It is estimated that over 40% of motor insurance customers and around 52% of household insurance customers in the UK opt to pay their annual premiums by monthly instalments1, with many entering into regulated credit agreements in order to do so.
The FCA is focused on the extent to which firms offering premium finance under regulated credit agreements are meeting the requirements of the consumer credit regime, including changes to the rules around creditworthiness and affordability.
In our experience, firms offering premium finance are sometimes unaware of the full extent of their regulatory obligations under the consumer credit regime. This blog highlights key aspects of the recent rule changes and FCA reviews of the wider consumer credit market which have important implications for premium finance firms.
Premium finance and consumer credit
Firms offering premium finance secondary to their main regulated activity have, in Deloitte’s experience, often been unaware that they were undertaking a regulated activity until the FCA highlighted that they were providing credit under regulated credit agreements.
The FCA is clear that firms should be aware of whether they are arranging or providing premium finance under regulated credit agreements and ensure they have the right policies, procedures and controls in place to discharge their obligations. In particular, as it highlighted in its 2015 review of premium finance, the FCA expects firms to ensure that customers are provided with the information and explanations required under the Insurance Conduct of Business Rules (ICOBs), the consumer credit (CONC) rules and the Consumer Credit Act (CCA).
It also expects the credit agreement to be given sufficient prominence as part of the sales process to allow the customer to assess whether the proposed agreement is appropriate for their needs and circumstances, including the key risks of the credit, the consequences of non-payment and the costs related to the agreement.
Assessing creditworthiness in consumer credit- changes to the FCA rules
In November 2018, the following key changes to the FCA’s rules around assessing creditworthiness came into force. These are applicable to firms undertaking consumer credit lending in relation to premium finance.
The distinction between affordability and credit risk
The new rules require that, when providing consumer credit, firms make a reasonable assessment not just of whether a customer will repay (credit risk), but also of their ability to repay both affordably and without this significantly affecting their wider financial situation (affordability risk). The FCA also provided an explicit definition of affordability risk, setting out the factors which firms should consider when assessing whether credit is likely to be affordable for the borrower2.
Firms must have appropriate methods and processes in place to assess affordability to the consumer, as well as credit risk to the firm. The assessment must be based on sufficient information – from the customer where appropriate, and from a credit reference agency (CRA) where necessary. Firms may assess credit risk and affordability as part of the same process but must ensure that this adequately assesses the risk to the customer of being unable to make repayments.
Income and expenditure information
The FCA expects firms to take reasonable steps to determine the customer’s income when assessing affordability. This includes any likely reduction in income during the period of the credit, where this is “reasonably foreseeable”- such as retirement - and could have a material impact on affordability risk for the customer.
Estimating future changes in a customer’s income gives rise to challenges for firms who may be unclear about what assumptions, if any, they are required to make about the customer’s future circumstances or the information that they are required to obtain from the customer in order to assess this.
The FCA is clear that it expects firms to make the assessment based on information available to them at the time, or obtained after further enquiry, where appropriate. In some scenarios, it may be helpful for firms to factor in qualitative data, provided by the customer, which can help them reach a conclusion about whether a customer’s future financial circumstances may be reasonably foreseeable at the point of sale.
Proportionality of assessments
The scope of the creditworthiness assessment, and the steps taken to ensure it is a reasonable one, should depend upon, and be proportionate to, the individual circumstances. The FCA expects firms to “use their judgement to determine what is appropriate in the circumstances, having regard to the nature of their products and customers”. However, in deciding how rigorous the creditworthiness assessment should be, the FCA also expects them to have regard to information they know at the time that may indicate that the customer is in, has recently experienced, or is likely to experience financial difficulties or is particularly vulnerable.
