Insurance Regulatory Review
UK insurance regulation looking forward to 2022
After a year of upheaval for the UK insurance sector in 2021, there seems little prospect of 2022 being any quieter.
From a regulatory perspective, 2021 began with the end of the Brexit transition period. And while firms operating in UK insurance markets have been insulated from the full impact of Brexit during 2021, this is set to change in 2022. PRA and FCA concessions to firms affected by Brexit will stop from 31 March 2022 and most firms that are currently in the Temporary Permissions Regime will need to transition to full authorisation over the next two years.
Table of contents
1. Regulatory framework 2
2. Changes in prudential
3. FCA - Conduct of business reforms
4. Environmental, social,
5. Operational resilience 10
Solvency II reforms can now also be introduced in the UK without
regard to the constraints of EU membership. We can expect to
see developments on this front in 2022.
Meanwhile, the FCA has embarked on an ambitious
transformation programme, putting consumer protection at the heart of its focus on becoming a "more assertive, innovative, and adaptable" regulator. Proposals to introduce a Consumer Duty
Herbert Smith Freehills Insurance
represent a step change in how financial sector firms are expected to behave and build on the FCA's work in other areas,
including general insurance pricing and distribution chains. Other
recent developments that will carry over into 2022 include
proposals to improve regulated firms' oversight of Appointed Representatives.
In some cases, UK initiatives align with international trends in regulation, including within Europe. ESG remains, of course, high on the agenda of firms and regulators worldwide, with increasing engagement at Board and senior executive level on a range of issues. Notably, COP26 brought climate change into sharp focus, with both the PRA and FCA confirming their role in ensuring that firms manage climate change risk. The regulators are also looking to "accelerate the pace of meaningful change" in diversity & inclusion ("D&I") in the financial services sector. Further activity can be expected in relation to each of "E", "S" and "G" during 2022.
We consider below some of the key regulatory developments that have taken place in 2021 and look forward to 2022.
1. Regulatory framework
Financial Services Future Regulatory Framework Review
In June 2019, the UK government launched a review of whether the financial services regulatory framework is fit for the future, in particular, in the light of Brexit. HM Treasury's ("HMT") consultation paper, published in December 2021, proposes a number of changes (summarised in our blog post here).
One welcome aspect of the proposals is to address shortcomings in how EU legislation that previously applied directly in the UK has been "on-shored". The approach initially taken means that many EU regulations now sit in UK legislation when they should really appear in the PRA/FCA rulebooks. This brings confusion and inflexibility to the regime.
Taking Solvency II as an example:
the Solvency II Directive, which sets out the high-level framework of the regime, was primarily implemented through the PRA rulebook and, as such, can be adapted with relative ease;
but the Solvency 2 Delegated Regulation and Solvency II technical standards, which contain more detailed requirements, appear in UK legislation and can only be changed by Parliament.
This is illogical and was undoubtedly the result of the need to "translate" a substantial amount of EU legislation into UK domestic law during the relatively short period before Brexit took effect. The broader regulatory framework should be set out in legislation (ie in FSMA and supporting secondary legislation) leaving the detail to the regulators. The technical expertise that is needed to determine how insurers should be regulated sits primarily within the PRA, but it has little power to effect change to the prudential framework without calling on Parliament to help. This can be difficult given pressures on Parliamentary time.
Unfortunately, any return to coherence is expected to take place "over a number of years" so it will be some time before the current position can be put right.
Regulatory perimeter UK firms
Published in October 2021, the FCA's latest Perimeter Report notes the challenges associated with defining, and maintaining, the regulatory perimeter. The development of new products and services or of new ways in which products and services are delivered can put the perimeter under strain. Rapid technological change and the increased digitalisation of financial services are just part of the reason for this. And, because the regulatory perimeter is defined by (secondary) legislation, it can take some time for regulation to react to market changes.
General insurance perimeter
On the general insurance perimeter:
Discretion The FCA questions the use of discretion in contracts to avoid insurance regulation. It argues that in some cases the discretion is illusory rather than real. In others, it would expect the discretionary aspect of a contract to be an unfair term. We are aware of careful FCA scrutiny of this type of contract in recent years.
