FCA critical of product oversight and governance in Thematic Review

Introduction

On 21 August 2024, the FCA published its Thematic Review TR24/2 on Product Oversight and Governance in the insurance sector.

Overall, the FCA is clearly unhappy with what they consider to be a lack of progress in embedding appropriate product oversight and governance within insurers and intermediaries. The FCA has found that:

(a) many manufacturers are not adequately assessing and evidencing that their products deliver fair value and good outcomes; and

(b) many distributors are not getting sufficient information from manufacturers to understand their distribution strategies and do not understand how their remuneration can impact on a product's value.

We expect the FCA will follow up with more focussed requirements, whether placed on individual firms or at product level. In that regard, the FCA has already shown willingness to act strongly in the face of products it is not happy with, with an example being the restrictions on new sales of GAP policies introduced earlier this year whilst commission levels and perceived product value issues were addressed. There is also the prospect of the FCA expecting prompt remediation of any perceived customer harm.

Key findings from the Thematic Review

Manufacturers

Product Oversight & Governance arrangements: According to the FCA, many manufacturers have product governance frameworks that are not compliant with PROD 4. The FCA is concerned that many firms did not demonstrate appropriate governance around ensuring products deliver fair value and good outcomes for customers.

More specifically, some firms could not evidence appropriate challenge to and approval of products, fair value assessments (FVAs) and ongoing monitoring of product performance. The FCA criticised firms that had not identified their governing body as having ultimate responsibility for their products and where senior management did not have sufficient input into and oversight of product approval and review.

Examples of poor practice included where a distributor had concluded that a product did not provide fair value but the manufacturer had taken no action in response. Another concerned the simplification of information into product governance forums or the responsible SMF holder without sufficient underlying data to allow issues to be identified and considered.

Fair value assessments, ongoing monitoring and regular review of products: The FCA concluded that FVAs are not being embedded properly in the product approval process or used effectively/consistently. The FCA identified, for example, situations where FVAs contained vague or generic statements, were not supported by sufficient evidence or were not given due consideration within the firm. They also criticised FVAs that do not consider how the product would continue to provide fair value for a reasonably foreseeable period.

Examples given of poor practice in FVAs include:

(a) not adequately considering the total price paid (including the impact of remuneration paid to distributors) on the overall value of the product;

(b) insufficient MI to demonstrate how products are actually performing;

(c) being unable to demonstrate how fair value is assessed for different customer types (including vulnerable or outlier groups of customers);

(d) firms failing to have in place sufficient measures to ensure they identified and consistently reported product issues or circumstances that may harm the customer.

The FCA was critical of firms that relied overly on benchmarking against other providers. The fact that the data relating to a particular metric matches market norms does not, itself, demonstrate that a product is providing fair value. The FCA was also critical of firms adopting sweeping and poorly considered RAG thresholds across product lines. They gave the example of a firm setting a tolerance threshold for its claims ratios of 20% across all products, without any assessment of the appropriateness of that threshold for individual products.

Target market: The FCA stated that some manufacturers' target market descriptions are too vague and broadly defined. The FCA criticised target market analysis that did not reflect the risk appetite and tolerance of both the firm and the customer. The FCA noted that the underwriting criteria for a product could be useful in helping to define the appropriate target market. The FCA also gave some examples of good target market statements. These included, for instance, a more granular breakdown of the intended customer base.

Manufacture by more than one firm (co-manufacturing): According to the FCA, some co-manufacturers do not understand or meet their obligations under PROD 4.2.Some co-manufacturers do not have a co-manufacturing agreement in place that meets the PROD requirements. Some insurers had attempted to allocate full responsibility for compliance with PROD 4 to an intermediary. The FCA emphasised that this is not permitted.

Distribution arrangements including information disclosure to distributors: Some manufacturers have not appropriately considered their distribution arrangements or choice of distributors in light of the product and its target market. Manufacturers are also not providing appropriate and timely information to distributors.

Common themes: There are a number of common themes that run through the FCA's findings that relate to insurance product manufacturers.

(a) Is there a sufficient level of granularity of and analysis of data being circulated, debated and challenged within firms?

(b) Is the right MI being captured and benchmarked using the right tolerance thresholds?

(c) Is there proper assessment and challenge to that data? Is proper root cause analysis being performed based on issues flagged by the data? And are the conclusions being escalated and challenged?

(d) Are appropriate actions being taken when customer harm is identified?

(e) Specifically, can manufacturers demonstrate appropriate assessment and review of target market identification and distribution strategies?

(f) Finally, is all of this evidenced?

