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The end of the low cost insurance scheme?

15 February 2016. Published by Sally Lord, Knowledge Lawyer

The Financial Conduct Authority (FCA) and Prudential Regulation Authority (PRA) have taken disciplinary action against Mr Shay Reches, the firms Coverall and Millburn, and four other related individuals in relation to solicitors' professional indemnity insurance and other insurance scheme failures.

The penalties imposed included issuing fines with a total in excess of £18 million.

What happened?

This decision was the result of an investigation undertaken jointly by the FCA and Prudential Regulation Authority (PRA) after concerns had been raised over the validity of solicitors' professional indemnity insurance, which had been arranged for over 1000 firms in England and Wales The insurance schemes (set out in more detail below) at the heart of the investigation which, at first blush, appeared to be a good way of achieving low premiums, have been exposed by the FCA and PRA as resulting in inadequate insurance cover, being set up in an unauthorised and unregulated manner and having contributed to the failure of various insurance companies. Although having been widely commented on in the insurance market for years and with many people expressing their views on the likely outcome, it seems the FCA and PRA have now taken control over the situation.

Mr Reches was linked to all the insurance schemes that were involved in the action taken by the FCA and PRA. The FCA has indicated that "These schemes used binding authorities issued by a London-based managing general agent, Aderia, to various coverholders, including to specialist insurance broker, Bar, which sold Solicitors’ PII. Aderia was an appointed representative of a UK insurer, Millburn, and a UK insurance intermediary, Coverall.

For this complex system to work, security needed to be available from a number of insurers and reinsurers based in the UK, Europe and offshore. The principal risk carrier, Sinclair Insurance Company Limited (Sinclair), is registered in the of the Comoros and owned and controlled by Mr Reches."

The FCA considered Mr Reches' misconduct contributed to Balva Insurance Company, European Risk Insurance Company (ERIC) and Millburn (who did not deal with solicitors' professional indemnity cover) going into administration (which was in part due to the debts of Sinclair). This led to many firms of solicitors not having adequate insurance cover.

What was the decision?

The FCA Decision

The FCA found that Mr Shay Reches set up and ran insurance schemes and therefore performed the CF1 (director) controlled function at Coverall Worldwide Limited (an authorised firm), with responsibility for Aderia UK Limited (its appointed representative) and conducted regulated activities when he was not approved to do so by the FCA.

The FCA held that Mr Reches had "recklessly" increased the risk that policyholders' claims would not be paid when he directed insurance premiums to parties other than the actual insurers and reinsurers responsible for paying claims.

Mr Reches has been fined over £1 million and has also agreed to pay the three insurance companies listed above, in excess of £13 million.

The FCA has also fined the other key individuals at Coverall (Colin McIntosh (also a director at Milburn), Robert Bygrave and Andrea Sadler) as well as Milburn, Bar (a specialist insurance brokerage) and its director, Wayne Redgrave £51,600.

The PRA Decision

The PRA has fined and banned Colin McIntosh, CEO of Millburn Insurance Company Limited, for serious regulatory breaches and also fined Millburn £2,863,066.

What are the wider implications of this decision?

The FCA has set out what it considers to be the wider concerns from this investigation, and which are supported by the FCA's thematic review in respect of outsourcing in the general insurance market (TR15/7Delegated Authority)

"• the lack of due diligence applied by market participants when selecting potential insurance and reinsurance security

• poor understanding and scrutiny of appointed representatives and those carrying out other delegated authority functions

• the need for clarity and certainty about roles and responsibilities

• the responsibilities of intermediaries used in the distribution chain

• the lack of understanding and correct application of the client money rules; and

• the lack of adequate systems and controls in ensuring client money is protected."

This decision is also the first time that a person has been fined for carrying out regulated activities without FCA approval.

For insurers, adequate due diligence and management of their business are paramount in ensuring that premiums are treated correctly.  Insurers must also take reasonable steps to ensure that their business complies with all of the relevant requirements and standards of the regulatory system. Andrew Bailey, Deputy Governor for Prudential Regulation and CEO of the PRA said:

 "Insurance firms which are not well governed have the potential to cause significant losses to policyholders.  It is therefore vital that they have robust systems and controls for understanding and managing risk".

Many commentators argue that the SRA used the lower premiums typically charged by unrated insurers such as Balva as a means of keeping the general cost of solicitors PI down, and that the SRA – knowing the dangers - ought to have prevented them from gaining access to the profession from the outset.  It is certainly the case that the SRA is now looking at lessons that can be learned from this episode, and they will be looking to formulate some proposals for the future of solicitors PI at some point in the near future.  As soon as we know more about these proposals, we will circulate details.

Click here for the FCA decision and here for the PRA decision for further information.