Contracts for repair services The FCA is not always convinced by claims that warranties are mainly service contracts providing for the repair of a product with only a minor indemnity (and therefore insurance) element covering loss of or damage to the product. It argues that closer examination of the terms of the contracts would suggest that this analysis is flawed.
The FCA is considering whether to clarify its position through its Perimeter Guidance Manual (PERG). The difficulty it may have in challenging the characterisation of products that contain a discretionary element is that case law sets some relatively clear guidelines that could only be overturned by legislation (assuming no opportunity arises to take the point to a higher court). For example, the decision in Medical Defence Union v.
Department of Trade and Industry  2 W.L.R. 686 establishes that contracts which leave the provider with an absolute discretion whether to pay out on the occurrence of a relevant event will not be contracts of insurance even if, in practice, that discretion has never been exercised to deny a benefit. PERG recognises these points, and it will be interesting to see how the FCA addresses the concerns it has raised while still being consistent with the prevailing jurisprudence.
In June 2021, HMT confirmed its intention to introduce a new regulatory gateway for firms approving financial promotions for unauthorised firms. Under the current rules, there is a concern that firms can approve a financial promotion without fully understanding the product or service it relates to and, as a consequence, without being able to ensure that the promotion meets required standards. The gateway would allow the FCA to assess a firm's ability to approve financial promotions before it issues any approvals.
Aspects of the FCA's Perimeter Report relating to the Appointed Representatives ("ARs") regime; the overseas persons exclusion ("OPE"); and outsourcing and third party service providers are considered separately below.
Regulatory perimeter Overseas firms
HMT's review of the regulatory framework for overseas firms is ongoing. In July 2021, it published a response to its December 2020 Call for Evidence ("CfE"). Topics covered by the CfE included the OPE and the financial promotions regime, specifically in relation to the distribution of overseas long term insurance products in the UK.
HMT noted that, whilst it had obtained valuable feedback from the CfE, gaps in its understanding remained. It committed to working with the PRA and the FCA with a view to identifying:
whether the balance of the overseas perimeter remains appropriate for the UK following Brexit;
whether there are elements of the overseas regulatory perimeter that need updating to reflect modern working patterns and advancements in technology, such as the 'in the UK' test which is the first consideration for firms assessing their regulatory compliance; and
areas of the overseas perimeter that could be clarified to allow greater transparency and clarity for firms.
2. Changes in prudential regulation
Solvency II reform UK
Both the UK government and the PRA have expressed their support for targeted reforms of the Solvency II regime for some years. Limited reforms were introduced prior to Brexit on the basis that this could be done while remaining compliant with EU legislation and guidance.
The argument for further change now that the UK is no longer constrained by EU membership is that the current rules do not always work well for the UK market. The EU's refusal to recognise the UK regime as "equivalent" (even at present, while on any objective basis such a recognition should be granted) arguably also makes it easier to justify further reform.
In October 2020, HMT published a CfE, inviting stakeholders to make the case for change. In its July 2021 response, HMT noted that there was "extensive evidence that many aspects of Solvency II are overly rigid and rules-based". It would work towards establishing a more proportionate and flexible regulatory regime. Reforms should include, unsurprisingly, the risk margin and the Transitional Measure on Technical
Provisions. Another area for review would be the eligibility of different asset classes for the matching adjustment as the government seeks to align regulation with its broader aims of encouraging investment in infrastructure and in the green economy. Consideration would also be given to the Solvency Capital Requirement calculation and to internal model application processes.
Having been asked to model different options for reform, the PRA first launched a Quantitative Impact Study ("QIS") in July 2021, allowing it to gather the data it needed to project the impact of various possible packages for reform. This was followed in August by a qualitative questionnaire, to supplement the QIS and support policy development in areas not covered by the QIS.
The PRA is now working with HMT to analyse the QIS results, which will inform a comprehensive package of reforms. This will be in addition to some more limited changes to Solvency II reporting requirements, which were confirmed by the PRA in December 2021 (see PS29/21).
Solvency II - PRA redefinition of "insurance holding company"
In an early change to the Solvency II regime inherited from the EU, the PRA's proposed new definition of "insurance holding company" (CP17/21) means that some companies that are currently regarded as "mixedactivity insurance holding companies" would probably be reclassified as insurance holding companies for the purposes of group supervision (see our blog post for discussion). This would bring with it a higher burden than at present in terms of how a group is supervised. It also appears to mean that different definitions will apply under UK legislation and regulation, which can only lead to additional confusion.
