Following the introduction of changes to comply with the European Union Insurance Mediation Directive, which have been enacted into UK law through amendments to the Financial Services and Markets Act 2000, the Financial Services Authority (FSA), will regulate the sale of all insurance products from GI day - 14 January 2005.
In preparing for the FSA's role, over a period of almost two years, the Treasury and the FSA have issued various consultation papers setting out the framework. Within this framework, businesses have needed first to establish whether they will be affected by the changes, and then whether they require authorisation in order to operate legally after the enactment date.
The application process itself first began in January this year. By the beginning of September, 9,191 organisations had already applied for permission to sell insurance next year. But hidden behind this number is a story of mounting concern for the industry, with over 40,850 firms having been estimated to need authorisation in future.
While the legislative changes predominantly affect those companies and persons that advise on, recommend, or sell contracts of insurance, the scope has been extended to include many firms that may assist in the sale, or in bringing the sale about. It is this extension that seems to have caused the most heartache. Until this year, many organisations had not realised that they might fall within the so-called secondary market. As awareness has increased, so too has the resistance of such organisations.
Organisations such as freight forwarders, car hire firms, plant hire firms, trade associations, some sports affiliations, vets, dentists, marketing companies responsible for promoting either insurance providers or their products, and even those enacting group acquisition of insurance on behalf of their fellow subsidiary companies are all being potentially caught by the widest of the forthcoming regulated activities: arranging deals in insurance.
Arranging deals in insurance
The FSA initially issued broad guidance over those activities which apply to the majority of secondary intermediaries. In broad terms, there are two types of regulated activity relating to arranging deals with regard to contracts of insurance:
- making arrangements for another person to buy or sell a particular insurance policy (see article 25(1) of the Regulated Activities Order (RAO))
- making arrangements with a view to a person who participates in the arrangements buying or selling insurance policies (see article 25(2) RAO).
The first activity applies only where the arrangements would bring about an actual insurance policy. For example, this would apply to an individual or organisation whose involvement in the chain of events leading to the issue of the policy is so important that without it, there would be no policy. Examples of this type of activity would therefore include negotiating the terms of the policy on behalf of the customer, or forwarding a proposal form or information to a regulated firm so that the insurance could be arranged.
It is this activity that potentially catches many group companies who negotiate the purchase of cover for more than one legal entity. Equally it can apply to the freight forwarder or car hire company that collects completed forms relating to the specific cover they offer and then sends them on, either to another intermediary or to an insurer.
The second activity does not require that the arrangements would themselves bring about the actual policy. Therefore, the range of those caught by this activity is much wider. For example, an organisation which simply introduces customers to an intermediary, either for advice or to help arrange an insurance policy, would be caught, whether such an introduction was oral or written. This second activity could therefore apply to many trade or professional associations that have elected to try and provide discounted or preferentially rated products to their members. Equally any organisation selling its membership or mailing list, in return for a share of commissions on completed sales, also comes under this regulated activity.
Does authorisation matter?
Despite the fact that the FSA has issued guidance notes and, in some instances, further fact sheets to try to help organisations decide if they need authorisation (see the FSA website - The objections, which in some cases have attracted a great deal of publicity, have raised the awareness of the need to consider authorisation. Less widely covered have been the implications should an organisation undertake regulated activity without the appropriate authorisation.
The FSA requires all firms involved in the chain between the end client purchasing or being provided with cover, to be authorised if their activities so dictate. If anyone in the chain undertakes regulated activity that requires authorisation without holding such authority, their activities will be considered to be illegal and the contract itself will become unenforceable.
Once the authorisation rules come into effect, an insurer would thus be entitled to avoid any claim that arose from such an illegal insurance deal, regardless of the materiality of these regulated activities, and could simply return the premium. If your organisation is using a broker, the latter should bring to your attention the requirement for material facts disclosure, and may even seek representations from you that you are not undertaking regulated activity. The perimeter guidance issued by the FSA is quite complex in terms of exclusions and exemptions, and it is unlikely that many brokers will be willing to give advice to their clients on whether or not they need to be regulated. However, if they do, or indeed do not, request such assurances, then you may be able to get some, albeit limited, compensation.
The potential effect
The following two examples relating to group risk management show the potential effect of the new rules.
EXAMPLE 1: Imagine a small family-owned group, where director X acts as the focal point for the purchase of insurance. The director, who has no insurance experience or qualifications, negotiates the purchase of a commercial combined all-risks policy for all the trading companies in the group, and arranges the property insurance cover for the company pension fund.
Despite the fact that X could hardly be considered to be either advising or selling insurance to his parent and subsidiary firms, his activities would be considered as assisting in arranging insurance deals from which the group would secure some benefit. It may be that this company does not actually require authorisation - there are other tests that need to be completed to determine if FSA authorisation is required or not.
But, for the sake of this example, let us assume that it is not authorised but that it should have been.
Some months later, the group suffers quite a sizeable loss. The policy purchased covers the events, and the firm makes a claim. However, when reviewing the policy and the original sales information relating to the claim, the insurer begins to ask detailed questions about the operations of the group and director X's position.
The insurer then advises that the loss will not be covered, because in its view the original policy sale required that the organisation was FSA authorised. The organisation's failure to assess its regulatory position was a material fact that should have been disclosed. Without appropriate authorisation, a criminal offence has been committed, voiding the cover that was purchased. In addition to non-payment of the claim, there could potentially be criminal charges. While the organisation has the the option of taking legal action against the insurer, disputing its view, there is no guarantee of success.
EXAMPLE 2: Take a large group with individual subsidiaries and a significant turnover. A risk manager, possibly backed by a team, and certainly with some insurance experience, handles insurance purchase.
