What is Fair Value and What Does it Mean for You From 31/12?

Darren Bagnall from Flat Living Insurance looks at what ‘fair value’ is and what it means for you from 31st December 2023.

There’s a new world on the horizon for the residential buildings insurance industry.

From 31^st December 2023, the Financial Conduct Authority has updated its rules surrounding the treatment of leaseholders across the sector.

Their rules mean that leaseholders will now be treated as a ‘stakeholder’, and as such, insurers, intermediaries, and brokers will have to consider their needs from policy draft to the point of sale. Everyone involved in the sale of a policy will need to be able to demonstrate that they are providing fair value to all parties, including leaseholders.

Here we’ll be discussing what ‘fair value’ actually is, and what the changes mean for leaseholders as we move towards 2024.

What Does “Fair Value” Mean?

Fair value is a tricky phrase to define and a tough quality to quantify. The FCA’s definition doesn’t refer to specific pricing or a numerical approach at all. Within their rules, services are defined as providing ‘fair value’ where the amount paid in exchange is considered reasonable, relative to the benefits received by the customer.

During their 2022 review of the market (instigated by Michael Gove’s inquiry into the buildings insurance market in January of that year), the FCA found that “Some remuneration practices within the market seem excessive and do not deliver fair value.”

What are the Current Rules and How are Things Changing?

Since 2021, there have been regulations in place that require firms to provide products that deliver ‘fair value’ to stakeholders in their target market.

In January 2022 (when Mr Gove kick-started the conversation with his inquiry) the FCA wrote to CEOs of insurers and intermediaries to remind them of their obligations. They pointed out in their reminder that, while freeholders may be the official ‘customer’, firms should also be considering the freeholder’s duty to their leaseholders.

During their 2022 review into the market, the FCA found that almost a third of the cost of insurance premiums could be made up of commission and fees (inflated by unscrupulous freeholders agreeing to higher premiums in return for a share of the brokers’ commissions). They also concluded that service charge demands were not transparent enough for this to be easily spotted by leaseholders.

In July 2023, the Financial Conduct Authority brought out their updated rules for Consumer Duty.

The new regulations comprised of:

• A new Consumer Principle that required firms to act to deliver good outcomes for retail customers
• Cross-cutting rules providing greater clarity on their expectations under the new Principle, and helping firms interpret the four outcomes (see below)
• Rules relating to the four outcomes they wanted to see under the Consumer Duty (these represent key elements of the firm-consumer relationship which are instrumental in helping to drive good outcomes for customers)

The four outcomes were:

• Products and Services  
• Price and Value   
• Consumer Understanding  
• Consumer Support  

The rules included products for the multi-occupancy buildings insurance market, but at this point leaseholders were not considered formally as ‘stakeholders’.

It was clear from the FCA’s review that their current rules didn’t go far enough, and that their reminder to firms hadn’t been truly heeded. The new rules aim to rectify this, building on the current requirements and extending the rights of being a ‘stakeholder’ to the leaseholders themselves.

Reduced Renumeration and a More Competitive Market

The new rules are expected to provide a boost to competition in the industry. Until now, leaseholders have been kept in the dark about the pricing behind their policies and the coverage they’re receiving. Now that they will be receiving more information, leaseholders will be able to challenge policy choices.

“We consider our new rules are compatible with advancing the FCA’s secondary international competitiveness and growth objective. By requiring firms to ensure their products are consistent with the needs of leaseholders and other policy stakeholders, and are priced and remunerated for, in a way that provides fair value, we hope to promote fairer and more effective competition in the UK insurance market.”

The regulations will also clamp down on commission and renumeration in the market:

“Intermediaries who receive percentage-based commissions that have increased in absolute amounts as risk premiums have risen would likely need to reduce the percentage they receive. Earnings that increase purely because of premium increases would be unlikely to reflect additional benefits provided to leaseholders, so would not meet our fair value requirements…

Firms need to consider the amount of remuneration they share with other parties in the distribution chain, such as freeholders and PMAs. Our rules would not allow such payments unless firms can demonstrate they provide fair value to leaseholders.”

And finally, the rules will reduce the practise of payments being made to property management firms and freeholders who arrange the insurance:

“The FCA expects brokers to immediately stop paying commissions to third parties (including property managing agents and freeholders) where they do not have appropriate justification and evidence for doing so in line with our rules on fair value.”

How Will This Affect You as a Leaseholder?

The effect of the new rules will bring empowerment and control for leaseholders. When your buildings insurance is being arranged, you will now be considered a stakeholder in the eyes of the law, and so the FCA’s regulations on Consumer Duty extend to you. You may not have a direct hand in the arrangements, but you will have to be considered equally alongside the needs of the freeholder.

Insurance companies and intermediaries will now need to:

• Consider leaseholders as a relevant part of the target market when designing, pricing and distributing their products.

• Demonstrate that products provide fair value to leaseholders as well as any other stakeholders. This means there must be a fair relationship between the total price and the overall benefits leaseholders receive.

Firms will need to be able to clearly demonstrate how their practises, products and services provide fair value to all parties, including leaseholders. In their publication of the new rules, the FCA states that one of the key outcomes they are seeking is:

“Requiring firms to ensure their products are consistent with the needs and interests of leaseholders and other policy stakeholders, are priced in a way that provides fair value and that remuneration practices do not lead to poor outcomes.”

Essentially, you can expect to see better pricing and far more clarity around who is receiving what in terms of renumeration, thanks to the disclosure document you will now be provided with. This is a document that will be given to whoever arranges your insurance with the express requirement of passing the information on.

It will include:

• A summary of the features of the policy, including main benefits, coverage and exclusions of the policy, duration and insured sum.
• The policy premium- where the policy covers a portfolio of buildings, firms must disclose the premium at building or dwelling level.
• The remuneration which any authorised intermediaries received for arranging the insurance, as well as remuneration they pay to other parties (including unregulated Property Managing Agents and freeholders).
• Information about potential conflicts of interests, such as ownership links between the intermediary and the insurer, and about the insurers with whom the intermediary may place the policy.
• The number of alternative quotes they have obtained (with further details of these to be provided on request) and a brief explanation of why they have proposed or recommended that the policy is in the interests of both the freeholder and leaseholders.

If you don’t receive this information following the arrangement of a policy, you can contact the intermediary or insurer for their assistance.

Flat Living Insurance provides specialist insurance policies for blocks of flats and apartments. For more information or a quote, please contact a member of the Flat Living Insurance team on 0333 577 2044.