The Consumer Duty for closed products came into force on 31 July 2024. The Financial Conduct Authority (FCA) has recognised the particular challenges closed products presents to the life insurance sector. The long-term nature of products, as well as the evolution of the market, means that insurers frequently have large and complex legacy books of closed products.
This article looks at what the financial impact of these additional operational and regulatory requirements may be for firms.
Closed books can often have higher capital requirements - for example, they may include high guarantee policies. They can also be managed on a very low margin basis with stranded fixed costs eating into margins as the book decreases both in premiums and number of policies. While the Duty doesn't change the Solvency II capital cost of a product, it can increase its servicing cost. Without careful management, these closed books can bring profitability challenges, particularly when dealing with inefficient IT and legacy systems.
Many insurers look to sell their closed books to consolidators or other insurers who use optimisation solutions, such as merging portfolios or digitalising processes, to reduce per policy cost. Will the upfront investment to implement the Duty and ongoing expense tilt the balance of economic viability for these legacy books, especially when considering returns expected by shareholders?
Firms should look to fully quantify the ongoing cost of complying with Consumer Duty obligations for closed books and verify whether there's sufficient projected income and liquidity to meet these requirements.
In a recent speech, Sheldon Mills, Executive Director at the FCA, said that the regulator was aware that historic products may not offer fair value to consumers, saying that "in some cases customers in legacy products might pay higher charges than they would for open products, where firms are competing for new business."
While the Consumer Duty doesn't apply retrospectively, the FCA has confirmed that "If a firm could have reasonably known that its assumptions were significantly wrong at the time a product was sold, we will consider if the firm complied with rules that were in place at the time."
The FCA has asked firms to consider why products were closed in the first place. Was it because it didn't offer fair value? Were there complaints that might indicate harm or poor outcomes? Was there poor product design?
The reality is, there may be an amount of foreseeable harm in insurers’ closed products. What impact will it have on a firm should a key and profitable part of their offering be judged not to deliver fair value? Adjustments will need to be made, as well as understanding the risk of portfolio remediation where customer harm is identified.
Although firms aren't expected to give up any vested contractual rights, such as annual fees or exit charges, the FCA has said they are "free to do so". Considering whether amending or waiving charges or exit fees on closed books may therefore be necessary to ensure that consumers aren't receiving poor outcomes.
In preparation for the implementation of the Duty, some firms in the market set aside Solvency II capital to provide for any fee charging caps on closed products which may have been required to comply with the regulations.
Where firms have identified areas where their fees and charges are not providing fair value, it is important to consider what impact any amendment fees or charges on closed products may have on the portfolio as well as the wider firm, taking into account their own costs of funding or administration. Some market participants have assessed this to cost them several millions.
From implementing Consumer Duty on open products, insurance firms will be aware of the investment required in data management, analytics and automation, together with training provided to staff members.
This task only becomes more challenging and expensive when dealing with closed books – due to legacy IT systems, the availability and quality of data, and customers who may be disengaged or walkaway. In addition, firms are likely to have lost institutional knowledge of their products and past decision making. In some instances limited resources are devoted to customer servicing of closed product business owing to the products' policy count.
Firms must take care to model all these costs, together with any potential impact of reduced future cash flows, which may occur due to changes in fees, charges or premiums. They need to fully understand the financial impact for their closed books, both on a portfolio basis as well as the wider firm.
For more insight and guidance, contact Will Stagg.
Camilla Fawkner
