Financial Conduct Authority Issues Report on Insurance for Multi-Occupancy Buildings

WASHINGTON, Nov. 10 (TNSrep) -- The Financial Conduct Authority, London, England, issued a 68-page report in September 2022 entitled "Report on Insurance for Multi-Occupancy Buildings."

Here are excerpts:

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CONTENTS

1 Executive summary ... 3

2 Overview ... 14

3 Our review and findings ... 21

4 Recommendations and potential remedies ... 54

5 Conclusions and next steps ... 67

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EXECUTIVE SUMMARY

Background

1.1 The cost of buildings insurance to residential leaseholders and other property owners of multi-occupancy buildings has increased across the United Kingdom in the wake of the Grenfell tragedy. In addition to the immediate horror of the events of 14 June 2017, hundreds of thousands of leaseholders have subsequently had to endure the difficulties and trauma of living in buildings with known fire safety issues. These problems have been compounded by the associated increases in the cost of their insurance.

1.2 On 28 January 2022 the Secretary of State for Levelling up, Housing and Communities asked us to review, in consultation with the Competition and Markets Authority (CMA), the way the market for multi-occupancy buildings insurance operates to:

* shed light on the underlying causes of year on year price increases

* assess the causes of the marked restriction in coverage available for multiple occupancy buildings

1.3 We were also asked to make practical recommendations for measures that industry, Government and regulators can take to achieve the goal of widely available and affordable cover for leaseholders of multi-occupancy buildings.

Our review

1.4 Our work has focused on understanding and assessing the factors which affect premiums for mid rise and high rise multi-occupancy buildings (those exceeding 3 floors or 11 metres in height) and the impact on leaseholders. In most cases, leaseholders have no ability to influence the choice of broker or insurer (and associated levels of premium and remuneration) but ultimately bear the costs. We have considered:

* insurers' risk appetites, underwriting and pricing approaches (the methodology used to assess the risk and set the price)

* the effect on pricing of cladding or material fire risk, as well as other factors, such as pooling together the risks of multiple buildings

* the role of parties both within and outside the scope of FCA regulation (including insurance brokers and property managing agents) in the distribution chain, and the impact of the remuneration paid to them

* relevant changes to the regulatory environment for buildings and fire safety

1.5 To inform our work, we requested extensive information from a sample of 17 insurers and 26 brokers,/1 which constitute the majority of insurers and brokers active in the multi-occupancy buildings insurance market.

1.6 The information we obtained through our request consisted of:

* qualitative and documentary information on areas such as risk appetite, underwriting approach and standard policy wordings (including applicable terms, conditions and excesses)

* quantitative data on policies underwritten in the period 2016-2021 for mid-rise and high rise multi-occupancy buildings, covering key policy features such as the premium and the sum insured, and information on risks like claims and exposure to flammable cladding/2

1.7 We have provided more detail on our scope and methodology when considering and analysing the data received in the overview section below.

1.8 Our analysis uses data from a subset of the firms we approached with our request (13 insurers and 13 brokers) as other firms were either unable to provide the requested information or provided information that could not be reliably incorporated into our work.

1.9 Alongside our analysis of the information received from insurers and brokers, we reviewed the range of other information we received on this topic (including MPs' letters and complaints regarding the actions of insurers and brokers). We also carried out a programme of engagement with both market participants and other stakeholders. Our programme of engagement included:

* two sets of roundtable workshops with insurance industry participants (including insurers, insurance brokers and trade bodies)

* roundtable workshops with a range of demand side stakeholders including leaseholder representatives, cladding action groups, freeholders, property managers and property industry trade associations

* separate meetings with other demand side stakeholders including property industry trade associations and housing associations who have been significantly affected by the issues in this report

1.10 We have provided more detail on our programme of engagement in the overview section below.

1.11 We have used the information and insight from these workshops and meetings to challenge and validate the information from firms and our analysis of this. This has informed our conclusions about the availability and affordability issues in this sector, the harms these are causing and the actions and interventions likely to help to mitigate these.

