Insurance Industry (Hansard, 13 May 1991)

§ Mr. Andrew Hunter (Basingstoke)

I doubt that I shall compete with the drama and passion that we have witnessed during the past hour or so, but I nevertheless welcome the opportunity to introduce a short debate on the Financial Services Act 1986 and the insurance industry —subjects in which I have a strong constituency interest. Earlier today, I gave my hon. Friend the Minister a draft of what I proposed to say.

A primary purpose of the Financial Services Act is to give the public adequate protection when buying investment products and services. However, there is broad agreement that, as far as retail financial services are concerned, the Act is in some respects not working well. That has arisen partly because the practical effects of some of the regulations run counter to the original intentions, and partly because the market for financial services has evolved so quickly in recent years that some of the fundamental regulations require updating and amendment.

Consequently, the Securities and Investment Board plc is currently conducting a wide-ranging review and has recently received a consultative paper on the subject. I welcome the review and look forward to an amended regime which will, to quote Mr. David Walker, the chairman of the SIB, be "robust and enduring." The SIB regards the review as urgent, but because the issues are complex and require extensive consultation, speedy changes cannot be expected. There seems no question of a new regime being introduced this year. Although the SIB may disagree, past form gives no great confidence that changes will become effective much before 1993. Meanwhile, there is an important issue of consumer protection which requires immediate action. That is the issue to which I wish primarily to draw attention.

An important principle of the Financial Services Act 1986 is that every seller of retail financial services should be authorised and supervised directly by the SIB, or indirectly by recognised self-regulatory organisations or recognised professional bodies. That is intended to ensure that all selling practices conform to the principles of the Act and that the public should have a clear line of recourse in the event of a breach.

The self-regulatory organisations have their own rule books which must at least match up to SIB standards. One such organisation is the Financial Intermediaries, Managers and Brokers Regulatory Association, which has responsibility for independent financial advisers. Such advisers are agents for the customer and are required to fulfil quite stringent conditions to secure and maintain authorisation.

The second regulatory organisation is the Life Assurance and Unit Trust Regulatory Organisation, which authorises the suppliers of financial services, such as the life assurance companies. It makes them responsible for the compliance of their tied intermediaries who may be employed salesmen of the supplying company, or an individual or firm that has contracted to sell its products. The tied intermediaries are agents of the supplier and not of the customer, and they are restricted to selling only the investment products issued by the supplier. Thus, the 130 structure is complete. The independent adviser is authorised and monitored directly by FIMBRA and the tied intermediary is policed by the supplying company, which is itself directly authorised and monitored by LAUTRO.

For the most part, the structure works well. However, one area in which major difficulties arise is that of the tied intermediary who is not an employee of the supplying company. Such an individual is formally known as an appointed representative and is bound to the supplier by an agency contract under section 44 of the Financial Services Act 1986.

Appointed representatives in practice come in two colours. Some are organised as a formal sales force, although they retain their self-employed status, but many others act as independent businesses, whether trading as a limited company, as a partnership or as a sole proprietor. They come in all shapes and sizes, from one-man operations to large financial institutions. The number of firms that act in that way has been growing substantially in the past year or two. Their principal operations need have little or no connection with financial services. Such firms may be an estate agency, a bank, a building society, a travel tour operator or even a football club.

With the best will in the world, it is not possible for the supplying company to exercise the same standard of supervision and direction with independent businesses as the standard that it can give its own employees. Experience has shown that adequate compliance with the regulations requires close and frequent examination both of the business practices and of the detailed sales documentation of the appointed representative. LAUTRO has had to crack the whip more than once in the hope of improving standards, but without evident success.

My many contacts in the industry who are close to the situation simply do not believe that the necessary standards will ever be achieved in practice through the current regime. It has been put to me that the appointed representative, being an independent business, tends to resent and resist the very close supervision of affairs which is required. However, sometimes being unable or unwilling to meet the stringent requirements imposed by the regulations on independent financial advisers, the appointed representative has settled reluctantly for a contractual tie to one supplier. It will often be financed through loans from the supplier for commission, yet to be earned or for what is often described as "business development". Firms will often look around for the supplier willing to give the best deal and some will think nothing of changing suppliers if they get a larger loan or better terms elsewhere.

The supplying company is sometimes reluctant to be too harsh in its supervision for fear of losing a valuable sales outlet, which will often owe it a substantial debt, which may prove hard to recover. There is a strong conflict of interest between its duty to supervise an appointed representative and its desire to retain a profitable business relationship with it.

