This country-specific Q&A gives a pragmatic overview of the law and practice of insurance & reinsurance law in the United Kingdom.
It addresses topics such as contract regulation, licensing, penalties, policyholder protection, alternative dispute resolution as well as personal insight and opinion as to the future of the insurance market over the next five years.
This Q&A is part of the global guide to Insurance & Reinsurance. For a full list of jurisdictional Insurance & Reinsurance Q&As visit http://www.inhouselawyer.co.uk/index.php/practice-areas/insurance-reinsurance
How is the writing of insurance contracts regulated in the jurisdiction?
The Financial Services and Markets Act 2000 (FSMA) establishes a system for the regulation of various ‘regulated activities’, as set out in the Financial Services and Markets Act 2000 (Regulated Activities Order) 2001. Underwriting and claims handling, included on the list of regulated activities as ‘effecting’ and ‘carrying out’ contracts of insurance, both require authorisation. Permission for authorisation is granted by the two UK financial market regulators under a ‘twin peaks’ approach. The Prudential Regulation Authority (PRA) manages the applications of insurers and reviews applicants for financial soundness, while the Financial Conduct Authority (FCA) reviews the applicant from the perspective of conduct of business risks. Before permission is granted, the applicant must meet various ‘threshold conditions’ for authorisation set by both the PRA and FCA. Permission is granted under Part 4A of FSMA.
The PRA supervises insurers to protect the interests of policyholders and the wider financial system in the UK and seeks to ensure that insurers have sufficient capital to meet liabilities. The PRA also requires insurers have certain individuals approved to take up positions on the board and in senior management. The FCA seeks to ensure that products meet customer expectations, policy terms are fair, claims are paid promptly and pre- and post-contractual information is clear, fair and not misleading.
Are types of insurers regulated differently (i.e. life companies, reinsurers)?
Life, non-life and reinsurance businesses are all subject to the Solvency II capital regime and in this respect are subject to the same regulatory structure. Because of the different nature of life and non-life business and the duration of liabilities for long-term business in particular, different rules will be applied to ensure that assets held to protect longer term liabilities are suitable. Sales of long-term investment products are subject to detailed requirements to ensure that customers are given as much information as possible before entering the contract. When an advised policy is sold to consumers, it must be done on the basis of a fee rather than commission.
Under FSMA reinsurers are treated as insurers unless a rule specifies that they are excluded or subject to an alternative approach. For example, reinsurers are excluded from rules on conduct of business as they deal with regulated entities.
Are insurance brokers and other types of market intermediary subject to regulation?
Various activities undertaken in relation to contracts of insurance (namely, dealing, arranging deals, making arrangements with a view to a contract, assisting in the administration and performance and advising on contracts of insurance) are regulated under FSMA. Accordingly, permission must be sought from the FCA to act as an insurance intermediary (note that the PRA does not regulated mediation). It is possible to become an appointed representative of a regulated firm in order to carry out mediation activities. The regulated principal has full responsibility for the actions of the appointed representative.
Is authorisation or a licence required and if so, how long does it take on average to obtain such permission?
Before a business can undertake a regulated activity (whether underwriting or mediation of insurance) it must seek permission to be authorised. Authorised firms appear on a Financial Services Register which shows which permissions they have been granted in relation to activities.
The PRA is under a statutory duty to complete applications for Part 4A permission within 6 months (12 months where the application submitted is incomplete).
Are there restrictions over who owns or controls insurers (including restrictions on foreign ownership)?
It is a criminal offence to acquire or increase control in an insurer authorised in the UK without the prior approval of the PRA (with the consent of the FCA). A person will acquire control under FSMA where they hold 10% or more of the shares or voting power in an undertaking (or its parent company) or where it is able to exercise significant influence over the undertaking.
Approval by the PRA is also required when an existing controller proposes to increase their shareholding or voting power in an undertaking (or its parent company) above 20%, 30% or 50%.
The PRA may approve the change in control unconditionally, impose conditions or object to the acquisition.
There are no legislative restrictions on non-UK (or EU) nationals owning insurance companies.
Is it possible to insure risks without a licence or authorisation? (i.e. on a non-admitted basis)?
