Select Committee on Treasury Fourth Report

2  The regulatory context

The costs and benefits of regulation

7. Regulation brings with it both benefits and costs. As the Economic Secretary to the Treasury acknowledged, "the challenge is in all these areas striking the right regulatory balance between protecting consumers without inhibiting or stifling innovation".[5] These objectives have been recognised by the Better Regulation Commission, whose terms of reference are to advise the Government on action to "reduce unnecessary regulatory and administrative burdens; and ensure that regulation and its enforcement are proportionate, accountable, consistent, transparent and targeted".[6]

8. The ABI has claimed that general insurance regulation costs customers nearly £400 million net per annum.[7] More specifically, in the context of travel insurance sold by insurance companies rather than intermediaries and thus subject to regulation, Zurich Finance suggested that insurance regulation costs holidaymakers an "estimated £2.50 added per policy sold in the UK".[8]

9. Although regulation of "standalone" travel insurance products brings with it a cost to the insurer and thus ultimately to the consumer, it also brings advantages. According to Mr Patrick Snowball, Chief Executive of Norwich Union Insurance, regulation brings about "greater transparency … and consistency of authorisation and enforcement".[9] FSA regulation also provides to customers of authorised firms access to the Financial Ombudsman Service (FOS) in the case of a dispute with an authorised firm and to the Financial Services Compensation Scheme in the case of an insolvency of an authorised firm. The FOS provides an independent and impartial complaints service, and the Ombudsman's decisions are binding on the insurer.[10]

10. In the case of "bundled" travel insurance sold through an intermediary, there is no FSA regulation and the consumer who purchased an insurance policy alongside a holiday has no recourse to the FOS if his or her complaint relates to the selling of the policy as opposed to the policy provided by the FSA-authorised insurer.[11]

The changing approach to regulation

11. The burden of regulation, which has been a repeated source of complaint by insurers and other industries regulated by the FSA, is not static. The FSA is seeking over time to change the way it regulates financial services markets, including the insurance market. There are signs of change in two areas—a switch of emphasis from rules-based to principles-based regulation and a differentiated and risk-based approach to the regulation of different insurance products.

12. Hitherto, regulation by the FSA has tended to be rules-based, involving regulation via procedure or processes, an approach associated with extensive rulebooks. The FSA is now seeking to place a greater emphasis on principles-based regulation in the insurance field, which involves preferences expressed in terms of outcomes.[12] The ABI has welcomed the FSA's move towards a more principles-based approach.[13] The Economic Secretary to the Treasury noted that a principles-based regime was "more sophisticated" than a rules-based system, but also thought that a principles-based approach "works better".[14] He considered that a rules-based regime, while simpler, could become routine and therefore "actually less focused on identifying than addressing risk".[15]

13. Before FSA regulation was first extended to the general insurance market, the FSA consulted on whether the regime should differentiate between lower and higher risk products. Following that consultation, the FSA decided not to bring in a differential approach to different products. Since then, however, evidence has emerged to suggest that different types of consumer detriment arise with different products, so that a different regulatory approach may be appropriate for, say, payment protection insurance or critical illness cover compared with household and motor policies. The FSA indicated in evidence to us that some parts of the insurance industry were now more disposed towards a differentiated approach.[16] The ABI, in oral evidence to us in October, indicated that it was "encouraged" by signs that the FSA was examining the distinctions between different products.[17] The Economic Secretary to the Treasury considered that

there is nothing soft touch at all about a risk-based approach to regulation. Indeed, a proper, proportionate risk-based approach to regulation is lighter in touch where risk is lower but clear, direct and heavy when there are risks which are not being addressed.[18]

14. In evidence to us in October 2006, Mr John Tiner, Chief Executive of the FSA, conceded that a number of product areas in the insurance market which, when the IMD was first implemented in January 2005, were subject to the full regulatory requirements of the Financial Services and Markets Act, did not need the "full rigours of the Financial Services and Markets Act".[19]


15. In advance of the completion of the FSA's review of its general insurance regulation, there are welcome signs that the overall approach to the regulation of that industry is changing. Insurance regulation should benefit from the FSA's move towards a more principles-based approach to regulation. There also appears to be broad support emerging for greater differentiation in the treatment of different kinds of insurance products through a more risk-based approach to regulation. We expect the FSA to clarify its overall approach in the first quarter of 2007, and in particular to clarify the extent to which it will be applying risk-based regulation to the insurance sector and the implications of adopting a risk-based approach. Developments in the overall approach to regulation form part of the context in which to consider the future treatment of bundled travel insurance.

5   Q 151 Back

6   Better Regulation Commission website, Back

7   ABI, The Regulation of General Insurance Sales: One Year on, March 2006 Back

8   Ev 44, 52 Back

9   Patrick Snowball, Norwich Union, Speech, 'General Insurance one year on: How can consumers benefit?', 23 March 2006 Back

10   Travel insurance review: Call for evidence, para 3.12 Back

11   Ibid, para 3.24 Back

12   John Tiner, FSA, Speech, "Principles-based regulation and what it means for insurers", 20 March 2006 Back

13   HC (2005-06) 1594-i & ii, Q 72 Back

14   Q 171  Back

15   Q 173  Back

16   Ev 42-43 Back

17   HC (2005-06) 1594-i & ii, Q 60 Back

18   Q 173  Back

19   HC (2005-06) 1594-i & ii, Q 117 Back

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Prepared 25 February 2007