The new definition will only apply to future determinations of insurance holding company status. Existing groups are, however, likely to be reassessed on the occurrence of a "trigger event", including an acquisition or disposal. If this includes all acquisitions or disposals, however small, groups may be subject to a reassessment rather sooner than they might hope. This would need to be factored into any project plans for group reorganisations. Concern has been expressed that future M&A activity may be stymied if the future regulatory status of a group is uncertain.
Solvency II reform EU
Raising the prospect of further divergence between the UK and its former EU partners, EU reform of the Solvency II regime is also not far away. Following its 2020 review, the EU Commission adopted two legislative proposals on 2 September 2021. A proposed directive amending the Solvency II Directive aims to improve aspects of the current regime, while enhancing the sector's capacity for making long-term investments in line with the EU's political priorities. Amendments relate to:
quality of supervision;
long term guarantee measures;
managing climate change and sustainability risks; and
Any changes that are made to the Solvency II Directive will not, of course, apply directly to UK-incorporated (re)insurers. They may, however, prompt the PRA to adopt similar changes to the extent consistent with the PRA's overall objectives for Solvency II reform. They may also be relevant to how an EEA-headquartered insurance group that contains a UK (re)insurer subsidiary is supervised the UK's lack of equivalence status may be a disadvantage here. The changes will also, of course, directly impact EEA (re)insurer subsidiaries within a UK-headquartered group.
Other reforms of the EU regime include a proposed new directive establishing a recovery and resolution framework for EU (re)insurers and insurance groups. In its Business Plan 2021/22, the PRA indicated that it would be developing its approach to recovery and resolution planning for insurers during 2021 but it has not to date published those plans. HMT did, however, publish proposals in August 2021 to amend insolvency rules applying to insurers (see our blog post here).
3. FCA - Conduct of business reforms
The FCA's first Business Plan to be published since Nikhil Rathi became Chief Executive sets out its key priorities for transforming the FCA. It is determined to build a culture that embraces risk, is more inquisitive, and acts decisively to tackle harmful behaviour as soon as it comes to light.
"We need to change the way we do things, and in some cases
what we do. We are becoming a different organisation."
General insurance pricing practices
FCA, BUSINESS PLAN 2021/22
FCA reforms announced in May 2021 address problems identified in its market study looking at pricing practices in home and motor insurance markets. "Price walking", a practice which means that existing customers can pay considerably more at renewal of their policies than new customers for the equivalent cover, has been banned.
Other remedies included:
extending existing product governance rules to all general insurance and pure protection products regardless of when they were manufactured and introducing new rules requiring firms to ensure their products offer "fair value";
addressing barriers to switching in contracts that are set to auto-renew; and
introducing new reporting requirements in home and motor insurance.
The reforms (summarised in our at a glance guide) are intended to support other FCA initiatives to ensure that general insurance markets "work well" for customers. These include the introduction of a Consumer Duty (see discussion below) and guidance for firms on the fair treatment of vulnerable customers (FG21/1).
Key dates: Rules related to product governance and systems and controls and retail premium finance took effect from October 2021. Rules on pricing, auto-renewal and reporting took effect from January
The FCA considers that the introduction of a new Consumer Duty will "fundamentally shift the mind-set of firms" and establish an appropriate level of care to consumers (for an overview of these proposals, see blog post here).
Proposed rules and guidance published in December 2021 (see CP 21/36) are familiar from those previously consulted on in May 2021 (CP21/13). They include a new Consumer Principle (Principle for Businesses 12) that would replace Principles 6 and 7 for retail business: "A firm must act to deliver good outcomes for retail clients". This new principle is supported by:
Three cross-cutting rules requiring firms to: act in good faith towards retail customers; avoid causing foreseeable harm to retail customers; enable and support retail customers to pursue their financial objectives; and
Four outcomes the FCA expects the new rules to achieve:
The product and services outcome: consumers are sold products and services that have been designed to meet their needs, characteristics and objectives.
The price and fair value outcome: consumers pay a price for products and services that represents fair value to them.
The consumer understanding outcome: consumers are equipped with the right information to make effective, timely and properly informed decisions.
The consumer support outcome: customers receive the support they need.
