Simplifying the FCA's TR on Governance and Oversight for Manufacturers and Distributors

On 21 August, the FCA published its long-awaited Thematic Review  on insurance manufacturers and distributors’ POG arrangements.  The FCA said it was “disappointed” by its findings. 

Manufacturers – Product Approvals.  The FCA found manufacturers generally had established structures including an appropriate senior manager and the firm’s governing body, although not all were embedded.  It also found some didn’t work due to human and evidential issues:

Human.  Manufacturers’ senior management was unempowered to challenge approvals was curtailed by limited visibility of, or input into, the individual product approval process.  Some senior managers were restricted to taking an advisory rather than decision-making roles in product approvals.  The FCA found the other main human factors affecting manufacturers’ approval processes to be:

• Product approval responsibility falling between unclear remits of multiple committees
• Escalation triggers which were either set at the wrong levels, not followed, or not acted on promptly
• Existing challenge mechanisms were not followed
• Product approval systems were inconsistently applied across the business, and
• Failure to amend or pull the product from distribution completely when issues arose.

Evidential 

• MI.  The FCA found that product MI presented to decision-makers was often insufficient.  Sufficient MI, it said, was digestible but not over-simplified: for example RAG-rated product assessments presented to decision-makers as stand-alone documents, instead of summaries  supported by a full set of MI/data.
•  Recordkeeping.  Many firms provided no minutes evidencing/substantiating either its governing body’s explicit product approval, or the bases on which those approvals were made. 

 Fair Value.  Fair value assessments/reviews (FVRs) exist to identify value issues for actioning.  The FCA found that although manufacturers were completing FVRs, they were generic, falling short of PROD 4.2’s depth and evidence requirements. 

 The FCA said product value must be evaluated on product components, benefits, add-ons and the total price paid by the customer.  In addition to identifying products’ values, manufacturers’ FVRs should identify their potential harms and include steps to mitigate them.  

Target Market.  Identifying risk of harm depends on target market identification.  As in its 23 February 2024 letter to manufacturers, the FCA found manufacturer target market definitions to be too wide and high-level to define its customer demographic.  In future, the FCA advises that target markets be defined against underwriting criteria (for example, if a customer’s particular characteristic makes their premium skyrocket, then the customer falls outside the target market) and that product value should be evaluated and evidenced against target market sub-sections, such as vulnerable customers. 

Evidence.  The FCA found manufacturers tended to decide products offered fair value, even when:

• The product’s nature and complexity wasn’t considered
• The minimum data specified by regulation wasn’t used, or 
• What evidence there was, didn’t demonstrate fair value.

Total Product Cost. The report emphasised that product value turns on its benefits in relation to its its end cost to the insured customer, including all remuneration paid in the distribution chain. The FCA found manufacturers were inconsistently factoring distribution costs impacts into cost due to insufficient (and sometimes no) remuneration data from distributors. 

Areas for improvement.  The FCA recommends that manufacturers ensure their FVRs:

• In addition to evaluating past/present performance, assess how products may meet customers’ future needs 
• Evidence not just that a satisfactory FVR was conducted, but how the result was reached including product review records, customer surveys, and sign-off
• (For manufacturers assuming their products offer fair value when their price falls within normal market range) take into account whether the market offers intrinsically offers fair value.   Put another way, manufacturers should ask themselves “Yes, our product offers the same value as our top three competitors.  However, what actual value do all those products offer customers?” 
• Include customer feedback; service levels including claims data (handling times, frequency, severity, ratios, acceptance and declinature rates) complaints data (root analysis and handling times) publicly information; distribution arrangements and remuneration. 

Co-Manufacturing  

Ambiguous agreements.  The report re-raised the FCA’s concerns about firms’ understanding the requirements around co-manufacturing.  It considers that this is due to co-manufacturing duties being insufficiently set out in unclear/nonspecific co-manufacturing contracts, such that it is immediately obvious which co-manufacturer is responsible for exactly which of co-manufacturing duty.

Intermediaries.  Insurer/intermediary delegated authority arrangements were highlighted as being particularly of concern.  Insurers whose intermediaries to take the lead on anything from product design to distribution, insurers must still demonstrate how the insurer itself meets its PROD 4.2 obligations.

Distributors

The FCA was equally concerned by its findings with respect to distributors. Along with day-to-day POG governance, it found failings in two main areas: 1) distributors sell products without understanding them, leading to distribution strategy issues, and 2) others assess their remuneration against neither the value of their activities/services, nor its impact on the product’s fair value.

Governance.  Like manufacturers, distributors had difficulty evidencing their product governance arrangements.  Their distribution strategies were high-level and unsupported by processes which allowed distributors to track their impact on the product’s overall value.  As well, distributors managed their conflicts of interest insufficiently well.  

Understanding. Whilst acknowledging that some manufacturers’ inadequate FVRs inhibit distributor product understanding, the FCA re-emphasised its expectation that distributors either understand the intended value/outcome of products and their packages, their target markets (including customers falling outside of it) and how distribution arrangements impact product value – or they refuse to distribute the product.  The FCA found that distributors, like manufacturers, had difficulty identifying target markets in meaningful detail.  This called the appropriateness of their distribution strategies into question. 

Remuneration.  The FCA found distributors were aware of the importance of their own remuneration.  However, it also found distributors’ fair value assessments were hindered by either not having a total breakdown of customer price, or by failure to quantify the extent and quality of the distributor’s services (i.e. added value) against that customer price.  Percentage based remuneration aroused the FCA’s particular concern.  Many distributors failed to introduce  commission caps to ensure fair value regardless of the size of premium. 

Distribution Strategy.  Distributors’ understanding of manufacturers’ product information should trigger regular reviews of the distributor’s distribution strategy to ensure it does not adversely affect the product’s fair value.  Reviews should be carried out annually or more often if appropriate; many distributors lacked criteria for deciding when more frequent reviews should take place.  Reviews  should examine:

• the value added by the distributors’ services and whether its remuneration is proportionate; and
• (if products are offered as part of a package) whether the package as a whole offers fair value, ensuring that no package component diminishes the value offered. 
• If retail premium finance is offered, this needs to be included in any reviews by the distributors. The regulator has found that many distributors failed to accurately assess and document the above. 

Packaged products and premium finance.  The FCA found that on creating a package, distributors fail to assess the intended value of the individual products by simply basing their fair value assessment on the sum of the package’s components, or by failing to consider whether the components adversely affect the value of the insurance product at its core.   Apart from price, specific examples of harm distributors should watch out for are duplication of cover, packages which are inappropriate to the product at their core, and packages which are distributed to a target market changed by outside circumstances.  

The FCA singled out premium finance as a key determiner of value in packages.  Specifically, distributors should consider in their FVAs whether the cost of any premium financing might ‘tip the scales’, resulting in customer cost which exceeds the product’s value proposition. 

Expectations and the Way Forward

The FCA expects both manufacturers and distributors to have robust governance processes which:

• Require a thorough understanding of the target market
• Are based on thorough, product-specific MI including underwriting criteria
• Include practical challenge to senior decision-makers, and 

• Are based on thorough, meaningful MI including remuneration of the entire distribution chain
• Involve a detailed understanding of the product’s distribution strategy, including its drawbacks.

Firms whose processes highlight value issues are expected to act on them promptly by either adapting the product, or ceasing to distribute it.

TR 24/2 highlights long-standing market issues.  To that extent, it holds no surprises – but it also comprises the FCA’s clearest articulation of guidance on how to assess product value in a meaningful way to date.  Firms should take the opportunity to use it as a blueprint for sense-testing their own governance systems.

Szymon B. Pamela G.