The FCA’s spotlight turns to Premium Finance

The FCA’s Head of Insurance recently gave an interview outlining the regulator's concerns in respect to the value that the Premium Finance product provides and suggested that regulatory action may be taken against firms in this sector¹. Whilst the suggestion of regulatory action comes as news to many, the FCA’s concerns over this product and the risk of poor outcomes provided to customers in this market is not new. In this blog, we step through the key areas of focus that the FCA has been highlighting to firms over the last 18 months, what this means to Premium Finance lenders (including Insurers that provide Premium Finance products), and the key questions that firms should be asking themselves now in the context of their end-to-end framework in order to meet FCA expectations in this area and to support the delivery of good customer outcomes.

Background and Regulatory landscape

Whilst the FCA has recently suggested that they may take action against firms offering a Premium Finance product², this shift in focus and the regulator's concerns over this product are not new and have been prominent over the last 18 months across a range of key publications:

• 29 September 2022 – The FCA published its Dear CEO Letter³ outlining its expectations for insurance firms to treat customers in financial difficulty fairly and to ensure that adequate levels of support is provided to customers in order to prevent essential insurance cover from being cancelled. As part of this publication, the FCA also highlighted that that the Premium Finance product should be considered as part of a firm's overall fair value assessment. In doing so, the FCA outlines that firms should be considering fair value more broadly and not only limiting considerations relating to price;
• 25 May 2023 – The FCA published its Consultation Paper⁴ outlining its proposals to further strengthen protections for borrowers in financial difficulty more broadly across the Consumer Credit Sector (including Premium Finance firms), including how customers are supported, the communications provided to customers alongside the need to provide more focused monitoring of customer outcomes in this area; and
• 03 July 2023 – The FCA published its finalised insurance guidance⁵ on supporting customers in financial difficulty with the objective of ensuring that insurance customers in financial difficulty, including as a result of cost-of-living increases, have the support that they need from firms.

In addition to the above areas of focus, the Consumer Duty rules and requirements⁶ have also further heightened the regulator's expectations for Premium Finance lenders (including Insurers that lend Premium Finance), with a greater onus placed on firms to ensure that the product provides fair value, is sufficiently understood by customers and customers are adequately supported.

What does this mean for firms?

Whilst there is still uncertainty around whether the FCA will take action or the nature of the specific subject matter of any action, the consistent messages from the FCA over the last 18 months do provide some insight on the likely focus areas of the regulator.

In addition to these publications, Premium Finance lenders also have a regulatory obligation to comply with the FCA’s requirements and expectations⁷ and to ensure the delivery of good customer outcomes. This is an area where we have typically found that many firm's end to end frameworks lack a sufficient degree of maturity largely because the Premium Finance product is seen as an add-on to the primary insurance offering and as a result is not given a sufficient level of focus, ownership or oversight.

Taking all of this into account firms should take proactive steps and start to take action now.

What firms should be doing now?

A sensible starting point for action at this stage is for firms to review their end-to-end Premium Finance framework, processes and controls against applicable regulatory requirements and expectations across the pre and post-sales customer journey. This type of activity will support firms in identifying any key gaps and the actions that need to be taken now in order to fully demonstrate regulatory compliance and to support the delivery of good customer outcomes. Some key regulatory areas that firms should focus on as part of their review activity are outlined below⁸:

a) Fair Value:

Insurers and brokers have had to consider the value of premium finance sold alongside their insurance products since the FCA’s PROD 4 rules on fair value came into force in October 2021. Lenders also had to assess the value of their premium finance products ahead of the Consumer Duty implementation deadline on 31 July 2023. As such, even though firms in each of these categories will have completed fair value assessments, it is important for firms to consider whether assessments have been sufficiently robust and can withstand the current challenge from the FCA on the value offered by the premium finance product. In light of this, firms should ask themselves the following:

• Can the firm articulate and justify its rationale for the rate of interest charged? As well as considering how rates compare with peers, lenders need to be mindful of the FCA’s comments around the limited credit risk to lenders in many cases, because non-payment generally results in policy cancellation on a pro-rata basis⁹.
• Can the firm demonstrate that its distribution arrangements are consistent with fair value? This is a specific area of focus highlighted in the FCA’s recent feedback to the industry on Consumer Duty¹⁰. In light of this, lenders need to be able to demonstrate that commission or other remuneration arrangements with brokers and/or insurers provide value to customers, and are reflective of the role distributors play. In particular, firms should consider how conflicts of interest are managed through their distribution arrangements, including where brokers have discretion to determine commission rates and pricing, bearing in mind the FCA’s current diagnostic work considering potential historic harm arising from discretionary commission arrangements in the Motor Finance market¹¹.
• Has the firm identified and justified all fees and charges? It is important that lenders can demonstrate they have considered all potential customer costs, and that they are not making profit from fees where this would be inappropriate (e.g., arrears charges).
• Has the firm assessed the benefits and quality of the product, as well as the price? The FCA has highlighted the importance of considering value holistically, which includes the benefit side of the value equation, as well as the cost side¹². For example, firms should consider what their customer outcome monitoring tells them about the quality of the support they provide to customers, including those who are vulnerable and those in financial difficulties – and how lower levels of service might impact the overall value offered.

