responsible for compliance;
2. allowing the co-manufacturers to decide whether they wish to appoint a 'lead' insurer or share responsibility; or
3. publishing additional FCA clarificatory guidance on the existing rules.

Bespoke Insurance Products

The PROD rules exclude 'bespoke products' from the definition of 'manufactured' products. However, this exclusion currently applies only to intermediaries and not to insurers. As a result, insurers may still be considered manufacturers of bespoke contracts, even if the contracts were designed by intermediaries. This interpretation has led most insurers to avoid using the exclusion, increasing the costs associated with applying PROD to these contracts. Additionally, the FCA handbook lacks a clear definition of 'bespoke contracts,' which adds to the ambiguity.

Given the FCA's particular interest in promoting bespoke contracts as requested by individual customers, the FCA has sought feedback on whether it should broaden the scope of exclusion to include both intermediaries and the insurers, and/or clarify the scope of bespoke contracts.

Next Steps

The last few years have seen commercial insurance firms having to implement various new consumer protection requirements (particularly in the context of consumer duty), which may have at times felt disproportionate given the nature of their business. In this context, the DP is a positive step towards reducing these regulatory burdens and providing clarity, particularly regarding which consumers should be subject to the wholesale insurance market related regulations. This is certainly being seen as a positive first step by firms underwriting and distributing commercial and bespoke insurance. Industry bodies, such as ABI and LMA, have also welcomed the DP as well as the commitment from the FCA to implement its secondary objective of growth and competitiveness.

The FCA's efforts to make proportionality a constant feature of its regulatory framework appear to be aligned with those of its European counterparts. Proportionality in regulation has also received increased focus from regulators in Europe, with the European Insurance and Occupational Pensions Authority (EIOPA) publishing a consultation paper on 2 August 2024 to assess the future implementation of the new proportionality framework under Solvency II. EIOPA's consultation paper proposes a revised framework around proportionality that sets clear criteria for identifying small and non-complex insurers in relation to the nature, scale and complexity of their risks. It also empowers supervisors to grant – and withdraw – similar concessions to other non-small insurers who do not fit strictly within the definition but whose risk profile nevertheless justifies the use of some proportionality measures.

We encourage firms with SME and large risk customers to review this DP and consider engaging with the FCA before the 16 September 2024 deadline to provide their comments and inputs whilst the FCA designs a proportionate policy.