Many people buy their cars on finance. We are now hearing that UK banks are setting aside tens if not hundreds of millions in provision for the motor financing mis-selling scandal.

 

It is thought the total cost to the finance industry could reach as high as £25bn. The scandal concerns undisclosed “discretionary” commission payments made by lenders to car dealers in which the dealers were rewarded for selling finance on more onerous terms to car buyers (“Discretionary Commission Arrangements” or “DCAs”). These DCAs were banned by the UK’s financial regulator the FCA in 2021 (see FCA PS20/8). Since then, complaints about the preceding period have been mounting against the lenders.

 

In January 2024 the FCA launched an investigation into the pre-2021 period and in October 2024 the UK Court of Appeal decided it was against the law for the dealers to receive a commission from lenders without first telling the customer about the commission and getting their informed consent to the payment. This is being appealed to the UK Supreme Court.

 

The FCA is due to decide what action should be taken later this year after the Supreme Court has ruled. The implications could be far reaching and go well beyond car financing. Indeed, the UK government took the unusual step of attempting (unsuccessfully) to intervene in the case over its concerns that the case could harm the car industry. In the meantime, claims management companies are circling.

 

The likely compensation to car buyers, if payable, will be the financial loss they suffered as a result of being mis-sold. This would essentially be the difference between their financial position had they not been mis-sold and their actual financial position.

 

Many will remember the PPI mis-selling scandal ten years ago which led to the largest UK consumer redress scheme ever set up, with some £38bn paid out to customers mis-sold payment protection insurance products.

 

Mis-selling claims can be covered under a FIPI policy.

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What is Financial Institutions’ Professional Indemnity Insurance (“FIPI”)?

FIPI is PI insurance for the finance industry. As well as mis-selling claims, also potentially covered are claims by clients of financial institutions for poor advice, execution errors or delays, or acting outside their authority. Whether claims will be covered will depend on the facts and the exact terms and conditions of the policy. What follows is a summary of what may typically be covered / not covered and is not based on any actual scenario.

 

Who is FIPI offered to?

Potentially FIPI can be bought by any entity providing services regulated by a financial services regulator, the UK FCA and US SEC being examples, unless a more specialised form of E&O insurance is available (eg insurance brokers are regulated entities but buy brokers’ E&O instead). This would include banks, life companies, asset managers (perhaps via an Investment Management Insurance product), non-life insurers, and broker-dealers (“regulated firms”).

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What does FIPI Cover?

A FIPI policy covers the regulated firm for claims against it arising from a failure in the provision of professional services provided (or meant to be provided) by the regulated firm. How broad this is will depend on the wording and a couple of key definitions: Claim and Professional Service.

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When FIPI was first developed, the main liability exposure for financial institutions was civil claims for damages, so the policy has always covered civil liability compensation claims. However, these days the emphasis has shifted to the bringing of proceedings by clients through ombudsmen services or even claims brought by regulators themselves, either on behalf of customers or by way of enforcement in relation toservices provided. This has led to the product broadening, so that the definition of Claim will often embrace regulatory and even criminal proceedings, but with caveats (see later). It’s important to be clear about the exact nature of claims intended to be covered under the policy.

 

Professional Services may be defined according to activities stated in the policy schedule, or disclosed in the submission, or may be more general but still tied to activities done for a fee and/or pursuant to a contract of services. In some cases, it may even be as broad as “the services and activities” of the firm. This could include all aspects of the firm’s business not just the provision of services to clients. So, you can see how the breadth of cover is affected by the definition and it’s important that both broker and insurer get this right to avoid unintended consequences (ie too narrow – too broad cover). The breadth of the definition will probably affect the number and nature of the exclusions added.

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The changing nature of “Claims”

A policy covering “claims” still requires a claim to be brought (obviously!). But what happens if the regulator requires the regulated firm to offer redress to customers without the customer having to assert a claim for anything? This might be because the regulated firm (and the regulator because of a self-report for instance) are a step ahead of the customer and already know there’s a problem before the customer does.

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In a highly regulated environment in which sophisticated systems and controls are in place, this is increasingly the case. So, the first a customer may know they have a problem is the regulated firm writing to them to tell them this, saying it is investigating whether any redress may be due, and possibly asking some questions.

