100 days of the FCA

Consumer focus

Thank you for that introduction. It’s a pleasure and privilege to help close the conference with Otto this afternoon.

As we all know, the UK insurance industry remains a pillar of the world economy.

On the macro scale – making possible the financing of otherwise impossible projects: from the launch of satellites into space to the construction of the new World Trade Centre.

On the micro level – the individual level: allowing us to hedge against risk and have peace of mind in our major purchases, from homes to mobiles and everything in between.

So I wanted to start with a thank you to the ABI and your members.

And I also want to applaud the positive work you are doing to provide consumers with strong services: both the important thinking you’ve undertaken on retirement choices – the code of conduct[1].

As well as the telematics good practice guide[2] for the insurance industry, on which the FCA engaged with the ABI in its development.

These publications speak of an insurance industry that places significant weight on consumer outcomes. An industry that continues to evolve and adapt.

100 days in

The UK regulatory system has been going through its own reconstruction – albeit in more radical fashion.

That process is now largely complete. And we’re celebrating a centenary of sorts at the FCA today – it is now 100 days since we were formally incorporated.

One of the questions I was most frequently asked 101 days ago was: ‘Is the FCA going to be genuinely different from the FSA?’ ‘Are the changes cosmetic – a quick nip and tuck – or meaningful?’ There was scepticism over the depth and breadth of regulatory change.

And we can understand that. We can understand why people reserved judgement – why they wanted to see robust reform. Not an airbrushed version of what went before.

The FSA needed to change. That’s the simple truth. Some areas needed a fresh approach.

Too much of what went before in regulation – both in the UK and abroad – was based on implausible economic assessments. The impossibility of perfectly rational consumers and markets. A world where everything and everyone behaves entirely predictably – or at least predictably in the classical economic sense:

• where consumers are always rational actors
• where prices are competitive and respond to new information
• where people read and understood the terms and conditions.

We know that was a false paradigm.

Looking back now, we can see this approach to regulation was flawed. It was too simplistic and inflexible. It left too many questions unanswered. For example, it had very little to say, or offer, pre-crisis about the effect of over-rapid business expansion on behaviour.

So, at what point does the relentless push for growth in earnings-per-share bump into the interests of the customer? And how do staff incentives become skewed under those economic conditions?

It also had very little to say about the complex relationship between technical rules and moral judgements. Can you mandate by rulebook alone? Or does that militate against its intelligent application? Is it possible to produce good outcomes with a toolkit of tick lists and tenets?

We came to the new FCA with the view that we had to have convincing answers to these questions. 100 days later we are taking steps in the right direction. The FCA is in many areas a very different animal from the FSA.

So, not only do we have a new overarching objective to make markets work well. We also have new powers and a new philosophy to be forward looking and forward thinking.

You can see that in the approach we took on interest-only mortgages[3] – potentially a big issue bubbling away that could affect borrowers without a repayment strategy years down the line.

We could have taken the tried and trusted ‘sit back and wait’ approach to see how things turned out.  If the fears materialised, we could have then carried out an industry review many years down the line, looking backwards at the problem.

Instead, we acted to try and nip this in the bud.  We studied the market to see the extent of any potential issues. We then worked alongside trade bodies to get the industry to take ownership and start engaging with their customers now rather than later.

And as a result, the most at-risk customers will get a letter from their lender: prompting them to check their repayment plan is on track and to consider the options available to them.

This means that 600,000 borrowers who could have been sleepwalking into a problem, will instead get a wake-up call to take action now.

I welcomed this – and lenders’ commitment to help their customers try and find a solution.

This type of pre-emptive work is indicative of how we will act – spotting potential problem areas and preventing them developing into bigger issues.

Another example is about the simple changes that make a meaningful difference to consumers.  

We worked with seven of our high street banks to agree what’s known as a ‘retry system’[4] when processing money due to go out of their customers’ accounts.  

In the past, bank customers faced a problem based on a simple timing difference – the time gap between when in the day money was taken out of their account, and when in the day money cleared.

Bills, standing orders, direct debits, are often processed first thing in the morning.

But many customers had money going into their accounts to cover those payments that would not clear until later on in the day – and so were hit with penalty charges when the attempts to take the money were made.

We saw a simple solution to this, and the banks have agreed with us that when an attempt fails earlier in the day, they will retry before the end of the day to see if money has cleared by then.

A relatively straightforward step, but one that is extremely helpful to their customers, as it could together save as much as £200m a year in penalty charges.

What this shows is that if it’s this simple, and it will help people, we will always try and work with the industry to get things fixed.

We want to encourage the industry to move quickly and take, what may in some cases be small and simple actions, that collectively can have a big impact.

We’re also applying the lessons of behavioural economics[5] in all of our regulatory work.  In particular the predictable mistakes consumers make, how firms respond and the affect this has on competition.  We’re adding all this up when we look at particular issues to see what interventions from us may be useful.

