The FCA’s regulation of funeral plan providers: regulatory and insolvency issues

29 July 2022 marks the date when funeral plan providers and intermediaries will become subject to regulation by the FCA.

The Financial Services and Markets Act 2000 was amended in November 2020 and the FCA consulted on its plans for regulation during 2021 so providers have known for some time that regulation is on the horizon. Firms that do not intend to apply for authorisation are expected to wind down their business in relation to pre-paid funeral plans before 29 July 2022. After that date, providing pre-paid funeral plans without authorisation will be a criminal offence.

The FCA maintains a list of funeral plan firms on its website, where it publishes the status of firms: whether they have applied for authorisation, and if so what the status of their application is. Interestingly, the data shows that 7 firms did not apply for authorisation and 10 firms since withdrawn their applications (with 2 of those entering into insolvency proceedings). A number of other firms have planned to, or have already transferred their books to other providers.

For those firms going through the process of becoming regulated, we have summarised below some key changes which the new regulatory regime will entail and what providers should be aware of ahead of the new regulatory regime taking effect.

Updates to the FCA Handbook

The FCA states that by bringing the sector into its regulatory permitter, it aims to achieve good outcomes for customers, by ensuring that funeral plan products meet consumer needs and offer fair value. In-line with that principle, the FCA has produced its rules with the lens of ensuring that firms look after consumers' money and responsibly use that money to deliver funeral services.

As a result and in a similar vein to other regulated financial services providers, authorised funeral plan providers will be expected to adhere to the updated rules and guidance of the FCA Handbook, including the Principles for Business (“PRIN”), the Senior Management Arrangements, Systems and Controls sourcebook (“SYSC”), and the Product Intervention and Product Governance sourcebook (“PROD”). Also being amended in relation to funeral plan providers are the Dispute Resolution: Complaints sourcebook (“DISP”) and Compensation sourcebook (“COMP”) to grant customers the right to complain to the Financial Ombudsman Service and potentially receive compensation from the Financial Services Compensation Scheme (“FSCS”). Inserted into the Conduct of Business sourcebook (“COBS”) will be new conduct rules known as FPCOB; the Funeral Plan: Conduct of Business sourcebook.

Safeguarding

Many funeral plan providers already hold funds for pre-paid funeral plans on trust. The new rules introduce a number of requirements around safeguarding to ensure that consumers are protected in the event of a firm’s failure.

In particular, providers must either place monies received into a trust or apply them towards an insurance contract to meet pre-paid funeral plan contractual liabilities they have entered into. A properly constructed trust arrangement should safeguard monies paid for funeral plans until such time as these are required to be paid out, and should mean that such monies are not and do not become assets of the firm upon its insolvency. Similarly, a life insurance policy must be sufficient for the purpose of providing the agreed funeral as sold to consumers and must not terminate upon the failure of the regulated funeral plan provider. The effect of both safeguarding options is to provide a degree of protection for consumers by ensuring transfer of risk to either the trust or the insurer.

Where monies are held on trust, there are additional requirements to ensure that funeral plan trust arrangements are robust. This includes a new requirement on plan providers to arrange for a solvency assessment report to be produced at least once every 12 months by an actuary, which must be sent to the FCA within 7 days of completion and made available to consumers free of charge on request. If the report identifies a deficit in the trust to cover the liabilities, the provider must prepare and submit a remediation plan to the FCA and notify the FCA if they have not (or may not be able to) fully implement their remediation plan.

FPCOB sets out that trusts must be established by written instrument containing terms that will deliver certain objectives. Among them is that, in the event of insolvency of the funeral plan provider, an insolvency practitioner may claim against trust assets, in priority to all other claims against those assets, to meet their costs properly attributable to: (i) causing the provider to continue providing or arranging funerals under existing funeral plan contracts; (ii) effecting a transfer of those contracts to another authorised funeral plan provider; or (iii) making payments on the failure of the provider or if it is in default. See our further comments below regarding insolvency and trust assets. The written instrument should also set out that trustees are required to make payments on a transfer by the funeral plan provider, of all or part of its funeral plan business, to another provider or to the trustees of another trust set up by the other provider.

In addition, the trust must be compatible with the authorised provider’s obligations to have arrangements for continuity and reimbursement to customers, on its failure.

Authorised funeral plan providers will now be subject to the FCA’s Principle 3 which requires firms to take reasonable care to organise and control their affairs responsibly and effectively, with adequate risk management systems. Providers will need to ensure that plans offered to customers are appropriately priced to ensure trusts are adequately funded to cover the funeral plan agreed. This should factor in the risk of inflation and, if applicable, the volatility of trust assets.

The general solvency and core capital resources requirements

In addition to safeguarding, funeral plan providers will be subject to prudential standards that seek to ensure that each provider has adequate financial resources for contingencies, such as operational and compliance failures and to pay redress. The standards are also intended to reduce the risk of a shortfall in available funds for the delivery of funeral services in line with the consumer’s expectations.