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In the motor financing mis-selling scandal, whilst some customers have made claims in the traditional sense, many will not have done. The outcome may be that the FCA orders a redress scheme be set up, a move that will be reminiscent of the PPI scandal. The manner of this may well obviate the need for claims in the traditional sense to be made (despite the plethora of claims management companies swarming all over the thing).

 

Is all this rendering FIPI obsolete? No, it isn’t, for a couple of reasons. First, UK courts have held that the regulated firm sending out a questionnaire for customers to complete as part of an investigation into mis-selling may on its own amount to a claim when the customer completes and returns it, and/or accepts a compensation payment[1]. Secondly, the product itself has adapted to this changing environment with the addition of Mitigation Cover.

 

Mitigation Cover in FIPI

Mitigation may arguably have become the most important cover in today’s FIPI product. In the early days of mitigation, the cover was sub-limited but given its significance now the full limit is more likely to be available.

 

Given the potential amounts involved, the difficulty for the insurer is to establish a basis for covering mitigation, in the absence of claims, that is tied to some objective standard, not simply paying out where the regulated firm considers it needs to make customers whole if something hasn’t gone as well as it hoped. It would be sensible to stay away from what the motivations of the firm may be in making payments and keep the cover tied to what would happen if a claim for legal liability were brought. Even that may be hard to establish. One option would be to tie the cover to matters where the financial services regulator has become involved – as this would indicate either the regulator or the firm was of the opinion there is a tangible issue potentially requiring redress.

 

This has been a fertile area for coverage litigation in the past and so the scope of this cover and the hurdles the firm is required to overcome to access it need to be carefully considered by both insurer and broker. For instance, above the excess the insurer’s consent will need to be sought, and the wording will need to address how the parties assess the probability of a legal liability if claims were brought, and the likely extent of any damage.

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There are good examples and bad examples of these clauses out there!

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[1] Rothschild v Collyear, 1999

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What is not covered?

Careful attention needs to be paid to the excess (or retention). In the earlier years of FIPI it was common for the excess to be small but would in effect apply to each claim made. Given how consumer claims in mis-selling are for relatively modest amounts, this could have the effect of the cover being rarely engaged even in systemic situations.

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These days it is more likely there will be a single but significant excess amount for all related claims. This will mean the insurers won’t be liable for anything until the value of all related claims has exceeded the excess point. From then onwards,100% of all related claims will be paid. This seems to me like a fair way to share the exposure given how financially damaging these scandals can be for everyone. I’ve often thought co-insurance (whereby the firm and insurer share the exposure on a quota share basis) would be an even more effective method but this view has never had any traction!

 

FIPI policy limits are aggregate, so once the limit’s gone, it’s gone.

 

Beyond that, some common exclusions to consider are as follows:

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1. Prior Matters – like other types of financial lines “claims made” policies there will be an exclusion for matters already known about and/or reported to a prior insurer. Check the “series” clause in the conditions to see how far this captures related claims in the current year.

2. Pure contractual liability – whilst there will almost always be a contract involved in the firm’s relationship with its customers, this exclusion should only take out contractual loss that goes beyond what would be recoverable in the absence of the contract. A guaranteed outcome might be an example of this. However, claims by customers for negligence should still be covered.

3. Repayment of fees and commissions – (sometimes referred to as “disgorgement”) amounts received by the firm in remuneration or commissions that a court or regulator finds it was not entitled to and are simply ordered to be repaid will usually not be covered, on the basis there is no actual loss. The exclusion is likely to be a focus in mis-selling claims involving commissions. In the motor finance scandal, the cost of the discretionary commission paid to the car dealer by the lender was ultimately passed on to the car buyer. However, where the amount of a commission paid somewhere in the transaction forms part of a claim for compensatory damages it may fall outside the exclusion.

4. Deliberate bad conduct by the senior management – in certain situations bad behaviour by the board of the firm will be imputed to the firm triggering this exclusion. However, bad conduct by employees will not – the firm is deemed to be a victim just as the customers who lost out are. So, the firm’s vicarious liability for a dishonest employee will be covered. As an aside, theft of customer deposits would not be covered under a FIPI policy, this does not create a liability and therefore is covered under an FI Crime policy instead. The two policies are frequently bought alongside each other. You can see an article I wrote about Crime insurance in 2023 here.