Yet that, although important, is only part of the problem. The Financial Services Act regulates only the sales of what it defines as investment business. In this context, that would primarily be life insurance, pensions and unit trusts. The supplying company is required to monitor and take responsibility for only' those types of business. The appointed representative, however, may on his own account be offering financial services to his 131 customers that are not subject to the Act, such as mortgage broking, the taking of deposits or the holding of customers' money for purposes unrelated to the Act.

It is often too much to expect the general public to distinguish between financial transactions that are regulated under the Act and those that are not. Often, what to the customer is one transaction—for example, buying a house—will involve investment business covered by the Act, financial transactions not covered by it and, frequently, elements that are not financial at all. Customers are likely to suppose that they have protection under the Act for transactions when in fact no such protection exists. Moreover, they may well believe that the supplier to whom the appointed representative is contracted—perhaps a respectable and long-established life assurance company—will stand behind all the transactions. The supplier, however, has no such obligation in relation to any transaction not covered by the Act.

Supplying companies have often chosen to stand behind such transactions for the sake of their good names; but that is a shaky foundation on which to build consumer protection, and one quite inconsistent with the purposes of the Act, which were to buttress protection in financial matters with the force of law. It would, moreover, be wholly unreasonable to expect the life company to stand behind a transaction carried out by the appointed representative on behalf of another supplier, such as a building society, whose deposit-taking business was outside the scope of the Financial Services Act. Yet the customer is likely to think that the protection of the Act, and the obligations of the life company, will protect his interests against, say, the fraud or negligence of the appointed representative.

Having debated the matter extensively with members of the industry, and after long thought, I conclude that appointed representatives can be adequately supervised only by being directly authorised, and not by authorisation at second hand through the supplying company. Only thus is it possible to escape the conflict of interests that I have described, and to ensure the proper monitoring of the appointed representative's investment business. That authorisation could be given and supervised by one of the existing regulatory organisations.

Such authorisation would make it much easier to clarify for the customer which financial products came within the scope of the Act, and the opportunity could be taken to ensure the financial adequacy of the appointed representative at a level appropriate to his financial liabilities, together with the provision of suitable professional indemnity insurance. The buying public need the assurance that all intermediaries are adequately capitalised and responsible.

I do not propose any change for the employed member of a supplier's sales force. Because he is employed, the supplier can give its employee the close supervision that is required; can direct which classes of business that employee may undertake; and must, in any event—quite apart from the Financial Services Act—stand behind the employee's actions. Thus, the public are already protected, in the full spirit of the legislation.

I am aware that LAUTRO is advocating some proposals that are directly aimed at the problems of the 132 appointed representative. In themselves the new proposals are good, but they suffer from a fundamental flaw; they still depend on regulation by the supplying company, not on direct authorisation. Without direct authorisation, no additional proposals will be effective in practice. Can we afford to wait while LAUTRO's proposals are finalised, implemented and observed in action, when all experience tells us that they will be nothing more than a palliative? Is that a risk that we want the buying public to run for a day longer than necessary?

I do not expect all existing appointed representatives to welcome such proposals, particularly those who are experiencing an unfair advantage under the present regime. But those—I am glad to say that there are many—who are scrupulous in their professional conduct will welcome the clarification in status that only direct authorisation will give.

There will certainly be greater expense, much of which will fall on the shoulders of the appointed representatives. We should remind those who jib at this that they have chosen to operate as self-employed individuals or as independent firms rather than subject themselves to the direction of an employer. There are great advantages in acting as an independent contractor, but business independence has its price, and those who practise it should be willing to pay that price.

To return to the broad revisions currently being investigated by the Securities and Investments Board, I notice that a novel proposition is being informally canvassed. It concerns the possibility of an additional class of intermediary which would act as agent for a limited number of companies—that is to say, a class lying somewhere between an independent financial adviser and an appointed representative. Direct authorisation would certainly be necessary for such a hybrid intermediary if total confusion about who is answerable to whom is to be avoided. Consequently, the argument for the direct authorisation of appointed representatives is quite consistent with the steps that the SIB is exploring.

In summary, I suggest that the current method of controlling appointed representatives through the actions of their supplying company bring about a conflict of interest and in many instances cannot be practically carried out to the standards envisaged by the Financial Services Act. I have further argued that the public are frequently misled, perhaps quite innocently, into believing that they have the protection of the Act and the strength of the supplying company behind them when this will often not be the case. It is important to rectify that, and the direct authorisation of appointed representatives is a clear way forward.