b) Annual Percentage Rate of Charge (APR) Calculations:

The APR is a critical aspect of providing transparency to customers regarding the cost of premium finance. It allows lending products from across the market, including premium finance products, to be compared in terms of cost on a like-for-like basis. It is also likely to be a key factor in determining whether premium finance provides fair value to customers. Firms should ask themselves the following:

• Is the APR calculated accurately and clearly communicated to customers? This includes ensuring that all relevant fees, charges, and interest rates are accounted for in the calculation and that the APR level is clearly disclosed to customers. Firms should also ensure that APR information is easily accessible to customers across different channels (e.g., online platforms, paper documents), and that customers have understood the implications of the APR upon their financial commitments.
• Is the APR for premium finance appropriately calibrated to the risk profile of the business being written, the bad debt charge being covered, the cost of providing the product and the benefits being provided to customers? This also includes recalculating the APR with respect to any mid-term adjustments made during the product lifecycle.
• Are the APR calculations and communications aligned to applicable regulatory requirements and guidance e.g., The Consumer Credit Sourcebook (CONC¹³), Insurance Conduct of Business Sourcebook (ICOBS¹⁴)? In cases where regulations are not entirely prescriptive and / or open to interpretation, industry best practices and market norms should also be considered.
• Are the APR calculations sufficiently and proactively monitored and reviewed to identify any discrepancies or areas for improvement? As part of this review, firms should consider alignment to regulatory requirements and expectations, consistency with industry practice and the effectiveness and transparency with which they are communicated to customers.

c) Pre-Contract Credit Disclosures (PCCI):

Whilst there are specific requirements in CONC¹⁵ over the provision of PCCI, the Consumer Duty rules (specifically in respect to customer understanding) have further heightened the regulator's expectations on providing customers with a sufficient degree of information to support customers in making an informed decision to finance the cost of their insurance premiums. In light of this, firms should ask themselves the following:

• Has the firm considered the content of PCCI information it provides, how it is displayed across all relevant journeys (e.g., desktop, mobile/app based journeys) and the stage in the journey of when this information is provided to the customer to ensure that the customer is sufficiently informed that they are entering into a credit agreement prior to any credit search being undertaken?
• Whether there are sufficient oversight arrangements in place over brokers, aggregators and Price Comparison websites, to ensure that PCCI information, adequate explanations and commission arrangements are adequately and prominently disclosed to customers?

d) Affordability and Creditworthiness:

An ongoing area of regulatory focus remains on affordability and creditworthiness, with regulatory interest in this area likely to continue in light of the current economic environment. Typically, firms within this sector, rely solely on credit reference agency checks in establishing the customers creditworthiness and ability to afford the credit. Whilst this is common and accepted practice for this sector, firms should ask themselves the following in light of their current approach to affordability:

• In addition to the customers credit record being checked, does the firms approach enable a reasonable and proportionate¹⁶ assessment of the customer’s ability to afford the credit that is being taken? For example, are appropriate affordability metrics (i.e. income and expenditure values, net disposable income scores etc.) included and considered as part of the credit check to sufficiently assess affordability;
• Does the firm sufficiently use internal customer data that it has available to inform the affordability assessment? For example, the impact of multiple premium payments in the instance that the customer takes out more than one insurance policy and considering the repayment record of existing customers prior to offering credit as part of a Mid-Term adjustment or at renewal.
• In the instance that the aforementioned data is available to inform the assessment, does the firms approach to assessing affordability extend to other key areas of the customer journey where a reassessment of the customer's ability to afford the credit may required (e.g., at Mid-Term Adjustments and renewals)?

e) Credit Reciprocation and data accuracy:

Credit reciprocation has always been an important and long-standing area of regulatory focus as it provides a reliable market standard for organisations to follow when using credit bureau data and performing required credit checks during the application, underwriting and portfolio monitoring aspects of the customer journey. This also includes the use of reciprocated data to verify income and expenditure estimates as part of a firms affordability assessment. In light of this, completeness and quality of reciprocated data being used is essential in ensuring the accuracy of any affordability assessments undertaken and therefore firms should ask themselves:

• Whether the correct processes, roles and controls are in place to ensure the accuracy of reciprocated data? As part of this, firms should consider whether they have adequate processes in place to ensure that the correct data is selected for submission to credit reference agencies and this data and associated submission includes the correct account flags (e.g., closed account flags, deceased flags and flags indicating any changes to the agreement) alongside the ability to link multiple customers to the data submission (where applicable).
• Whether appropriate data management systems are in place to ensure data quality and timeliness of the submission? As part of this, firms should consider if there are robust processes in place to undertake data consistency checks, information completeness checks and whether a sufficient record of data being submitted to credit reference agencies is retained.
• Whether firms make full use of the data they have access to as part of the reciprocation agreement? For example, credit bureau data providing insight to customers behavioural trends.

f) Treatment of customers in financial difficulty (including customers with characteristics of vulnerability):

The regulatory focus of this topic in the past has largely been in respect to the broader consumer credit market. However, increasing cost of insurance¹⁷ and policy cancellation rates as customers seek to cut costs amid cost-of-living pressures¹⁸ have all contributed to the FCA broadening its focus and expectations¹⁹ over the last 18 months to include Insurers/Premium Finance firms. In light of this, firms should ask themselves:

• Whether the firm’s policy cancellation timeframes following a missed payment is sufficient and provides the customer with adequate time to rectify the missed payment (e.g., through obtaining at least another month’s pay) prior to essential insurance being cancelled?
• Whether the firm’s contact strategies and associated customer communications are sufficiently robust and pro-active to engage customers following the missed payment and to enable forbearance to be provided?
• Whether the firm has in place an appropriate suite of forbearance options in place that can be tailored to the customers circumstances in order to support the customer in keeping their insurance policy active?
• When considering forbearance, does the firm have sufficient processes in place to establish the customers affordability to sustain the forbearance that is being agreed?
• Whether the firm has robust controls and monitoring in place to identify and pro-actively respond to early signs of financial difficulty (e.g., contacting customers that have had multiple missed payments during the insurance period to determine if their payment date remains suitable or if any alternative form of support is required).
• Whether there are sufficient processes in place to monitor the outcomes that customers in financial difficulty are receiving (e.g., through Quality Assurance processes and outcomes testing)?

Next Steps and how Deloitte can help?

Firms should prioritise evaluating their approach and act on the actions set-out above. Time and focus should be applied on reviewing existing frameworks, processes and capabilities to gain comfort over the firms compliance with regulatory requirements and expectations and the ability to deliver good customer outcomes across this product offering.

Firms that have been proactive in reviewing their frameworks and implementing robust plans to address any deficiencies identified will be better positioned to navigate through any potential challenges that may be faced by the regulator later down the line.

For firms that would like to discuss this topic or require help or guidance, Deloitte has a highly experienced team of regulatory compliance and conduct SMEs that can support firms through the provision of advice, review and challenge, assurance and/or design and development of regulatory frameworks across the end-to-end customer journey to help firms navigate through the required activities in this area.

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References:

¹ Big Interview: Matt Brewis, FCA - Insurance Post (postonline.co.uk)

² Big Interview: Matt Brewis, FCA - Insurance Post (postonline.co.uk)

³ Dear CEO letter: Our expectations on cost of living and insurance (fca.org.uk)

⁴ CP23/13: Strengthening protections for borrowers in financial difficulty: Consumer credit and mortgages | FCA

⁵ PS23/9: Finalised insurance guidance on supporting customers in financial difficulty (fca.org.uk)

⁶ PS22/9: A new Consumer Duty | FCA

⁷ As outlined in the FCA’s Consumer Credit Sourcebook (CONC), Principles for Businesses (PRIN) and the Consumer Duty Rules and requirements

⁸ Please note, this is not intended to be an exhaustive list of considerations.

⁹ https://www.fca.org.uk/publication/transcripts/consumer-duty-insurance-webinar-transcript.pdf

¹⁰ https://www.fca.org.uk/publications/good-and-poor-practice/consumer-duty-implementation-good-practice-and-areas-improvement

¹¹ https://www.fca.org.uk/news/statements/fca-undertake-work-motor-finance-market

¹² https://www.fca.org.uk/publications/good-and-poor-practice/consumer-duty-findings-our-review-fair-value-frameworks

¹³ Specifically, CONC 3.5 and CONC App 1.2

¹⁴ Specifically, ICOBs 6B.2 and 6A.5.

¹⁵ Per CONC 4.2.

¹⁶ Per CONC 5.2A

¹⁷ ‘It’s insane’: motorists are driven to extremes by soaring insurance costs | Money | The Guardian

¹⁸ Cost of living crisis causes 43% of insurance customers to cancel policies when seeking to cut cover costs | Insurance Times

¹⁹ Dear CEO letter: Our expectations on cost of living and insurance (fca.org.uk), PS23/9: Finalised insurance guidance on supporting customers in financial difficulty (fca.org.uk) and CP23/13: Strengthening protections for borrowers in financial difficulty: Consumer credit and mortgages | FCA