5. Pure regulatory proceedings – as mentioned above, regulatory claims are a fact of regulated life these days. Whilst coverage of regulatory claims brought by or on behalf of customers are likely to be covered, enforcement proceedings against the firm by regulators in relation to professional services may not be – or if they are, may carry a sub-limit. This aspect needs to be carefully considered.

6. Insolvency – you see some wildly varying insolvency exclusions. Careful attention needs to be paid to them to avoid unintended consequences. The general purpose of the exclusion should be to remove cover for claims caused by the firm’s insolvency. It stands to reason that the insolvency of a firm is a change in risk given many of the checks and balances that were applied to the provision of services previously may be materially compromised once the firm is on the slide.

7. Infrastructure / Cyber – this seeks to remove claims for service failure whose underlying cause was an issue with the wider infrastructure on which all firms depend eg an electricity or telecommunications failure, or a cyber outage. The purpose of the clause is to save insurers from systemic losses arising from the same incident affecting many regulated firms; a power cut in the City of London would be an example. However, this must be difficult to explain to the firm who failed in its delivery of a professional service in a way expected to be covered under the policy but cannot recover due to events beyond its control. One potential resolution of this tension that’s available in the market is for the exclusion not to apply where there was also negligence on the part of the regulated firm. As for the interaction between FIPI and Cyber – that’s a topic for another day!

8. Money Laundering – you can expect to see a money laundering exclusion added. This is to remove what has been a costly systemic issue for insurers in the past. The exclusion can take several different forms. One issue to consider is whether it is a blanket exclusion – so removing all cover based merely on an allegation, or is on a “final adjudication” basis (so defence costs are covered), or has carve-backs. These items are all part of the negotiation.

 

Some Key Conditions

It’s tempting just to focus on the front end of the policy where the cover is and not the boring stuff at the back. Unfortunately, this “stuff” can have a significant bearing on what happens when there are claims. It tends to become a lot less boring when it is going to determine whether there is any cover.

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Another feature of mis-selling scandals is they present challenges for everyone when it comes to obtaining insurers’ consent to settle. Every FIPI policy contains a consent to settle clause, and its exact terms will determine how the parties interact around settlement. A poorly drafted clause can be a very fertile area for disputes.

 

On the one hand, the firm may be under a lot of pressure from a regulator to make customers whole (whether or not there is a legal liability to do so). It may also be prevented by the regulator from saying very much to anyone (insurers included) about what the issue is.

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On the other hand, the insurer has a legitimate interest in making sure it isn’t paying for things that go beyond a potential legal liability or are not covered. It is unlikely to part with large sums of money without information. The wording can build in a pragmatic way through this to ensure everyone’s needs are met. Disputes clauses can also play a part – they can provide for an assessment process that avoids the parties ending up in court with another unwanted reported case!

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The future for FIPI?

FIPI has a part to play but is one of those covers where there have been challenges for the supply and demand to meet. The more firms want to buy it the more reticent the market is to provide it. Insurers have had their fingers severely burned on occasion. The key is getting the balance right.

 

We all want a sustainable market that can supply products like this to the firms that need it, but the limitations need to be clearly communicated to the buyers in well-constructed policy language: it will never be a solution to all issues that a regulated firm may have, such as picking up (for example) costs that are just part of doing regulated business. Conversely, if the limitations go too far and there is a suspicion of “illusory” cover, or if every claim is contested, the demand will slip away.

 

I talked earlier about the PPI scandal, a complex scenario which certainly played its part in demonstrating the challenges that arise for both parties to the insurance contract when the circumstances of a financial loss to the regulated firm have not been placed clearly in the contemplation of the cover provided, whether that is within the insuring clauses, definitions, or the exclusionary language.

 

A final word on addressing customer needs: offering or buying FIPI as part of a co-ordinated process (perhaps even a product) that also includes Crime and Cyber makes a lot of sense to me – as it takes a more holistic approach to regulated firms’ needs, removing the debate about which product should attach in any given scenario, but it also needs to be at the right price.

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