Our key findings

1.12 Our review and analysis of the qualitative and quantitative information received and our stakeholder engagement have highlighted the following issues affecting insurance for multi-occupancy residential buildings in the period from the Grenfell tragedy until the end of 2021.

Supply of insurance for mid rise and high rise multi-occupancy residential buildings has contracted significantly

1.13 There has been a significant contraction in the supply of insurance for mid rise and high rise multi-occupancy residential buildings over the period, notably for buildings affected by cladding or other material fire safety issues. Before the Grenfell tragedy, there were fewer than 20 insurers operating in this market. Of the insurers in our sample, 11 reported that they have reduced activity in this market or withdrawn from it completely. Only 3 reported no material change (the appetite and actions of the other 3 insurers in our sample were not clear from the responses received). We found that those within the market have limited or no appetite for writing new business. Insurers told us that the contraction results from the declining underwriting profitability of this line of business (see paragraphs 3.26 and 3.69). We found some evidence that underwriting profitability has decreased due to sustained inflation in escape of water claims over the last 15 year and this was exacerbated by the more severe fire risks identified after the Grenfell tragedy.

1.14 The contraction in supply is likely to have reduced competition in this market. Competition can drive lower prices as purchasers can choose between suppliers. In a contracted market, there is less pressure on prices which can lead to increases.

1.15 We have observed trends which are consistent with market contraction, as well as the increased risk exposure from identifying that a building could be destroyed by fire due to flammable cladding or other material fire risks. These include, in some cases, multiple insurers underwriting a single policy and risk layering. This frequent use of excess layers or secondary markets/3 allows the risk to be spread across more than 1 insurer to reduce their individual exposure to catastrophic loss. However, risk layering is likely to be more complex and more costly. It can also involve reduced coverage or higher excesses where individual insurers (particularly excess layer or secondary markets) have different risk appetites or willingness to provide elements of cover.

Premium rates have doubled between 2016 and 2021

1.16 Premium rates for multi-occupancy residential buildings have risen significantly. Mean prices have increased by 125% from 2016 to 2021 across the sample, driven primarily by the risks from properties with flammable cladding or other material fire safety risks. The number of properties insurers have identified as having such issues has risen throughout the period and more steeply between 2020 and 2021, as more detailed building surveying work is undertaken and completed across the population of affected buildings. In some cases, a lack of appropriately qualified surveyors and building fire safety experts has delayed insurers' efforts to better understand the risks being underwritten.

1.17 The increases in premium for properties with flammable cladding and other material fire safety risks are lower where these properties are insured as part of a larger property portfolio along with properties without these risks, than where they are insured on an individual basis.

1.18 While we have been able to identify the main drivers of the price increases, we were not able to assess whether the increase in premium rates is fair and appropriate for the risks being underwritten. This is due to the complexity of underwriting and risk pricing this line of business, not least given the evolution in the fire risk assessments being undertaken since Grenfell and the issues being identified, as well as the limitations in the data available to us. But we do recognise that the reduction in availability of cover and the significant increase in premium has had material negative impacts on leaseholders.

1.19 We found that insurers' approach to pricing is based on total loss, as opposed to loss of life. Successful remediation for the risk of loss of life does not, on the basis of the way insurers price, usually equate to remediation of the issues in terms of fire risk to the building and the potential for total loss. This means insurers do not believe the premium reduction from remediation will result in the premium returning to the rates previously charged. The level of reduction will depend on the extent to which the full range of identified fire risk factors have been addressed.

1.20 The data provided by insurers included a very limited number of buildings where flammable cladding had been fully remediated during the period under review. From those buildings, it appeared that, regardless of insurers' approach to pricing, the premium would remain subject to the general level of claims inflation applicable to this market over the period.

Commission rates for brokers vary but we found evidence of some high commission rates and poor practice which are not consistent with driving fair value to the customer

1.21 Brokers arranging multi-occupancy buildings insurance for the owners and managers of these buildings can be remunerated in a variety of ways, including through fees and work transfer payments. However, based on our analysis and the discussions in our workshops, this remains primarily a commission driven remuneration model, especially when insuring individual buildings rather than portfolios of buildings.