Authorised providers will be subject to a general solvency requirement. This means that providers must, at all times, maintain overall financial resources (both capital and liquidity resources) which are adequate to meet liabilities as they fall due. The FCA expects firms to self-assess their general solvency requirement on a regular basis and may, as part of its supervisory function, set the amount or quality of capital or liquidity resources that it believes a firm must hold.

Plan providers must also hold a minimum level of capital resources that is proportionate to the size, risk profile and complexity of the firm’s business activities, which is intended to protect firms against costs from contingent risks such as future redress payments. Firms, other than funeral plan distributors, are subject to a capital floor of £20,000 or 2.5% of the firm’s annual income (whichever is higher) and the threshold may increase depending on the number of undrawn plans and the amount agreed for the delivery of the funeral purchased. For intermediaries, the core prudential resources requirement is the higher of £10,000 or 2.5% of the firm’s annual income.

Firm failure

The FCA considers that its ongoing supervision of firms, including at authorisation stage, will reduce the risk of firm failure. In the event that an authorised provider does fail, FPCOB requires that there must be arrangements in place to provide that there is a reasonable likelihood that another authorised provider can carry out the funeral plan contract. Where that is not possible, there is a duty on firms to maintain a good outcome for customers. A customer will also now have access to the FSCS to arrange continuity of the plan or appropriate compensation if the provider is declared ‘in default’ by the FSCS.

Providers will undoubtedly need to ensure that their funeral plan contracts are appropriately drafted to facilitate the transfer of plans to another authorised provider in the event of insolvency. Contracts should be drafted in such a way as to safeguard that those funeral plan contracts can be assigned to the new provider, with the same rights and obligations in place, and that there is no frustration of contract. They should set out what happens in the event of the authorised provider’s insolvency and include provisions around how the contract will be transferred, or the customer reimbursed. Contracts should not contain any terms that limit liability, which would serve to limit a customer’s claims upon insolvency, including via the FSCS.

Insolvency considerations

Whilst the FCA has set out clearly their expectations for regulation of funeral plan providers, insolvency practitioners appointed to a funeral plan provider are under separate statutory duties to ensure that the interests of creditors as a whole are protected. Insolvency practitioners are required to consider whether any particular course of action is in line with their duties and to consider what the benefit to creditors would be.

There may therefore be circumstances where there is a mis-alignment between the regulatory position and what an insolvency practitioner can and should do in any particular circumstance. In particular, an insolvency practitioner will not be bound to continue operating the business of the authorised provider. Indeed, it may be the position of the insolvency practitioner that all trading should cease immediately. Further, the insolvency practitioner will not be bound by the terms of a contract entered into by an authorised provider (unless they adopt the contract) and will therefore not be bound to comply with the pre-insolvency contractual terms.

In addition, in terms of any sale or assignment of the funeral provider’s interest, the insolvency practitioner would require to consider marketing the interests and to consider what offer represents the best offer taking into account the interests of the creditors. It is therefore not necessarily the case that a contractual provision providing for assignment to a specified party will automatically be applied in insolvency, or, that an insolvency practitioner will step in and operate the business of the authorised provider on insolvency. However, where there are trust arrangements in place, if the insolvency practitioner has access to the trust assets for the purposes of enabling certain strategies to be adopted, this may well inform strategy and provide more scope to adopt a particular course of action that may otherwise not have been adopted by the insolvency practitioner.

It remains to be seen exactly how the regulatory position and the insolvency legislation will fit together and no doubt each case will be reviewed on a case by case basis with there being clear communication between the regulator and the insolvency practitioner.

In terms of any claim which a customer may have, it is important to note that assets subject to a properly constituted trust would sit outside of an insolvent estate and therefore would not form part of the authorised provider’s assets for distribution to the wider creditors. Rather, the trust assets would remain held in trust for the relevant beneficiary or beneficiaries. From a regulator’s position they clearly wish for the trusts to be properly constituted to ensure protection of the trust assets from insolvency. What will be important in any particular situation is for the insolvency practitioner to assess whether or not the assets are indeed subject to appropriate trust arrangements. It will therefore be critical that there is clear evidence of the trust arrangements and any strict legal requirements to constitute the trust arrangements having been adhered to.

Burness Paull can advise on:

• Applying for authorisation or winding down/selling your book prior to 29 July 2022.
• If you are already regulated and now wanting to carry out activities in relation to pre-paid funeral plans, you may need to submit a variation of permission application.
• Adding new regulated activities to existing permissions or adding the investment type ‘funeral plan contract’ to the scope of existing permissions.
• Insolvency issues in a Scottish or English context.

If you’d like to discuss how these issues might affect your business, please get in touch.