The new Insurance Conduct of Business Sourcebook (ICOBS) produced by the Financial Services Authority (FSA) recently is shorter, but it is not easier, as Heather Thomas explains in this article.

Introduction

The new FSA Handbook rules on insurance administration and selling came into effect on 5^th January 2008 with a transitional period of six months, giving the industry, with one exception, until 5^th July 2008 to comply with the new regime. The one exception is that firms have twelve months to issue revised Initial Disclosure Documents. This article will comment on the principal changes made. There are two headline aspects: the overall reduction in scale and detail as part of the move to principles-based regulation; and the classification of products into “protection products” and “other products” (although these are not defined terms) with different rules applicable in each case. However, the FSA’s discretion to reduce and simplify is constrained by the terms of the Insurance Mediation Directive (2002/92/EC) and indeed by the Distance Marketing Directive (2002/65/EC) and E‑Commerce Directive (2000/31/EC), to which the Handbook rules are cross-referenced where applicable. For any firm not selling protection products, there will be no need to make any change at all, as a firm may opt to continue with the previous, more prescriptive, regime. The FSA’s own commentary on ICOBS is to be found in its Policy Statement 07/04.

Important Definitions

Before looking at the substance of the new rules it is necessary to have in mind some important definitions. The first group relates to the persons being protected, particularly in Chapters 5 (Identifying client needs and advising) and 6 (Product information). In the following definitions italicised words are also defined in the FSA Glossary. First of all a “customer” is “a person who is a policyholder or a prospective policyholder but (except in ICOBS 2 (general matters), and (in respect of that chapter) ICOBS 1 (application)) excluding a policyholder or prospective policyholder who does not make the arrangements preparatory to him concluding the contract of insurance.”  A “policyholder” is “the person who for the time being is the legal holder of the policy, including any person to whom, under the policy, a sum is due, a periodic payment is payable or any other benefit is to be provided or to whom such a sum, payment or benefit is contingently due, payable or to be provided.”  Additionally under ICOBS 2.2.1 G (1) a policyholder “includes anyone who, upon the occurrence of the contingency insured against, is entitled to make a claim directly to the insurance undertaking”. A “consumer” is “any natural person acting for purposes outside his trade, business or profession.”  Finally, a “commercial customer” is “a customer who is not a consumer.”  Note that many of the provisions in ICOBS apply to all customers, not just to consumers.

The exclusion from the definition of customer of those not making arrangements refers to employee beneficiaries under group policies. That apart, the customer and the policyholder will be one and the same. Indeed, only a policyholder can be a customer (ICOBS 2.1.1 G (2)  Note the width of the definition of policyholder, which will capture third party beneficiaries even if they do not appear under the definition of the insured within the policy. The previous distinction between retail and commercial customers has been replaced with the distinction between consumers and commercial customers. There is therefore the wide group of customers (policyholders in all guises) and two subgroups of consumers and commercial customers.

The next group of definitions relates to the products. ICOBS applies to “non-investment insurance contracts” (ICOBS 1.1.1 R). Like many Glossary terms this is a compendium of other defined terms namely: a “contract of insurance which is a general insurance contract or a pure protection contract but which is not a long-term care insurance contract.” The definition of “contract of insurance” also contains defined terms in its definition and since it is the starting point for the non-investment insurance contract, the contract of insurance will be dealt with first.

A "contract of insurance" is rights under any contract of insurance within the categories of either a long-term contract of insurance or a general insurance contract (the Glossary adds a list of examples of contracts of insurance indicating the width of the class e.g. fidelity bonds and tontines). A "long-term contract of insurance" comprises a list, including life and annuity business. A "general insurance contract" is likewise a list of types of insurance, including accident, sickness and credit. The "pure protection contract" is what is commonly called term assurance, where the contract pays on death or incapacity and has no surrender value. The "long-term care insurance contract" is what its name suggests, namely a policy which pays when a person’s health deteriorates so that independent living is not longer practicable.

The overall effect is that long-term business is not dealt with by ICOBS, but the process of arriving at the categorisation is hardly elegant or user friendly. There is now another definition to be aware of: the “payment protection contract”. A “payment protection contract” is “a non-investment insurance contract which has elements of a general insurance contract and the benefits of which are described as enabling a policyholder to protect his ability to continue to make payments due to third parties, or can reasonably be expected to be used in this way.”  The reference to “elements” of a general insurance contract is confusing, given that, as pointed out above, a general insurance contract is not defined as such, but is merely a list. If it has to include coverage of accident, sickness or unemployment (this last not mentioned in the list), then it may be better to say so. This is the approach the OFT has taken in defining payment protection insurance in the terms of reference for the Competition Commission. In any event, payment protection contracts and pure protection contracts are now the subject of additional rules in ICOBS.