1.22 The commission rate paid by the insurer to the broker varies significantly. In most cases within the observations we received and used for our analysis it is at least 30% (they range from <10% to 62%). The level of some commissions in this market are an area of significant concern.

1.23 The broker often shares the commission with the freeholder or the property managing agent. Brokers in our workshops explained they share their commissions so that freeholders and property managing agents can be remunerated for the support they provide to procure insurance and then to deliver elements of post sales service. For example, to provide necessary evidence on the buildings' features, instruct survey work and administrative services. Property managing agents, most of whom are not regulated by the FCA, are usually remunerated by the leaseholder for the activities they perform through a service charge. Freeholders often play a more limited role in obtaining insurance. So, it is often not clear why it is appropriate or necessary for property managing agents or freeholders to receive additional remuneration via broker commissions. We are very concerned that this practice does not represent value ultimately for the leaseholder.

1.24 While property managing agents are generally not FCA regulated, we want to ensure that the remuneration all parties receive is fair relative to the benefits their work provides. The level or even existence of commission is generally not made clear to leaseholders and the amounts of broker commission freeholders or property managing agents get are even less likely to be known to leaseholders. Leaseholder groups noted concerns about remuneration and the potential for secret or hidden commission and profits. We share these concerns, particularly where there is no transparency and the amounts in question are broker commissions from the regulated activity of arranging insurance.

1.25 Commission percentage rates have fallen across the period for buildings with flammable cladding within our analysis. The mean commission rate retained by the broker and the commission rate passed to the freeholder or the property managing agent for these buildings fell by 6 percentage points in the period after the Grenfell tragedy. However, the mean absolute value of commissions more than tripled for brokers between 2016 and 2021 (261% increase) and more than doubled for freeholders/property managing agents (137% increase).

1.26 Commission percentage rates remained broadly stable across 2016 2021 for buildings without flammable cladding. However, the mean absolute value of commissions gradually increased in the same period (by 51% for brokers and 30% for freeholders/ property managing agents).

Concerns relating to quality of service, renewals and frictional costs

1.27 We found that the distribution of insurance for multi-occupancy buildings is complex due to the nature of property ownership in the UK. We found that the demand side4 is weak and is unable, or potentially unwilling, to place downward pricing pressure on insurers or brokers. This is exacerbated by leaseholders, who in almost all cases have the insurance bill passed to them, having no role in the process to exert any leverage or information that would allow them to challenge the chain.

1.28 We have seen that buyers, including property managing agents and freeholders (or their representatives), are finding it more difficult to get insurance than before Grenfell, and that this issue was acute for buildings with flammable cladding. They noted a lack of choice with often no alternative to the incumbent insurer and a range of frictional costs and service issues. We found that these issues included the increasing volume and variety of risk information and buildings surveys requested by insurers, the rejection of risks or refusal to underwrite the entire risk by the incumbent insurer and the late provision of quotes leaving no time to negotiate or seek alternative options.

1.29 Where alternative insurance providers are available, we heard that certain frictional costs can limit the extent to which freeholders and property managing agents switch away from their incumbent insurer at the end of a policy. Although not conclusive, our analysis suggests that renewals with the same provider have higher premiums.

Lack of transparency and increased cost for leaseholders leading to significant distress

1.30 Leaseholders and their representatives noted many of these same issues. They also expressed understandable frustration with the many parts of the process of insuring buildings where they do not receive relevant information, access or rights despite the fact that they pay for the insurance. Their experience is frequently of an ongoing lack of transparency and disclosure from both the insurance and the property sectors. This includes often finding it difficult to get even the limited or partial information they are currently entitled to. These issues have caused considerable distress for many leaseholders, including on their mental health and wellbeing.

1.31 Leaseholders also explained their material concerns around remuneration practices, and the lack of regulatory protection or access to recourse. Leaseholders generally have no voice in choosing the insurer or broker, despite the fact that this determines the amount they have to pay for insurance and the benefits they can receive from it. In this context they also noted the significant potential for unmanaged conflicts of interest where freeholders or property managing agents make these choices and may be driven by their own interests, including the associated levels of earnings.

