This article was written for and first featured in Insurance Day
The Financial Services Authority is changing its approach to regulation to “intervene, earlier in the product chain if necessary, to anticipate consumer detriment and choke it off before it occurs.” An area on which it is focussing and which should be of concern to those involved in offering insurance products is the sale of warranty and protection policies. These policies are big business for both major and smaller insurance companies, accounting for a significant proportion of revenue.
The type of warranty and protection policies being targeted by the FSA are those directed at consumers: insurance or warranties for mobile telephones, satellite boxes and other home appliances. Whilst such products are often sold to consumers under the guise of being a ‘warranty product’, in the view of the FSA, they are actually contract of insurance. If the FSA is correct then FSA authorisation is required, as the arranging and effecting of contracts of insurance is a regulated activity.
What is a contract of insurance?
In the case of Re Digital Satellite Warranty Cover Ltd & Ors [2011] EWHC 122 (Ch), for which judgment was given for the FSA earlier this year, the FSA presented “public interest” petitions to wind up the respondent companies. Those respondent companies, in return for a monthly sum, offered to repair and/or replace their customers’ satellite equipment. According to the terms of the contract, they were not obliged to pay out money to their customers. In 2010, the first respondent’s turnover was £2.1 million. The FSA presented the petitions on the basis that the warranties were contracts of insurance which fell within the relevant provision of the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (the “RAO”) which protects the insured from financial loss and so the respondents should have been authorised by the FSA to sell those contracts of insurance.
The respondents’ main argument against the petition was that a contract of insurance must provide for the payment of a sum of money; and that the provision of services alone cannot make a contract a contract of insurance. They also argued that the cover provided could not be described as financial loss within RAO, as the risk covered was the risk that the equipment would break down.
Mr Justice Warren examined: the relevant European directives (First Council Directive 73/239/EEC and Council Directive 84/641/EEC); the Financial Services and Markets Act 2000 (“FSMA”) and the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (the “RAO”); as well as the common law.
Article 10 of the RAO states that effecting or carrying out a contract of insurance is a regulated activity. Article 3 of the same order defines a “contract of insurance” as being a contract of long-term insurance or a contract of general insurance. That definition, having been drafted deliberately widely, does not assist insurers in ascertaining with any certainty whether their particular products are regulated or not.
The Judge found in favour of the FSA and winding-up orders were made on each of the petitions. He held that the warranties were capable of being contracts of insurance because: “a contract which provides cover for a risk in the shape of a consideration other than money, and in particular an obligation to repair or replace is, at common law, capable of being an insurance contract”. As to the second strand of the respondents’ arguments, Mr Justice Warren found that a “contract which brings about the result which [the insured] would otherwise have to pay to achieve (i.e. having functioning equipment) can properly be categorised as a contract which protects him from financial loss”.
This case is being appealed. The outcome of the appeal is likely to become an important decision for insurers, as it may well give further guidance on the identification of contracts of insurance. This is a key issue for insurers, who need to know whether they are dealing with regulated or unregulated products both because of the impact on the protection to which their customers are entitled and because of the way in which they need to conduct their own businesses, if it is found that the products they are selling are regulated.
What is the consequence of engaging in a regulated authority without authorisation?
Pursuant to section 19 of FSMA, carrying out an authorised activity without authorisation or a relevant exemption is a criminal offence. The penalty, if found guilty on indictment, is a maximum term of two years’ imprisonment and/or a fine. In addition, as happened in Re Digital Satellite Warranty Cover Ltd & Ors, an unauthorised company may find itself being wound up pursuant to a public interest petition.
The FSA is taking an increasingly hard-line attitude towards consumer protection. Perhaps more importantly is that authorised firms need to be clear as to whether the specific products they offer to consumers are contracts of insurance, or not, as this will impact upon the application of the FSA’s conduct of business rules to such products. The consequences of failing correctly to identify such issues may place authorised firms of being in breach of the FSA’s requirements.
As a final observation, the Financial Conduct Authority, which will be the FSA’s successor body (from the end of 2012) and which will have responsibility for protecting consumers, has stated that it will take a much more interventionist role than the FSA did previously: “aiming to shift the balance towards tackling the root causes of problems, not just the symptoms.” It intends to achieve this aim by making full use of its enforcement powers: levying higher penalties; bringing criminal prosecutions; and focusing closely on the responsibility of individuals.
Therefore, as the regulator becomes more proactive, there arises a corresponding need for the regulated to be more vigilant about their own products.