But even in this new era, there is a continuation of approach in several areas.  The first 100 days have been another stage on the journey to the FCA that started well before 1 April this year.  

And so in areas like enforcement, we continue to work to deliver the FSA’s robust message of credible deterrence.  In our regulation of securities and investment markets too, there is an evolution of approach, not a complete revolution.  And we will see through big FSA projects like the MMR, and remain committed to the improvements the RDR will bring.

But there are still clear signs of a change in approach.

That means we are now far more actively looking at market trends, innovations, business plans, products and outcomes to support both markets, as well as customers.

In other words, we’re not just asking: Is this product compliant? Does it tick every legal box?

But actually: is the outcome good? Is the market competitive? And is fair treatment of consumers designed into products and culture?

I know some people think this focus on business ethics is a regulatory ‘phase’. I’ve heard it described as a ‘cold breeze’ that will pass through.

But I want to make it clear today that the first 100 days of the FCA are a bellwether of things to come. It is lasting change – as opposed to the firework that peters out and falls to earth.

Enhancing competition

The financial sector needs to believe this change is permanent and prepare itself now for the new regulatory world.

Our new competition duty is the single most significant change in our objectives as a regulator.

This is not just because it is new on the face of the Bill, but because of the approach it drives.

It means we have to spend more time and effort looking at markets as a whole and whether they function well for consumers.

It means we have to look for remedies that help markets work better for consumers.

And it means that we don’t just wait for problems before we try to promote competition in the markets we regulate.

We’ve started in our own back yard – looking at whether some of our authorisation procedures cause unnecessary barriers to entry,

We also have our first market study underway looking at general insurance add-ons[6].  We’ve called for evidence and approached a number of firms in the market for information. Based on this early work we are publishing today our theories of harm that we are testing.

We are focusing closely on testing whether poor outcomes in add-on sales could reflect particular consumer behavioural traits and firms’ responses to them.  The specific context of the add-on sale may limit how far consumers explore alternatives or base their decisions on relevant measures of price and quality.

We heard stories from consumers who said they bought the add-on because it cost very little a month, or seemed worth it for the peace of mind and being covered if anything should happen.

But in our early consumer research we found that the ‘peace of mind’ expectation was not always met. When we asked consumers to look at their policies many were surprised to find they hadn’t got the cover they expected.

For example, a policy to cover the shortfall in a finance agreement did not cover the full term. And home emergency and gadget policies bought with the expectation of covering all eventualities had unexpected policy exclusions and excesses.

We heard some positive stories, but also about how some customers felt under emotional pressure to buy the add-on.

We will have a further period to gather evidence before we get to any conclusions early in the new year.

Later this month we’ll also set out our general approach to our objectives, including competition and consult on these.

What I want to emphasise is that we are open on this agenda. We also want engagement from the industry.

We want your thoughts and ideas about what works well for competition and where there’s a lack of competition in the interest of consumers.

We have a powerful new set of tools, which we intend to use responsibly and consistently. If we get this right the potential benefits for consumers could be vast.

And it’s worth noting here that the Office of Fair Trading estimated a direct financial benefit to consumers of £648m per year between 2009 and 2012 from their market investigation regime.  Our focus on competition matters will unearth issues that could otherwise be hidden and will add significantly to these benefits.

Let’s be clear. A market that works well for consumers and for firms will be of benefit to everyone and to the UK economy.

We want consumers to be in a position to drive healthy competitive markets, so that they become the new normal.

That means markets where people take on risks that they understand and realise that they can gain and can lose. Whtoere consumers can work out which products best meet their needs and can buy from the suppliers offering them the best terms. And where firms can profit from putting consumers first and where they can’t, they exit the market without disrupting its integrity.

MLEI and mobile

The other, linked area, I want to highlight is the growing importance and use of judgement in regulation. Our increasing determination to step beyond the old reliance on technical rules and processes. To take a broader position on morals and outcomes.

We all, regulators and firms alike, have a responsibility to make sure financial services are not just adhering to the rules, but to their spirit.

First, we have to look at whether products are being retailed correctly. Are we 100% sure customers are choosing to buy products? Or are they, as is sometimes suggested, being sold them. An important distinction.

In our first 100 days, this is an issue the FCA has taken particularly seriously and that trend will continue.

As most here will know, we’ve already published two reviews in the insurance space: on mobile phone insurance[7] and Motor Legal Expenses Insurance[8] (MLEI).

On the former, we’ve flagged some important questions. Questions that demand serious attention.

So, is the industry selling mobile insurance products that are designed to meet the end consumers’ needs? Are they being sold to the right people in the right way? And – importantly – are the terms and conditions clear and fair?