Competition is not working effectively for customers

1.32 Our review found some evidence that competition in this market does not appear to be working effectively to ensure that all customers (and the leaseholders who bear the costs) can consistently get appropriate insurance cover for multi-occupancy buildings at affordable prices. Features of the multi-occupancy residential buildings insurance market that could be limiting or undermining effective competition are:

* The exit of some insurers from the market has reduced the number of firms prepared to underwrite material numbers of buildings exposed to flammable cladding risks to a core group of 5 insurers. The remaining 5 insurers supplying insurance for these buildings have limited commercial incentive to supply this insurance, reducing the pressure on insurers to lower prices.

* Leaseholders often have limited visibility on why a particular insurance policy may be selected over others, as well as on the remuneration paid to parties in the distribution chain. They also have few routes to challenge the insurance costs passed on to them by freeholders. This limits their ability to put pressure on the different elements of the insurance cost (eg insurance premium, commission to brokers and freeholders/property managing agents).

* The fact that some freeholders and property managing agents receive a share of the insurance commission could be giving them an incentive to consider the impact on their own remuneration when choosing an insurance policy.

* Costs and frictions associated with searching for alternative offers and switching to a different insurer could be dampening competition between insurers, leading to higher premiums.

Other findings on the regulation of insurers and brokers

1.33 We have found that there were material issues and shortcomings in the availability, accuracy and quality of data consistently recorded by insurers and brokers. These have significantly affected our ability to carry out our analysis and reach definitive conclusions.

1.34 We expect regulated firms involved in this line of business to improve the quality, depth and consistency of information they systematically record and are able to report, particularly features and risk factors materially affecting the premium.

1.35 While the lack of consistent data has limited the ability to draw firm and reliable conclusions, it suggests that remediation, where it is sufficiently extensive to address key fire risks to the building as well as risks to life, can effectively reduce premiums.

Monitoring and update

1.36 We will continue to monitor this market while we take forward our program of actions in concert with the insurance industry, Government and other stakeholders. We will publish an update statement in 6 months on the progress made against the recommendations and potential remedies set out in this paper.

Recommendations and potential remedies

1.37 We have set out our recommendations and potential remedies below in Section 4 of our review. They are summarised below:

Key findings :

* There has been a contraction in supply and competition is weak in the market, with insurers having limited appetite for buildings with flammable cladding. This is resulting in high premiums for some buildings causing harm to leaseholders and others who ultimately bear these costs

* There is an ongoing lack of transparency and disclosure for leaseholders from both the insurance and property sectors

* Leaseholders are not customers in FCA rules or in insurance contracts

* The increases in absolute commission earned by brokers, freeholders and property managing agents may be disproportionate to increases in service costs

* There are material issues and shortcomings surrounding the availability, accuracy and quality of data recorded consistently by insurers and brokers involved in the multi-occupancy buildings insurance market.

* The lack of appropriately qualified surveyors and building fire safety experts was also identified as having delayed insurers' efforts to better understand the risks being underwritten.

Action we will take:

* We will continue to work with the insurance industry and Government to develop proposals for how a cross industry risk pooling solution could work in practice, including considering the role of the reinsurance sector.

* We will consult on improved information disclosure from regulated parties for leaseholders.

We are seeking views on exactly what information this should cover.

* We will consult on amending our rules to classify leaseholders as customers.

We are seeking views on to which parts of our rules this change should apply to.

* Our rules require that the prices paid represent fair value. We will undertake a review of those brokers who charge the highest commissions, and publish our findings.

We are also considering further rules on remuneration. This could include preventing remuneration being paid to unauthorised parties, and prohibiting remuneration calculations as a percentage (instead requiring it set in monetary terms).

* We will support the insurance industry in the development of a common code for the core risk data which should be collected and recorded consistently to facilitate the risk pooling arrangement and the functioning of a competitive and effective market.

* Remedies are outside our remit.

Recommendations for others:

* We recommend that the Association of British Insurers (ABI) work with Government and us to create a risk pooling solution, providing a plan for this solution and its implementation within 2 months. This plan should include estimates of the impact on premiums.

