The RDR and pure protection products

Out-Law Guide | 22 Apr 2010 | 11:58 am | 5 min. read

This guide is subject to UK law and was last updated on 6th October 2010. The Financial Services Authority (FSA) has confirmed that retail investment advisers selling pure protection products to...

This guide is subject to UK law and was last updated on 6th October 2010.

The Financial Services Authority (FSA) has confirmed that retail investment advisers selling pure protection products to retail clients in the UK will not have to apply adviser charging when the Retail Distribution Review (RDR) comes into force at the end of 2012. 

This will create an exception to the general rule under the RDR that firms providing independent or restricted advice to retail clients on retail investment products can be remunerated only by an adviser charge agreed with the client in advance, not by a commission set by the product provider.

The special rule will mean advisers who sell pure protection products (critical illness, income protection and non-investment life insurance) will still be able to earn commission on the sale, subject to new requirements to explain and disclose their remuneration to the client.

This will apply whether the firm has chosen to sell pure protection products under the Conduct of Business Sourcebook (COBS) or under the Insurance Conduct of Business Sourcebook (ICOBS).

This guide looks specifically at the FSA's final rules for the sale of pure protection products by retail investment firms published on 30th September 2010. The final rules on independent and restricted advice and adviser charging are considered in separate notes.

Election

Most retail investment advisers also sell pure protection business. Since June 2007, firms have been able to elect whether they do so under COBS or ICOBS rules.

Although firms must keep a record of their election, they are not required to report it to the FSA, which consequently has no information on which option firms are choosing. An informal survey carried out in 2008 by the Association of Independent Financial Advisers, however, suggested that about 40% of pure protection sales were made under ICOBS and 60% under COBS.

In the absence of a special rule for pure protection, the RDR regime would mean advisers electing to sell pure protection products under COBS would have to apply adviser charging but those selling under ICOBS would not.

The FSA, however, saw no case for introducing adviser charging into pure protection. It found no evidence that commission-based sales of pure protection products were leading to consumer detriment. Introducing adviser charging, on the other hand, could lead to disproportionately high fees compared to premiums, which might discourage consumers from taking protection advice.

More importantly, the FSA concluded that adviser charging would not address the recurring problem it has identified in relation to pure protection sales – advisers failing to explain adequately what the product does and does not cover.

Having reached this conclusion, the FSA needed to level the playing field between pure protection sales made under ICOBS (where commissions can be earned) and COBS (where commissions will be banned after 31st December 2012).

The solution is a simple carve-out from the adviser charging rules for retail investment firms who elect to sell pure protection products under COBS. This will not prevent firms opting to apply adviser charging to pure protection advice if they wish.

Explanation and disclosure

The FSA, however, believes firms need to be more transparent about how they are remunerated for pure protection services associated with investment advice.

A pure protection service is where a firm provides a personal recommendation for pure protection and/or arranges the sale of a pure protection contract (advised and non-advised sales).

The new rules and guidance expressly address the risk that a consumer receiving both investment advice and a pure protection service might mistakenly believe that the firm's remuneration for the pure protection service is included in the adviser charge.

Accordingly, a firm which agrees an adviser charge and provides the consumer with an associated pure protection service must (in good time before the provision of the service) take reasonable steps to ensure the consumer understands how the firm is paid and, if applicable, that the firm will receive commission in addition to the adviser charge.

In addition, "as close as practicable" to the time the firm makes the personal recommendation or arranges the pure protection sale, the firm must comply with COBS requirements for the disclosure of commission or (where the firm is the product provider) a commission equivalent representing the cost of advice and/or distribution.

Where the firm or its associate is the pure protection product contract insurer, a new COBS rule will allow it to disclose an "indicative adviser charge" as an alternative to a commission equivalent. This must be reasonably representative of the services associated with making the personal recommendation.

Where information about the adviser charge is given orally, the explanation about pure protection remuneration must be given orally too.

Associated pure protection services

The meaning of "associated" pure protection services is not defined, but the guidance suggests a pure protection service is "unlikely" to be associated with an adviser charge if the firm agrees the adviser charge 12 months or more before the pure protection services are provided.

The replaces an earlier proposal that pure protection services would be associated with investment advice if the firm had agreed an adviser charge with the client in the previous 12 months, or was likely to do so.

The new wording means that firms will need to judge for themselves whether they need to make the disclosure, depending on the circumstances of the services being provided. A firm could, of course, adopt disclosure practices that go beyond the requirements.

The guidance also confirms that a pure protection service will not be associated with an adviser charge if the adviser charge is agreed by one firm and the pure protection service is provided by another. But the referring firm should consider what explanations it should give to avoid the risk of the consumer misunderstanding that those services will be included in the adviser charge.

RDR read-across?

Under ICOBS, there is currently no obligation on a firm to disclose commission to a consumer. As from 31st December 2012, however, there will be different disclosure regimes for pure protection services and for general insurance sales.

Could this be the beginning of a new commission disclosure regime for all insurance sales? The FSA says not. The new rules address a particular problem and have no wider significance:

"For standalone sales not associated with investment advice, our view remains that the customer's main concern is the premium he will have to pay rather than his adviser's remuneration," the policy paper states.

"It is only in the specific circumstances where the customer is also paying an adviser charge that we are concerned confusion could arise about what the adviser charge covers. We think it is important that the customer understands the entirety of his adviser's remuneration in these circumstances."

The wider market

The December 2009 consultation paper mentioned two other areas where the FSA was considering RDR principles might be introduced into the wider pure protection market, not just in relation to sales by retail investment advisers: increasing professional standards and adopting advice service labelling.

On the question of professional standards, the FSA said it was "open-minded" about how higher professional requirements might apply to pure protection and asked for evidence from the industry on how these might work in practice.

In June 2010, it published the feedback received and its proposals for professional standards. That consultation closed on 24th September.

In 2009, the FSA also thought there might be some merit in adopting the new advice service labels of independent and restricted advice for the pure protection market. But it has retreated from this position. 

The FSA now says its priority is to address the fact that too many consumers have a limited and incorrect understanding of pure protection products because firms are still not providing adequate explanations of the extent and limitations of the cover. These issues will not be resolved by new labels, so the FSA has no plans to consult on advice labelling "in the near future".

Contact: Bruno Geiringer ([email protected] / 020 7418 7306)

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