UK: FCA Thematic Reviews On Coverholders And TPAs | Key Market Solutions And Commercial Challenges

This is the final part of a four-part blog series on the FCA's Coverholder and TPA thematic review (often referred to by the FCA as its "distribution chain" thematic review).

Firms are achieving workable conduct solutions for delegated authorities in a number of ways, whether it's by updating existing controls to add a conduct lens; increasing the evidence and documentation around existing practices; or by designing new aspects of control and oversight. 

A lot of these changes are within the gift of firms, as long as there's buy-in from internal stakeholders and, of course, the Coverholders and TPAs. However, as firms continue to implement their updated frameworks and find out what works in practice, we're entering a stage of having informed discussions on market solutions. These solutions have the potential to minimise duplication and cost to the market, while ensuring a robust approach to mitigate conduct risk. However, there are commercial and operational challenges to overcome.

Market solutions

Market solutions are about mitigating conduct risk through consistent practices and sharing information that reduces duplication and cost in the market. There are potential market solutions for all the key aspects of control and oversight we have discussed over the last few weeks, from risk assessments, to due diligence, audits and management information (MI).

Often, market solutions require placing reliance on information provided by other insurers and brokers, or by the Coverholders and TPAs. However, as reliance cannot be "blind reliance", firms should evidence how they are comfortable to place reliance.

MI

The receiving, analysing and presenting of MI can be onerous for firms and can require investment in staff for manual processes or for a systems solution. While the MI requested from Coverholders may differ slightly in content, format and submission times, a lot of the requests will be similar in nature.

A lack of consistency across the market can increase the work for Coverholders and create uncertainty among firms. Lloyd's has recognised this and issued its Y4847 market bulletin with suggested MI. To achieve consistency and proportionality across the market, it is important for firms to keep up with evolving good market practice for what MI is requested from high, medium and low risk Coverholders and TPAs.

With consistency can come sharing of MI, for example, with followers in the subscription market. There are practical considerations for how this data is transmitted, stored and shared. Should firms use the traditional bordereaux process for receiving MI, potentially with a new standard template on what conduct MI is required? Or is the solution to gather MI centrally and then distribute to managing agents?

Audits

It is widely recognised that Coverholder audits need to be more efficient, with examples of numerous similar audits undertaken over the same Coverholders around the same period of time. The central co-ordination of audits by Lloyd's is a good start towards minimising duplication. However, there are a number of other potential market solutions that can increase efficiency.

We're seeing insurers proactively commissioning a new style of Coverholder audit whereby larger and more detailed audits are undertaken over higher risk Coverholders (see our first blog on conduct risk assessments). The audit report can be shared with other insurers where commercial agreement can be reached.

Coverholders can also help to streamline the market. How much duplication can be avoided by the Coverholder commissioning an audit and providing the output to their markets? Coverholders may also have sophisticated assurance functions which already undertake audits and produce quality reports. How much reliance can insurers place on the assurance activity within the Coverholder?

The role of brokers

Duplication could also be removed from the market through relying on broker processes. Brokers may already be undertaking several of the key processes – including risk assessments, due diligence and MI gathering – due to the regulatory focus on conduct, conflicts of interest and product design in the broking space.

Challenges to market solutions

The market has taken steps towards some of these market solutions. For example, CR8.4 in the Lloyd's conduct minimum standards encourages the sharing of information between managing agents. While we have heard mixed reactions from managing agents to this part of the minimum standards, it's likely that engagement will increase as the conduct frameworks within firms become more consistent and embedded.

The cost of increased conduct activity is also a challenge. With firms having to produce more MI, there are conversations underway on who pays for this extra activity. Is the production of additional MI worth addition commission? Or is this just the new cost of doing business correctly? If done right and proportionately, we expect the commercial benefits from updated processes to outweigh the costs.

There are also considerations around data protection and commercially sensitive data. Could market solutions increase the risk that sensitive commission arrangements (a key driver of conduct risk) are shared with competitors?

There are practical ways to avoid these situations. For example, Coverholders commissioning their own audits to share with their markets focus the audit scope on the aspects of their business that apply across all binders, such as the effectiveness of their compliance function and assurance framework. Insurers can then efficiently top this up with smaller audits on just their binder to keep commercially sensitive information away from competitors. Similar structures can be used by insurers commissioning audits they want to share with the wider market. 

Conclusion

The market has come a long way over the last 18 months and it continues to evolve. Before the market solutions show their full potential, there will be firms who understandably want to see what works practically at their own place first.

Over the next 6 to 12 months (and probably beyond), conduct practices will continue to be tested and enhanced by firms, either through pilots or day to day business operations. With the Lloyd's conduct assurance visits now also in full swing, the quality and consistency in the market will continue to improve.

Alongside this, dialogue and activity across the market around market solutions should continue, including the potential solutions discussed in this blog. As removing duplication and cost from the market will assist to maintain the competitiveness of the London insurance market.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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