We recommend that the British Insurance Brokers' Association (BIBA) engage with the design of the risk pool to limit the commission costs, reducing the price passed on to leaseholders.

We recommend that the Department for Levelling Up, Housing and Communities (DLUHC) consider Government providing financial backing of the risk pool.

* We recommend that Government consider imposing a legal requirement on freeholders and property managing agents to provide information on the insurance policy to leaseholders.

This should include passing on the information which regulated insurers and brokers provide to them.

* Government may wish to consider ways in which leaseholders could be made parties to insurance contracts.

We also recommend Government consider ways to give leaseholders a straightforward and easily accessible route to challenge insurance costs passed on to them by freeholders.

* Government may wish to consider legislation applying directly to unregulated property managers and freeholders regarding their remuneration.

* We recommend that the ABI and BIBA work with industry participants to establish a common code for the core pieces of risk information to be systematically collected and recorded for multi-occupancy buildings affected by flammable cladding or other material fire safety issues. We recommend that this code is designed and communicated by the end of 2022, and implemented by the industry by the end of February 2023.

* Recommendations are outside our remit.

Risk pooling

1.38 We have found that prices have increased for insurance for multi-occupancy buildings with flammable cladding by 187% and that availability has decreased. We have also found competition in this market is not working well to support increased availability or lower prices. We have considered a range of interventions to tackle the problems identified and these are set out at Section 4 below.

1.39 As set out in the summary above, we have identified a range of remedies based on disclosure and transparency, targeted regulation of practices in the insurer and broker industry to improve the way premium are provided on renewal and quality of service. These will support this market. However, we have not found evidence showing that there is excess profitability in this market for insurers and so, based on the way competition is working, we do not anticipate that prices will decrease for the majority of customers as a result of these proposed remedies.

1.40 We therefore consider the intervention most likely to reduce prices for the minority of multi-occupancy buildings with the most substantial price increases, would be cross industry risk pooling or sharing. This would enable the risk of covering certain higher risk buildings, notably those severely affected by flammable cladding (or other material fire safety risks giving rise to the risk of total loss of the building), to be shared across multiple insurers. An effective risk pooling arrangement is also likely to reduce the amount of work required of brokers and other parties when placing the risk; especially if the current layering is no longer needed. This should result in a corresponding reduction in commissions, and we would expect this reduction to be passed on to leaseholders.

1.41 Any such pooling arrangement could potentially be designed for and targeted solely at those multi-occupancy buildings not already benefitting from the pooling effect of being insured as part of a larger portfolio of buildings. This would differ from the layering described above in paragraph 1.15 in that it could potentially involve the primary insurers active in this market pooling the more complex or challenging risks between them, on similar terms and without the level of risk premium often required by secondary markets.

1.42 Industry figures suggest greater and quicker reductions could come from Government providing backing to cover this minority of higher risk multi-occupancy buildings. These buildings are those which are beyond or at the margins of the risk appetite of insurers due to the impact of flammable cladding (or other material fire safety issues giving rise to the risk of total loss of the building) and not already benefitting from the pooling effect of being part of a larger portfolio of buildings.

1.43 Our recommendations in relation to risk pooling are:

* The ABI, on behalf of the insurance industry, continue to work with Government and us to create an effective risk pooling arrangement to share the risks of properties affected by flammable cladding and other material fire safety risks. This includes developing criteria for accepting buildings into the pool. We would expect a plan for this arrangement and its implementation to be in place in the next 2 months. This plan should include estimates of the impact on premiums for eligible buildings.

* BIBA, on behalf the insurance broking industry, engage with the design of a risk pooling arrangement and consider how to ensure that substantive commission reductions are achieved and can be reflected in the amount leaseholders pay. In this context we would expect the amount of work performed and value added by the broker to be the key driver of the level of remuneration and assessing whether this is reasonable and appropriate, in the context of the relevant product governance rules. This is as opposed to the level of remuneration being determined more arbitrarily as a set percentage of premium even where very substantial increases in that premium have not been matched by commensurate increases in the amount of work undertaken by the broker.