Areas of simplification

The greatest degree of simplification is evident in Chapter 2 of ICOBS, where one now finds the rules relating to communications/financial promotions, inducements, record-keeping,  the limited right for a firm to exclude liability and reliance on others. Previously detailed rules are now shortly expressed and, in the case of inducements, record-keeping and reliance on others, confined to guidance. Communications with clients and financial promotions are simply to be clear, fair and not misleading in accordance with Principle 7, with brief additional guidance on pricing claims. The inducements guidance refers to Principle 8 and provides a common sense definition of an inducement (ICOBS 2.3.1 G (2). Firms are reminded that SYSC also deals with records, but that firms must be ready to respond to information requests from the FSA as well as maintain records of personal recommendations, of documents provided to customers and of the rationale for claims settlements. The previous record-keeping requirements in ICOB were not in fact all that helpful in that they were rather on the low side. For example, policy summaries and documents were to be kept for three years, a wholly inadequate period for a number of classes of insurance. So far as excluding liability is concerned, there is one rule which imposes a reasonableness test except that restricting the regulatory regime is absolutely prohibited. Clearly, firms will have to apply their judgement in all these areas, but that was in fact the net result under ICOB. For all the extensive rules and guidance in these areas previously in the Handbook, firms still had to take a view on their own circumstances and will continue to have to do so.

Reclassification of insurance products

The most significant and controversial change in ICOBS is the partition of products into “protected” and “other”. Protection products are term assurance, critical illness insurance, income protection insurance and payment protection insurance (PPI). These products have been identified as more complex than others and the consumer is seen as particularly vulnerable to PPI in particular. The FSA’s thematic review of this product has been running in parallel with the Office of Fair Trading’s reference to the Competition Commission, which is due to report before the end of 2008. The FSA has explicitly reserved the right to revisit the ICOBS rules in the light of the Commission’s report in due course.

The regulatory regime for protection products appears to have toughened considerably even where the purchaser is a customer i.e. not just consumers are protected, although, given the nature of the product, most customers will likely be consumers. The justification for this is principally the complexity of the products, although it is clear from Policy Statement 07/24 that this is not all the FSA has against PPI in particular. Insurers have enjoyed a gradual relaxation of the IMD regime since the rules first came in, but this is an exception. Both insurers and intermediaries must, in relation to pure protection and payment protection contracts, take reasonable steps to ensure that a customer who does not benefit from a personal recommendation i.e. a non-advised sale, realises that he is responsible for establishing whether the policy meets his demands and needs (ICOBS 4.2.4 R (1)). Firms must make a careful check that a customer is eligible for the benefits provided by a payment protection contract and should advise him if there are any benefits for which he would not qualify (ICOBS 5.1.2 R and 5.1.3 G). Where firms are making advised sales, the rule on taking reasonable care to establish the suitability of the product (ICOBS 5.3.1 R) is amplified by guidance at ICOBS 5.3.2 G applicable to payment protection contracts and pure protection contracts. Under this guidance firms must establish the customer’s demands and needs from detailed information obtained from the customer; take reasonable care to ensure that the demands and needs are met, having regard to the limit of cover, cost, exclusions, excesses, limitations and conditions; and inform the customer if any of his demands or needs are not in fact met.

The new product information regime

The product information regime in ICOBS Chapter 6 is likewise more prescriptive for protection products. The table of information at ICOBS 6.3.1 R required to be given in respect of a pure protection contract is driven by the Consolidated Life Directive (2002/83/EC), but the provisions governing both payment protection contracts and pure protection contracts at ICOBS 6.4 are the FSA’s own invention. This is now one of ICOBS’ longer provisions. Any reference during an oral sales process to a main characteristic of the product must be supplemented by information about all the main characteristics (significant benefits, exclusions, limitations, duration and price information). The customer must be able to take an informed decision without being overloaded and without information being obscured. A policy summary (dispensed with for other products) must be provided prior to the conclusion of the contract. The firm must draw to the attention of the customer the importance of reading the documentation before the cancellation period expires. Price information must be provided in a way which enables the customer to relate it to a regular budget with a rule elaborating what must be provided for non-revolving credit agreements and guidance for revolving credit agreements. Finally there are further rules and guidance where a contract provides for mid-term changes.

Although this list appears onerous, is it really much different from the higher level requirements for all products set out in ICOBS 6.1?  At 6.1.5 R a firm must take reasonable steps to ensure that the customer is given appropriate information about a policy in good time and in a comprehensible form to make an informed buying decision. This requirement applies pre- and post- contract and includes information about mid-term changes, renewals and price. Information which should be taken into account is listed in the guidance at 6.1.7 G:

·           the knowledge, experience and ability of a typical customer for the policy;

·           the policy terms;

·           the policy’s overall complexity;

·           whether the policy is bought with other goods or services;

·           the distance communication information requirements; and

·           information previously given to the customer.

If a payment protection contract is an inherently complex product (and many of them are), then it is at least arguable that applying these more general requirements would given rise in any event to the process more elaborately set out at ICOBS 6.4. However, the FSA clearly does not want this to be a matter for a firm’s discretion.

Cancellation rights

The right to cancel is matched to the two categories of product: 30 days for payment protection and pure protection contracts and 14 days for all others.

Conclusion

No-one will miss the old form of ICOB. The new sourcebook is certainly more accessible. Those intermediaries who are not selling protection products may derive the impression that their role is now less burdensome than before. This would be a mistake. Between the provisions of ICOBS 6.1 and the Treating Customers Fairly initiative, challenges remain. Those intermediaries and insurers selling protection products will be under no illusion about the scale of the difficulties they now face.

Heather Thomas

Heather Thomas is a solicitor specialising in the law and regulation of insurance intermediaries and trading as Heather Thomas Consulting.  This article was written as at 14^th January 2008.

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