FSMA prohibits any person from undertaking a regulated activity by way of business in the UK without authorisation. Importantly however, the regime captures commercial activities that take place within the territory but does not capture a situation where an insurer underwrites a risk located in the UK so long as none of the activities linked to writing the business or claims handling actually take place within the territory.
What penalty is available for those who operate without appropriate permission?
It is a criminal offence to undertake a regulated activity in the UK without permission, punishable by up to two years imprisonment or a fine. An agreement entered into without permission is unenforceable by the business in contravention of the prohibition against the other party. A policy entered into by an unauthorised insurer is void at common law, accordingly the insured would be entitled to recover premium paid and can recover compensation for any loss sustained as a result of entering into a contract with an unauthorised business. There are limited exceptions that allow the contract to be upheld where just and equitable to do so.
How rigorous is the supervisory and enforcement environment?
The UK’s two regulators have extensive statutory enforcement powers set out in FSMA. As mentioned above, where someone has breached the prohibition on carrying out a regulated activity without permission they may be imprisoned or fined. The withdrawal of authorisation is available to both regulators where a business ceases to meet the threshold conditions. The regulators can also vary permissions, censure firms and individuals publicly for breaches of regulatory requirements and impose financial penalties, apply for an injunction where either regulator believes that a person or business will contravene a requirement of FSMA, seek a restitution order to recover assets received in contravention of a regulatory requirement and issue a prohibition order against an individual carrying on a regulated activity.
Both the PRA and FCA have investigatory powers. The PRA has the ability to outsource investigations to either the FCA or a third party. All regulated businesses are under an obligation to inform the regulator of anything relating to the firm of which the regulator would reasonably expect notice.
After the financial crisis of 2008 the predecessor to the FCA stepped up the number of enforcement actions undertaken in a programme called ‘credible deterrence’. The policy has been continued by the FCA which has issued some significant fines where firms have breached regulatory rules or principles. In 2015 Barclays Bank Plc was fined £284.4m for failing to control business practices in its foreign exchange business in London.
How is the solvency of insurers (and reinsurers where relevant) supervised?
UK insurers are subject to the European Solvency II regime (introduced on 1 January 2016). Solvency II is a risk-based capital regime, similar in concept to Basel II, based on three ‘pillars’. Pillar 1 is a market consistent calculation of insurance liabilities and risk-based calculation of capital. Pillar 2 is a supervisory review process. Pillar 3 imposes reporting and transparency requirements. Solvency II requires firms to hold both a Minimum Capital Requirement (MCR) and a Solvency Capital Requirement (SCR). Breach of the MCR is designed, unless remedied quickly, to lead to a loss of the insurer’s authorisation. Breach of the SCR results in supervisory intervention designed to restore the SCR level of capital.
In the UK the PRA has responsibility for ensuring that firms comply with Solvency II.
What are the minimum capital requirements?
The risk based capital requirement, the SCR, will be calculated using either a standard formula, a bespoke internal model that has been approved by the insurer’s supervisor, or a mixture of both. The standard formula will cover underwriting risk, market risk, credit risk and operational risk in a formulaic way (e.g. assumed stress level for equities). The calculation will be calibrated to seek to ensure a 99.5 per cent confidence level over a 1 year period which is said to equate to a BBB rating. There is also an MCR set at lower threshold (e.g. about 85 per cent confidence level). The MCR should not be less than 25 per cent of the SCR. The MCR has an absolute floor of €3.7 million for life insurers, €2.5 million for non-life insurers and €3.6 million for reinsurers.
Is there a policyholder protection scheme?
The Financial Services Compensation Scheme protects policyholders (including consumers and small businesses) should the insurer become insolvent. Compensation is only available for financial loss. In the event of insolvency 100% of a claim is protected in respect of a compulsory insurance policy, professional indemnity insurance or life and long-term sickness policies. In all other cases, 90% of the claim is protected.
How are groups supervised, if at all?
Under Solvency II groups are subject to supplementary supervision in addition to the solo supervision of individual insurance companies in order to protect policyholders against risks that might be present within a group but not necessarily apparent where only the individual insurance company is considered. The Solvency II Directive sets out the circumstances in which group supervision is triggered. The threshold is set relatively low meaning that only one insurance entity need be headquartered in the UK (or elsewhere in the European Union) for group supervision to be applied.