Using the same basis of insurance cover and loss as the previous example, the consequences will be similar. However, the likelihood that this type of organisation may require regulation is much greater. One of the reasons for this is that in this type of situation, the risk manager may actually be assisting in the purchase of insurance for third parties.Tell-tale signs for such situations include:
- sub-letting spare space in an office block, leased by the organisation
- offering group cover as a benefit in kind
- using management recharges to recover the cost of the insurance plus profit margin, perhaps to assist in advantageous tax planning
- purchasing cover for joint ventures or collaborative projects which are not owned by the organisation.
In larger companies it is also likely that the shareholder base will be more diverse, and therefore there may be other issues relating to corporate governance. Despite the introduction of the Combined Code, some companies are reluctant to disclose weaknesses in their risk management processes.
Having an insurer avoid a loss because of the company's failure to assess its regulatory position could have severe reputational implications.
The guidance issued by the FSA, supplemented by slightly modified guidance issued in its policy document as it applies to risk managers, does however give some further assistance to organisations as they work out whether they need to be regulated.
The tests you must fail
In considering whether FSA authorisation is required in respect of your firm's activities, the FSA suggests in its perimeter guidance that you undertake the following simple tests relating to your activities.
- Are you are undertaking regulated activities?
- Are you providing these to third parties?
- Are you receiving remuneration or consideration for the activity undertaken?
- Do you satisfy the 'by way of business' test by reference to the guidance issued by the FSA, which requires all the factors above to be present?
Receiving remuneration or consideration: Authorisation Manual, paragraph 5.4.3G in the FSA Handbook, provides organisations with some guidance as to what is considered to be remuneration for the purpose of assessing the need for FSA authorisation. It clearly states that the 'by way of business' order does not provide a definition of 'remuneration', but that in the FSA's view, it has a broad meaning covering both monetary and non-monetary rewards. This is regardless of who makes them.
The FSA specifically includes an example where a person pays discounted premiums for his own insurance needs in return for bringing other business to an insurance undertaking, confirming that the discount would amount to remuneration for the purposes of the 'by way of business' order.
Following the lobbying and legal opinion received by UK Association of Insurance and Risk Managers (AIRMIC), the FSA reconsidered this official guidance in respect of group operations. It concluded:
'Remuneration should be construed with regard to recital 11 of the directive, which states that it should apply to persons whose activity consists in providing insurance mediation services to third parties for remuneration.
We (the FSA) agree, that it is possible to view the relationship between one group entity and another as not being a 'third party' relationship as envisaged by the directive. On this basis, we think it is possible to conclude that payments passing between members of the group and another group firm established to carry on insurance mediation are not remuneration for the purposes of the directive and the By Way of Business Order. This would extend to payments made to satisfy Inland Revenue requirements directed to transfer pricing.'
Some care is still required though, as the FSA has indicated that remuneration is also considered to include an economic benefit which the firm may expect to receive as a result of carrying on insurance activities. In the FSA's view, the remuneration does not have to be provided or identified separately from remuneration for other goods or services. Nor is there a minimum level of remuneration. Consequently, making a loss on the provision of insurance cover itself may not eliminate you from being considered as being remunerated, if you can be shown as receiving overall economic benefit.
Property managing agents have tried, so far unsuccessfully, to argue that they do not receive economic benefit when, for example, linking arranging insurance to their actions in managing properties. It is clear that the true scope of this test will only be derived through the challenge and findings of subsequent court action. This gives little comfort to companies trying to assess this for themselves.
The business test: Authorisation Manual, paragraph 2.3.2G, clearly states that: 'A person who carries on an insurance mediation activity will not be regarded as doing so by way of business unless he takes up or pursues that activity for remuneration'. So you need to take care in reviewing the rationale prepared for the remuneration test.
You also need to give considerable consideration to the 'by way of business' test, as the FSA appears to have revised its guidance to conclude that 'the context and frequency of mediation activities carried on by group risk managers would suggest that they are carrying on those activities by way of business'. Thus, in considering the 'by way of business' test, you must address all the factors that the FSA suggests firms consider.
These include:
- regularity of the activity
- the level of remuneration and profit
- to whom the service is provided
- whether the activity is tied into, or is a consequence of, the organisation's main trade or profession
- relevance to either the main activity of the business, or, if ceased, a reduction in income to any entity in the organisation.
If having completed these tests, you cannot provide a strong argument that you do not fail at least one of them, you should consider some form of FSA authorisation. It is advisable to obtain expert advice, as there may be alternatives to full authorisation or ways of modifying your current operations.
In summary
- Consider whether your organisation needs to be regulated by the FSA.
The broad principles are set out in this article, but it is possible that you may qualify for exemptions and exclusions in respect of regulated activity or another of the tests.
- Do not underestimate either the skill or time required to complete a full review. Some organisations may find it easier to avoid the need for authorisation; others may wish to apply. Seeking assistance from a professional compliance consultant may save both time and money in the long run, and will help you document your rationale to provide to others on request.
- Unless you want to run the risk of buying insurance that may subsequently fail to respond when needed, be prepared to respond to your broker's or insurer's request for confirmation that you do not need to be authorised if you provide insurance cover to anyone else.
- If you need assistance, and do not have your own compliance adviser, then you may wish to contact the Association of Professional Compliance Advisors, www.apcc.org.uk And finally, if you do want to apply for FSA authorisation, it is not too late, but time is running out.
Alex Peterkin is founder of FSA Solutions(TM), Tel: 020 7663 5659, E-mail: apeterkin@fsasolutions.com