The FCA's cost benefit analysis highlights the likely impact of this initiative on firms. Total one-off direct costs the FCA considers that firms may incur to comply with the Consumer Duty could be up to 2.4bn. This cost would be incurred in performing a gap analysis on policies and processes, making relevant adjustments through change projects, training staff on the new requirements, as well as IT costs from system changes and costs to monitor and test consumer outcomes.
"The Consumer Duty aligns with our own transformation and our focus on being more assertive, innovative, and adaptable in our
Ongoing annual direct costs are predicted to be in the range of 74.0m to 176.2m across the financial services sector. These costs do not include indirect costs, such as loss of profits.
FCA, "A NEW CONSUMER DUTY", CP21/36
The following are just some of the many issues raised by the proposals:
Where are the gaps between the current FCA rules and the new Consumer Duty? To what extent do recent changes made to address consumer harm in general insurance markets set the benchmark for the Consumer Duty or do firms still need to do more? The interaction between the new duty and current rules and guidance is not always straightforward.
When is customer disappointment nonetheless consistent with a "good outcome" (eg if a consumer's home is repossessed under a mortgage, can that be consistent with a "good outcome")? How is "good" measured in such a case?
How should the Consumer Duty apply where there are multiple firms in a distribution chain and what standards will be expected, in particular, of those firms that have no direct contact with retail customers?
Although the Consumer Duty will not have retrospective effect, how will it impact on existing contracts? This may be a particular issue for the long term insurance market.
What changes will be needed to ensure that internal processes meet the new standards and that compliance can be demonstrated to the FCA?
How do the FCA's proposals affect the Board and individual officers and employees within firms? How should they look to fulfil any additional responsibilities that come with the new duty?
What approach will the Financial Ombudsman take to enforcement of the Consumer Duty?
Key dates: The consultation is open until15 February 2022and the FCAexpects to confirm any final rulesby the end of July 2022. The new duty is expected to apply from April 2023.
Appointed representatives regime
The FCA is concerned about the harm that may be caused to consumers and markets by the use of the AR regime. This is a model used by around 3,600 principals and 40,000 ARs across a wide range of financial services markets. To address some of its concerns, the FCA is consulting on changes to its rules (CP21/34) and HMT has published a CfE.
Key takeaways for firms and their ARs include the following:
"[W]e have seen a range of harm across all of the sectors
where firms have ARs."
FCA, "IMPROVING THE APPOINTED REPRESENTATIVES REGIME", CP21/34
The proposals (as summarised in our blog post) focus on clarifying and strengthening existing arrangements rather than bringing wholesale change. More change must, however, be expected as both the FCA and HMT develop their thinking.
Firms involved in AR arrangements should consider how the proposals will affect them and, where necessary, should expect to review and adjust their processes and existing contractual arrangements. Principals with large numbers of ARs, in particular, should start their planning now.
Firms considering new AR arrangements should bear in mind that the AR model is likely to become more restricted over time. Small principals with larger ARs, overseas ARs and regulatory hosting arrangements are expected to be most affected by any future tightening of the regime.
The proposals in CP21/34 form part of a wider intervention to tackle issues identified by the FCA. As set out in its 2021/22 Business Plan and 2020/21 Perimeter Report, the FCA is targeting supervisory action to ensure that principals and ARs are financially stable and competent. To fund this work, the FCA has introduced a new fee for principals with ARs.
Principals should also consider the impact of the new Consumer Dutyon their AR arrangements. Do their AR arrangements allow them to deliver good outcomes for retail consumers?
Key dates: The response date for both CP21/34 and the CfE is 3 March 2022. The FCA plans to publish final rules in H1 2022. HMT will decide whether amendments to FSMA are required once it has considered
responses to its CfE.
4. Environmental, social, governance (ESG)
Unsurprisingly, the focus of both firms and regulators on ESG remains undiminished as we move into 2022. A number of key announcements were timed to coincide with COP26, which took place in November 2021.