As French sociologist Emile Durkheim once said: ‘not everything in the contract is contractual’. In other words, there has to be some reference to a sense of fairness between buyer and seller.

That’s why I worry when I hear about examples like an advert for mobile phone insurance that ran recently with the tagline: ‘All is not lost if you lose your phone on the train’.

A reassuring message – yes – but when you then delve into the small print under the ad, there’s an important exclusion. In the ‘what’s not covered’ section, it says:

‘We do not cover you for theft or loss of your product while left unattended in a public place – or a place that’s easily accessible by people you don’t know.’

Ironically enough – given the gap here between the expectation set and product delivered – this particular advert was placed on the tube, in full view of commuters.

Yet when commercial interests are seen to wilfully trample consumer interests in this way, it is market reputation that suffers in the long run. It is the industry that is damaged.

So, as we go forward, it’s in all our interests to make sure the poor practice of the few is not allowed to damage the good reputation of the very large majority.

And that’s why I’m pleased the FCA motor legal expenses insurance review was so well received.

We know the complexity of MLEIs can make it difficult for consumers to understand the product. It is not easy to escape that fact.

But the evidence tells us there have been particular problems with it being sold as an add-on.

We know customers are not always engaged after a lengthy sales process, which is often devoted to the core motor policy. And we know they don’t always have the confidence to opt out of the cover – to untick the ticked box – not least because they don’t understand the product.

In fact our review work suggests some 81% of customers who took out MLEI cover believed, wrongly, that it would pay any legal costs associated with a motor accident if they were at fault for the accident.

78% believed, again wrongly, that it would pay the costs of defending them if they were sued by another driver.

The information asymmetries here were serious. I don’t believe firms knew how serious actually. But it is encouraging to see the industry now responding. Taking a lead in addressing the questions it raises.

For example, a number of firms have now decided to change their previous approach of automatically opting customers in to this cover.  They are now providing clearer information to help the customer make the choice that suits them.

Life and annuities

Finally, I wanted to mention the FCA’s work on thematic reviews. The third of the three areas I mentioned.

Thematic reviews are, as you’ll know, large scale investigations across markets, or parts of markets, where we take a step back and kick the tyres.

What is the evidence telling us about this sector? Are there warning signals? Super normal profits? Or perhaps rising numbers of consumer complaints that cause concern?

For life insurers, one of the most important thematic reviews we’ve been working on over the last 100 days is looking into the governance and management of unit-linked funds.

This is a hugely significant sector. It has somewhere around £902bn worth of funds under management, with 87% of that being pension business.

The question we are asking is whether these firms are acting in their customers’ best interests. Are they allocating a fair proportion of revenue received from stock – lending to the fund – or are they recycling too much to the shareholder?  Are they managing funds in line with the investment objectives disclosed to customers?

And, just as importantly, are they transferring counterparty credit risk from reinsured funds to policyholders without asking them? Without obtaining their express consent to do so.

We will be publishing the details of that review sometime in the early autumn. I encourage ABI members in this sector to engage with it.

Those insurers in the annuities market will have recently received an information request for our thematic review of annuities.

We strongly welcome the new ABI code in this area. It is a significant step forward. And it will be important as we work through the full consequences of consumers not exercising the open market option.

So, what exactly are the financial implications of not hunting around for the best deal? How do we make sure this important, one-off decision is made well? Particularly in a low yield environment. Axa recently estimated annuity incomes have fallen by some 30% over the last few years...

…While industry research by the Pension Income Choice Association (PICA) undertaken in 2008 suggested that there can be an average difference of around 16% in the rates offered by different providers. Much has changed since 2008, our review will help us understand the impact of these changes for UK pensioners.

These are questions and challenges we need to confront as one. There is a strong shared interest. But firms also need to take individual responsibility and be aware of what lies ahead.

Conclusion

The important point here is that this is a new epoch in financial regulation. Thematic reviews, market studies, and the increased use of judgement, these are regulatory features that are here to stay.

Like Icarus, financial services flew too close to the sun in the boom years. They pivoted too far towards commercial interests and too far away from consumer interests. Poor regulation provided an impetus for that fall and market failure.

Insurers were not the arch protagonists. They did not unpick the financial system in 2008.

But it is in all our interests to correct the balance now. Good regulation is not a zero-sum game. It’s not like a game of tennis or football, where for one side to win the other has to lose. We each have a vested interest in making markets work well for all participants.

In the words of Amin Rajan, firms need to sharpen their ‘gut instincts about what’s right and wrong’.

Regulators need to serve the market better by acting more swiftly. By intervening earlier and more intelligently to avoid crises down the line.

That process of repair is now underway. Our first 100 days are a marker of what lies ahead and I am enormously grateful to Otto, to the ABI, and to its members, for their engagement with the FCA over that period.

We very much look forward to working with you all in the days, months and years to come.