This requirement exposes a potential tension for insurers, in particular, who may feel that, due to the essential nature of some insurance contracts, such as motor insurance, there is a risk of poor outcomes for some customers whose applications for premium finance are subsequently declined (including being declined at renewal) because they are experiencing, or have recently experienced, financial difficulties or vulnerability. Nevertheless, while the FCA rules are intended to offer firms flexibility in assessing affordability, we think that the FCA would be concerned about, and might challenge, any decision to offer premium finance based solely on the necessity, to the borrower, of the underlying insurance if the finance was unaffordable. However, we recognise that this is not a straightforward decision given the wider impact on the customer if they can’t obtain insurance e.g. a driver being unable to work if they are unable to obtain motor insurance.
Commission arrangements and broker oversight
The FCA’s review of the motor finance sector (March 2019) found that the way some commission arrangements are structured may lead to consumer harm on a potentially significant scale. As such, it is currently consulting on proposals to ban “discretionary commission models” where the amount of commission received by the broker is linked to the interest rate the customer pays and which give brokers the power to adjust or set. This has important parallels in the premium finance market where similar commission models exist.
Whilst the FCA says that it currently does not have the evidence to justify consulting on banning particular commission models in the premium finance market, it will consider further interventions if it identifies evidence of consumer harm. Firms will therefore need to demonstrate that there are robust controls in place to prevent commission arrangements from leading to poor outcomes for customers. As part of its consultation on commission arrangements, the FCA is also proposing clarifications to the commission disclosure rules to ensure that brokers across the wider consumer credit sector adequately disclose the existence of commissions.
The FCA’s review of motor finance also highlighted concerns about the controls lenders have in place to monitor compliance by brokers. The FCA was particularly concerned that some lenders appeared to take the view that it was sufficient to check only that a broker was FCA authorised. It reminded lenders that they are required to take reasonable steps to ensure persons acting on their behalf comply with CONC.
Implications for Firms
In assessing creditworthiness for premium finance, firms must balance providing access to credit for customers who would benefit, and can afford it, with sufficient protection for those who may be adversely affected by unaffordability. To ensure that their creditworthiness assessment process strikes the right balance, and that they are able to demonstrate effective controls and oversight in place, we recommend that firms undertaking consumer credit lending consider the following actions:
- Ensure that their affordability assessments are adequate, bearing in mind that the higher the affordability risk to the consumer, the more rigorous the assessment is likely to need to be.
- Document these procedures and keep a comprehensive record of each decision to lend.
More generally, firms arranging or providing premium finance should:
- Satisfy themselves that their customer communications include the information and explanations required under CONC/CCA and that the sales process gives adequate prominence to the consumer credit agreement.
- Review their commercial books to identify any retail customers and ensure that they have been treated in accordance with the rules.
- Ensure that senior managers and boards are receiving robust management information (MI) that monitors compliance and highlights emerging risks and issues.
- Ensure that they have adequate policies, procedures and controls to ensure any commission arrangements do not result in poor outcomes for customers and that the existence of these commissions has been adequately disclosed.
- Ensure that they have adequate policies, procedures and controls to ensure brokers acting on their behalf comply with relevant regulatory requirements and treat customers fairly.
1 Datamonitor Financial, UK Personal Lines Distribution, February 2015 as quoted in FCA TR15/5 Provision of premium finance to retail general insurance customers,
2 See FCA CONC 5.2A.12
The firm must consider the customer’s ability to make repayments under the agreement:
1 as they fall due over the life of the agreement and, where the agreement is an open-end agreement, within a reasonable period;
2 out of, or using, one or more of the following:
(a) the customer’s income;
(b) income from savings or assets jointly held by the customer with another person, income received by the customer jointly with another person or income received by another person in so far as it is reasonable to expect such income to be available to the customer to make repayments under the agreement; and/or
(c) savings or other assets where the customer has indicated clearly an intention to repay (wholly or partly) using them;
3 without the customer having to borrow to meet the repayments;
4 without failing to make any other payment the customer has a contractual or statutory obligation to make; and
5 without the repayments having a significant adverse impact on the customer’s financial situation.