Where a European headquartered Solvency II group is identified, it must hold eligible own funds equal to or in excess of a group SCR. Group own funds must be transferable and fungible across the group. The group capital requirement can be calculated using either a standard formula or an internal model (similar to individual entity capital requirements). The recognition of individual company own funds (in excess of any applicable solo capital requirement) at the group level depends on their availability and transferability between group entities. In addition, group-wide governance, reporting and intra-group transaction and risk concentration monitoring shall apply.
Where a group is headquartered outside the European Union, Solvency II group supervision may still apply, either to a sub-group or to the worldwide group, depending on whether a finding of equivalence has been made or whether other methods have been applied.
Do senior managers have to meet fit and proper requirements and/or be approved?
FSMA requires that individuals in certain ‘controlled’ functions must be approved by the regulators. Certain roles in the business are therefore either classified as Senior Insurance Management Functions (the list of functions identified by the PRA) or Approved Persons (the list of functions identified by the FCA). It is possible for an individual in a PRA function to also require approval for one of the FCA functions. For example, the Chief Executive Senior Insurance Management Function will also fall within the Director function. Before taking up any controlled function an application must be made to the relevant regulator for approval. Both the PRA and FCA will seek to ensure that the individual is fit and proper for the role. They will consider the individual’s honesty, integrity and reputation as well as their competence and capability and financial soundness.
Solvency II requires that individuals in key functions within the business are fit and proper for their roles. This requirement exists alongside the Senior Insurance Management Functions and Approved Persons. Key function holders include all “persons who effectively run the undertaking” and those in “other key functions”, likely to include the board and senior management and other individuals who lead significant business units.
Are there restrictions on outsourcing parts of the business?
In accordance with Solvency II, where an insurer outsources part of its business it will remain fully responsible for discharging all of its obligations under law, regulation and administrative provisions. Specifically, insurers must not outsource any critical or important part of the business in such a way as might lead to any material impairment in the quality of the firm’s systems of governance, any increase in operational risks, impairment of the ability of the supervisory authorities to monitor compliance or undermining of continuous and satisfactory service to policyholders.
How are sales of insurance supervised or controlled?
FSMA sets out various objectives that both the PRA and FCA must meet. The FCA is obliged to advance certain strategic objectives, including protecting customers. It is with these objectives in mind that the FCA has set out both rules and guidance in relation to sales of insurance policies. The requirements primarily seek to balance information asymmetries between the insurer and the policyholder; particularly where the policyholder is a consumer. Rules for non-investment policies can be found in the Insurance Conduct of Business Sourcebook (ICOBS) while rules for investment products can be found in the Conduct of Business Sourcebook (COBS). These rules will be applied to both insurers and intermediaries and may affect the design, content and means of communicating policy terms and the processing of insurance claims. COBS also introduces additional requirements for investment intermediaries to manage conflicts of interest and prohibits the payment of commission in advised sales.
In addition to the rules and guidance set out in the two sourcebooks, the FCA also requires all regulated firms to meet certain principles for businesses. Principle 6 requires firms to pay due regard to the interests of customers and treat them fairly. In order to meet these requirements, the FCA expects firms to meet six Treating Customers Fairly (or ‘TCF’) objectives. The six objectives seek to ensure that products and services are marketed fairly, meet the needs of customers, are sold with clear and comprehensible information, any advice received is suitable and that customers do not face any post sales barriers.
Are consumer policies subject to restrictions? If so, briefly describe the range of protections offered to consumer policyholders.
Consumer policies must meet the requirements of the Consumer Rights Act 2015 (CRA 2015). The CRA 2015 prohibits the use of unfair contract terms in consumer agreements and consumer notices (including announcements, promotions and renewal letters). A term will be unfair if, contrary to the requirement of good faith it causes a significant imbalance in the parties’ rights and obligations under the contract, to the detriment of the consumer. Core terms (i.e. terms that either relate to the main subject matter of the contract or to the price to be paid) cannot be assessed for fairness to the extent that they are sufficiently transparent and prominent. Importantly, in insurance contracts core terms will include exclusions and conditions. To ensure that the insurer is able to rely on such terms both policy conditions and exclusions must be transparent (which will require drafting in plain and intelligible language) and also prominent (so that the consumer is sufficiently aware of the term). Certain terms are likely to be unfair such as high cancellation charges, terms that allow the insurer to determine the characteristics or price after the contract has been entered into. Any term found to be unfair will not bind a consumer.
