Constructive deterrence: will the FCA’s Business Plan result in better outcomes for customers?

In his introduction to the Financial Conduct Authority (FCA)’s Business Plan 2016/17 published on 5 April,  Chairman John Griffith-Jones uses the phrase “constructive deterrence” which he considers to be “arguably the best form of regulation”.

The use of this phrase may help insurers and distributors to understand the overall philosophy of the FCA, particularly as regards to work on new products, but will it lead to better customer outcomes?

We examine our two main concerns below. The first is regarding the application of this philosophy to existing business, and the second focuses on the implications for innovation.

Impact on existing business

The FCA’s views on the treatment of existing business have been set out in its Thematic Review TR16/2 ’Fair Treatment of long-standing customers in the life insurance sector’. Our briefing note on that document can be found here. In the Business Plan the FCA reiterates some of the key points in TR16/2 namely:

Using the terms “long-standing customers” and “closed-book customers” seemingly inter-changeably

In our view these are two very different concepts, with different sets of issues around how to Treat Customers Fairly and it is worrying that such an important distinction does not seem to be at the heart of the FCA’s thinking.

For a closed with-profit fund it is often the allocation of the estate that is the most important consideration on ensuring fair outcomes.

The desire to set out non-Handbook guidance “which will provide firms with extra detail on the actions they should be taking”

We have two concerns with this:

  • firstas we explain in our briefing note, setting out this additional detail can have adverse knock-on effects on customers. One example is in the FCA’s desire to see with-profit funds operating with narrower target pay-out bands when expressed as a percentage of asset share which could result in firms changing their investment strategy to the detriment of expected future payouts
  • second, the plethora of rules, guidance, non-handbook guidance and references to previous reports and papers makes it very complex for insurers to have a full overview of the FCA’s requirements. We consider that if items are important then there should be rules within the Handbook

The FCA says “We will convene an industry-wide discussion with a view to industry reaching a voluntary solution to capping or removing exit and/or paid-up charges”

This can appear attractive to the potentially impacted policyholders. However any such change will come at a cost that will have to be met from somewhere. For mutuals this will have to be from the estate or from reduced future surplus distributions – in effect taking from Peter to pay Paul.

More generally, exit or paid-up charges are in place for a myriad of different reasons, and seeking a simple cap may be too simplistic if fairness is the desired outcome. For example consider two equivalent individuals, one for whom initial costs were met by having a nil allocation period, the other by having a level allocation rate but with capital units being used for an initial period.

Normally on surrender after a certain period, ’fairness’ between the two equivalent policies would be achieved by charging a fee on the capital units. If this is now constrained the second policy will have benefited unduly from the new cap. 

Companies will need to thoroughly review their management of their with-profits business

Most companies will probably have considered that their current arrangements for with-profits management and governance are working and appropriate. We would probably agree with them. However the FCA appear to have raised fundamental issues which will need to be addressed.

Impact on new business

The Business Plan is keen to stress how the FCA would welcome innovation around product design and distribution. In particular it stresses the role of the ’Regulatory Sandbox’ to help explore new ways of working. However, companies will need to consider the wider implications of TR16/2 when designing new offerings.

Product features that appear appropriate and mutually beneficial for customers and providers at launch may not be considered in the same light in the future. This could apply equally to de-accumulation and protection business as it currently appears to apply for many savings and investment products.

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