* DLUHC consider whether Government backing of a risk pooling arrangement could lead to quicker and more substantial reductions in the costs paid by leaseholders.

Stronger protections for leaseholders

1.44 There continues to be a complex distribution chain in this sector, with many parties sitting between the insurer and the leaseholders who ultimately pay for the policy. Leaseholders often do not receive sufficient information to enable them to understand the policy and the price they are paying. We will consult on improved information disclosure for leaseholders. This could include information about the policy, including about remuneration of all parties in the distribution chain. We will also consult on changes to our rules to specifically include consideration of leaseholders' interests.

1.45 Our product governance rules require firms to consider fair value and act as an important protection against unjustified commission levels. Using these rules, we will undertake a multi firm review of those brokers who charge the highest commissions and consider whether further rules on remuneration (such as preventing percentage based commission structures) are required. We intend to publish the outcomes of this review in the first half of next year. This will include considering whether leaseholders may benefit from additional specific rules preventing some potentially harmful practices around commission, in the context of a market where premiums have increased substantially.

1.46 As we cannot make rules for unregulated firms, we recommend that Government could consider requiring freeholders and property managers provide the required information to leaseholders, and whether there should be new obligations about commission received by unregulated parties.

1.47 To put pressure on firms to improve their practices around product selection and remuneration, leaseholders need an effective, cheap and timely mechanism to challenge costs passed on to them. Without that, giving them additional information is unlikely to lead to any significant benefit. Government may consider ways to give leaseholders a straightforward and easily accessible route to challenge insurance costs passed on to them by freeholders. One option, for example, would be an independent alternative dispute resolution mechanism.

Industry data and approach

1.48 The absence of a consistent approach to underwriting, broking and recording key risk information in the multi-occupancy property insurance market serves to create significant frictions for users of this market. It also makes it very difficult to consider the appropriateness and fairness of premium and remuneration levels, as set out in Section 3 of this report. This has also had a substantial impact on our ability to quantify the impact of various remedies.

1.49 We understand the need for market participants to be able to follow their own underwriting and broking methodologies, to be able to provide cover for a diverse range of risks, price appropriately and facilitate competition. However, this does not preclude a greater degree of consistency being established for the core elements of risk information relevant to broking and underwriting policies for buildings affected by flammable cladding or other material fire safety issues. This is particularly important for those factors which are significant drivers of increased prices, and which will remain relevant throughout the coming years as remediation work is undertaken to reduce the fire risks identified in these buildings.

1.50 In this context, we recommend and expect that the ABI and BIBA work with industry to establish a common code for the core pieces of risk information to be systematically collected and recorded for multi-occupancy buildings affected by flammable cladding or other material fire safety issues. It may be appropriate for this code to reference relevant standards established by other bodies, such as Publicly Available Specification ('PAS') 9980: 2022, Fire risk appraisal of external wall construction and cladding of existing blocks of flats - Code of practice (published by the British Standards Institution), where such standards consider core risk elements of the fire risk of the building.

1.51 The lack of consistent data means it has not been possible for us to make observations in this report about the impact remediation of these issues has on the insurance premium charged for these buildings. We would expect any data collected to also record remediation information so we can measure the impact on the cost of insurance to leaseholders.

1.52 As such, there is a lack of clarity around the impact remediation has on insurance premium for these buildings. We accept that, from a claims perspective, there is a difference between the total loss of a building and remediation which serves to protect life. However, we would expect some recognition of the remediation work on premiums. We will do further work to ensure the industry is adopting appropriate and transparent processes and procedures to assess buildings where some remediation has occurred.

Next steps

1.53 We note that we do not preclude the opening of a market study into the subjects in this report if we do not see swift action and progress from the industry. A market study could lead to a market investigation referral to the CMA and a significant and detailed investigation into this market.

1.54 We will publish an update on progress on the recommendations summarised above (and set out in more detail in Section 4) in 6 months.

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The report is posted at: https://www.fca.org.uk/publication/corporate/report-insurance-multi-occupancy-buildings.pdf

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