In addition to the prohibition on the use of unfair terms, ICOBS prevents firms from seeking to exclude or restrict or rely on any exclusion or restriction of duty of liability towards a customer or other policyholder unless it is reasonable to do so.
Are the courts adept at handling complex commercial claims?
The commercial court in the High Court of Justice has a long history of dealing with complex insurance claims; the experience and quality of the judiciary that will hear international insurance claims is unrivalled. The English judiciary are widely regarded as impartial and expert in commercial disputes – frequently dealing with international parties. Judges will uphold freedom of contract where parties are bound by the terms they have agreed and take an objective view of the meaning of the contract (Arnold v Britton and others  UKSC 36). The extensive guidance provided by judicial precedent provides parties with a degree of certainty as to the outcome of commercial disputes.
Is alternative dispute resolution well established in the jurisdiction?
London Market insurers are some of the greatest users of alternative dispute resolution. The UK is a signatory of the New York Convention. The use of both arbitration and mediation is well established. In England and Wales the relevant law governing arbitration is contained in the Arbitration Act 1996 and any arbitration must be conducted within the framework of this Act. There are limited opportunities to appeal the decision of an arbitral tribunal.
What are the primary challenges to new market entrants?
The UK has a long-established and therefore mature insurance market that covers all product lines in life, general insurance and reinsurance and it has the infrastructure and professional expertise to rival any other global insurance hub. However, the past few years have seen extensive market consolidation in the pursuit of growth in an environment where rates have been falling, especially in competitive commercial lines. The soft market has resulted in low premium income in many lines and the ongoing low interest rate environment has made the operating environment challenging for any new market entrants.
The political and commercial uncertainty introduced following the EU referendum has meant that new market entrants do not have the same degree of certainty in relation to the breadth of market they can operate in as was the case before the Brexit vote. Many new entrants looking to benefit from access to European markets may consider other jurisdictions than the UK until there is greater clarity about the outcome of the UK Government’s plans to leave the European Union.
In addition to market challenges, the UK is one of the most highly regulated markets. The cost of compliance can pose a significant challenge to new entrants, particularly in the light of the highly sophisticated Solvency II supervisory regime.
On a more positive side, the use of cloud-based systems which can leverage scalability and flexibility and access to new data sources and appeal to a new customer base means that new market entrants may present an appealing proposition for new capital providers.
Lloyd’s of London can offer an attractive platform for new business entrants as there are a number of approaches through which new business can be written before a traditional syndicate is established. The Lloyd’s market has access to all major insurance markets and participants can benefit from the extensive licence network.
To what extent is the market being challenged by digital innovation?
The London Market is expected to be transformed by digital innovation such as telematics devices, distributed ledgers and connected devices (or the Internet of Things). Similarly, the harnessing and use of Big Data will change underwriting as insurers will have far greater access to personal (or at least risk-specific) information than ever before. With more personalised information and with automated processes, for example automated claims handling, insurers are seeing an opportunity to offer customers new product lines with potential cost savings.
Adapting to new business models will require significant investment (whether in research and development or acquisitions) by existing market players and start-ups are attracting funding. New market entrants that design their business models around new technology and the use of digital information may be able to steal a march on their competitors. In an overcrowded market, many existing product lines are likely to struggle without adaptation to the new digitally-reliant environment.
Over the next five years what type of business do you see taking a market lead?
Because of the pressures on growth in established markets UK insurers are likely to continue to seek growth in new markets such as Africa and Asia. Because of the regulatory and market pressures in Europe consolidation is likely to continue for the next few years. Buyers are likely to include investors from outside the traditional insurance markets, including private equity. For life businesses the quest for returns is likely to result in insurers investing in different asset classes such as infrastructure projects.
Cyber threats are challenging not just global business but also individuals and governments. Insurers that can genuinely offer credible solutions to both mitigate and manage cyber threats and adapt to the changing risk environment are likely to fare much better than those insurers relying on traditional product lines.