Distributors

Product Distribution Arrangements: According to the FCA, many distributors have a lack of clarity around their governance structures and processes with limited or no clear responsibility, rationale, or evidence for key decisions, including any actions taken when they identify value problems. Many distributors do not get or circulate appropriate management information from the manufacturer or otherwise to enable them to understand the product value.

For example, the FCA highlighted that fewer than 5 of the manufacturers who formed the review sample provided adequate information about the impact of the distribution arrangements on the product's overall value. They also stated that only a few of the distributors sampled provided adequate evidence that they properly assessed whether the distributor remuneration was consistent with the product providing fair value.

The FCA mentioned specifically the failure of distributors to assess the interaction between remuneration and fair value in the context of package products.

Target market: Some distributors' target market statements differ materially from the manufacturer's target markets which raises concerns about the product being mis-sold to customers outside of the target market.

Distribution strategy: Many distributors do not amend their distribution strategy where they identify problems with the outcome of product distribution arrangements, and do not get enough information from manufacturers to help them to do so.

Comment

Some of the issues raised by the FCA seem to us to be, in part at least, a reflection of confusion around the drafting of PROD and the Consumer Duty rules themselves. For example, the division of responsibility between manufacturers and distributors, and how to cater for vulnerable customers, remains unclear to many in the market.

That said, the FCA is clearly frustrated that firms have not made more progress in embedding proper product governance and oversight processes. In particular, they see a need to improve the effectiveness of governance structures, the quality of data circulated and debated, root cause analysis of issues that the data flags and the introduction of demonstrable improvements in product value in light of these assessments.

The FCA will no doubt emphasise the fact that the PROD requirements in broadly their current form have been around since 2021 (with an earlier and narrower iteration having been introduced in 2018). These are not new requirements introduced as part of the Consumer Duty in July 2023.

Furthermore, the FCA criticism is unlikely to come as a complete surprise. They have, for a number of years, emphasised that product value is a key priority in their conduct regulatory role. In their multi firm review of outcomes monitoring by insurance firms under the Consumer Duty, published in June, they concluded that there was too much data from firms on process completion (i.e. project plan updates) rather than the quality of customer outcomes (the substantive output of compliant processes and procedures). In that review they noted, as good practice, firms who documented foreseeable customer harm and then designed data requirements around those potential harms. They suggested that the use of tolerance thresholds as a way of identifying potential customer harms might be beneficial.

How should firms respond to the review?

Firms' responses to the Thematic Review may present a final chance to reassure the FCA that progress has been, and will be, made, before the FCA starts taking action in relation to products or individual firms. The market has already seen the FCA respond in a sweeping fashion to its concerns about the value of GAP insurance (whether add-on or stand-alone). Each insurer and intermediary will need to consider its response separately, based on its own circumstances. However, there are three general points we would emphasise:

1. It is important to demonstrate that (a) sufficiently detailed data is being escalated through the product governance structure; and (b) that this data is accompanied by proper analysis explaining what it shows and how any issues identified by the data should be remediated. In our experience, boards can often be given too little information, or too much without proper narrative data. Either way, the result is that no assessment and meaningful oversight is possible. Getting that balance right, and evidencing the engagement and challenge, is crucial.

2. MI, and what is done with that MI, is key. Firms should be reviewing and enhancing the MI they capture, the tolerance thresholds they have set for each metric and what the data is actually telling them. This last part can be the trickiest. The root cause analysis of issues can be time consuming and complicated, but is where the real substance of the product value assessment takes place. If claim declinature rates are too high, why is that the case? If no policies are ever cancelled, what does that say about barriers to cancellation? We would also encourage all firms to look at their product value metrics, and the results, considering the overall customer journey. This goes from the sales process all the way through to complaints.

3. The roles and responsibilities of each firm in the distribution chain, from manufacturer to customer, should be clearly defined and engagement encouraged.

Finally, the FCA has said (explicitly or implicitly) on a number of occasions, that it expects the introduction of the Consumer Duty to result in more pro-active measures being taken, including, where necessary, customer remediation. The legal basis for this requirement may be capable of challenge (in that regard, the market is waiting for the Court of Appeal decision in Bluecrest Capital Management (UK) LLP v The FCA with great interest). What is clear, in our view, is that there will be increasing pressure in the insurance market to demonstrate product value and to pro-actively address existing issues, through the course of 2024/25.

How we can help

We have extensive experience in the design of, amendments to and implementation of processes, procedures and reviews designed to meet regulatory requirements, including those relating to product oversight and governance and the Consumer Duty. We have supported numerous clients in preparation for s.166 skilled persons reviews, regulatory investigations and other regulatory interactions (with the FCA, PRA and Lloyd's). Should you have any queries or require any support, please do not hesitate to contact one of the team.