Notably, the FCA published its Strategy for Positive Change, describing its target outcomes for "E", "S" and "G" and actions it expects to take to deliver those outcomes. Five core themes underpinning its work are:
Transparency Promoting transparency on climate change and wider sustainability along the value
Trust Building trust and integrity in ESG-labelled instruments, products and the supporting
Tools Working with others to enhance industry capabilities
and support firms' management of climate-related and wider sustainability risks,
opportunities and impacts
Transition Supporting the role of finance
in delivering a market-led transition to a more sustainable economy
Team Developing strategies, organisational structures, resources and tools to support the integration of ESG into
The FCA is embedding ESG considerations across everything it does as an organisation. The Bank of England's response to climate change is based on five key goals. Its overriding objective is "to play a leading role, through our policies and operations, in ensuring the macroeconomy, the financial system, and the Bank of England itself are resilient to the risks from climate change and supportive of the transition to a net-zero economy".
Key dates: From 2022, the PRA will embed climate change within its supervisory approach and supervise firms actively in line with the expectations. Supervisory action will be taken against firms who
are not thought to be doing enough.
Climate change disclosure
On 17 December 2021, the FCA published its policy statement (PS21/24) on enhancing climate-related disclosures by asset managers, life insurers and FCA-regulated pension providers. Proposals issued in June 2021 (CP21/17) aimed to align disclosures at entity and product level with recommendations made by the Taskforce on Climate-related Financial Disclosures ("TCFD") created by the Financial Stability Board and are part of the FCA's broader strategy on ESG.
"Financial services and markets have a central role in the transition to a low
carbon economy and a more sustainable future. The Government has committed
to achieving a net zero economy by 2050. We will support this aim by
adapting our regulatory framework to enable a market-based transition."
FCA BUSINESS PLAN 2021/22
The FCA's final rules do contain some changes from those consulted on after data gaps and methodological challenges were identified by responses to the consultation. Nonetheless, this represents a step forward in relation to climate change disclosures required of certain categories of firm.
These rules will develop over time. While primarily focused on climate change at the moment, they can be expected to be broadened to encompass sustainability more generally. It is also anticipated that the FCA will increase its efforts to penalise "greenwashing", and firms will therefore need to ensure that they can back up claims that they make about the sustainability of products that they are selling. The FCA is supporting the government's work in this area to develop a UK taxonomy for sustainable activities, Sustainability Disclosure Requirements for businesses and investment products and a new sustainable investment label.
Key dates: There is a phased approach to implementation of the FCA's changes. The rules apply from 1 January 2022 for the largest inscope firms and one year later for smaller firms above the 5 billion exemption threshold. The first public disclosures will need to be made by 30 June 2023.
Disclosures in financial statements
The Bank of England has advocated for climate disclosures aligned with the TCFD framework and is committed to working internationally to ensure broader acceptance of the need for mandatory TCFD reporting. In the interests of leading by example, the Bank of England has itself published TCFD reports for two years.
Disclosure in financial statements will become mandatory (on at least a "comply or explain" basis) for an increasing number of companies (including life insurers) over the coming years. Even aside from regulatory requirements, pressures to disclose how businesses engage with ESG are becoming more intense (eg some asset managers (including those within insurance groups) have publicly said they will not invest in certain insurers who they perceive not to be doing enough to address issues such as climate change).
Key dates: When financial statements will first need to include TCFD reporting will vary by company type, with the first mandatory disclosures to be included in respect of financial years beginning on or after 1 January 2021. Most life insurers can, however, expect to be affected by TCFD reporting before the end of 2023, while at least some listed insurers will need to address those disclosures in the financial statements they release in 2022.
The PRA issued climate-related supervisory expectations for regulated firms in 2019, with a deadline for firms to have embedded them as far as possible by end-2021. In October 2021, the PRA and the FCA each published a climate change adaptation report. The reports look at how the financial services industry is adapting to climate change set against the broader context of each organisation's role as a regulator and its statutory objectives. Both regulators confirm that climate change creates material risks for the ongoing fulfilment of their objectives. Both confirm that they have a part to play in ensuring that firms manage their exposure to climate-related financial risks.
In the context of insurance, many of the risks that climate change poses to the PRA's objectives can be easily identified. A general insurer providing cover for extreme weather events, for example, clearly needs to be able to understand and manage risk associated with an increase in the number and severity of such events. And capital requirements need to respond to such increased levels of risk. Equally, an investment strategy that does not take account of climate change may pose additional risks to an insurer's financial soundness, for example, because the risk of a collapse in asset values in not accounted for in capital requirements.
More difficult, however, is how risk associated with climate change is measured and, therefore, how capital requirements should respond. In a letter published by the PRA in July 2020, it recognised that there were "some areas where the science, data or tools are not yet sufficient to estimate the risks accurately" and that firms should employ reasonable proxies and assumptions instead.
Key dates: The Bank of England has pledged to "advance its thinking" on the use of capital for prudential purposes and to provide an update by the end of 2022.
Diversity and inclusion
D&I has become an increasingly important area of concern for businesses, reflecting wider changes in society and a growing support for ESG agendas (see our blog post for recent comment). A joint discussion paper (DP21/2) published by the PRA and FCA in July 2021 sought to kick-start a discussion on how to "accelerate the pace of meaningful change" in improving D&I in financial services firms.
Financial regulators recognise the importance of D&I in ensuring that financial organisations (and the regulators themselves) mitigate the risks of "groupthink". Reflecting this emphasis, they refer to the concept of "diversity of thought", the "bringing together [of] a range of styles of thinking among members of a group". This more expansive definition recognises that diversity comes in many different forms and can be influenced by different factors. It also reflects a growing emphasis on intersectionality, which recognises the over-lapping systems of disadvantage and discrimination that some groups face.
"Lack of diversity at the top raises questions about firms' ability to understand the different
communities they serve, and their different needs"
NIKHIL RATHI, FCA CEO, MARCH 2021
However, diversity without inclusion is not enough. This is because an inclusive environment is one in which everyone feels involved, valued, respected and treated fairly. As such, they feel empowered to speak up and to make a contribution. An inclusive culture is therefore a necessary starting point for the benefits of diversity of thought to be realised.
Regulators have suggested a number of practices that firms could adopt in order to increase D&I. These include publishing their D&I policies; providing D&I training; linking remuneration to progress on D&I; and reporting diversity data. There are other suggestions which may prove more controversial, such as diversity quotas for the hiring of senior management.
Key dates: The PRA and FCA intend to consult on more detailed proposals in Q1 2022, followed by a Policy Statement in Q3 2022.
5. Operational resilience
In March 2021, UK regulators published their final policy on operational resilience - the ability of firms and the financial sector as a whole "to prevent, adapt, respond to, recover and learn from operational disruptions". At its most basic level, the idea is that a firm or sector which is operationally resilient can get back up after it has fallen over.
Initially, regulators drove the focus on operational resilience the debate in the UK was formally launched in 2018 but the advent of Covid-19 significantly accelerated industry engagement.
Documents published in March 2021 (see our blog post for further details) included the following:
A joint covering document "Operational Resilience: Impact tolerances for important business services", published by the Bank of England, the PRA and the FCA.
FCA policy statement "Building Operational Resilience" (PS21/3).
PRA policy statement "Operational Resilience: Impact tolerances for important business services" (PS6/21).
The PRA also published a policy statement on outsourcing and third party risk management (PS7/21), including a final Supervisory Statement (SS2/21). The FCA noted in its latest Regulatory Perimeter report (see section 1 above) that regulated firms' increasing reliance on unregulated service providers to support their business raises concerns about concentration risk, particularly as some unregulated third party service providers become increasingly dominant in their chosen markets. These third party firms cannot be brought
within the direct scope of regulation. However, the regulators' approach aims to ensure that regulated firms manage these relationships to minimise the scope for risk to customers.
Geoffrey Maddock, Partner T +44 20 7466 2067 M +44 7785 255 016 [email protected]
Alison Matthews, Consultant T +44 20 7466 2765 M +44 7809 200 879 [email protected]
Hywel Jenkins, Partner T +44 20 7466 2510 M +44 780 9200327 [email protected]
Barnaby Hinnigan, Partner T +44 20 7466 2816 M +44 7930 331 620 [email protected]
Grant Murtagh, Of Counsel T +44 20 7466 2158 M +44 7720 733 705 [email protected]
Benedicte Perowne, Senior Associate T +44 20 7466 2026 M +44 7595 967 377 [email protected]
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Herbert Smith Freehills LLP 2022 The contents of this publication, current at the date of publication set out above, are for reference purposes only. They do not constitute legal advice and should not be relied upon as such. Specific legal advice about your specific circumstances should always be sought separately before taking any action based on the information provided herein.