Responding to a fundamental shift in regulatory expectations · 1 Conduct risk for insurersR...
Transcript of Responding to a fundamental shift in regulatory expectations · 1 Conduct risk for insurersR...
1 Conduct risk for insurers: Responding to a fundamental shift in regulatory expectations
contentsContents3 Welcome
5 Executive Summary
7 1. The conduct era: more than just a risk type
8 2. Insurer perspectives and industry reaction
15 3. Moving beyond TCF
22 4. The response
30 5. The insurance industry working together
31 6. Conclusion
32 Appendix: List of participating firms
33 Who to contact
2 Conduct risk for insurers: Responding to a fundamental shift in regulatory expectations
This is a joint report from Oliver Wyman and the Chartered Insurance Institute.
AcknowledgementsTheauthorswouldliketothanktheCIIforitssupportandinputtothisreport.Theyare
alsogratefultonumerousindustryparticipantsfortheirtimeandthethoughtfulnessof
theircontributions.
3 Conduct risk for insurers: Responding to a fundamental shift in regulatory expectations
Message from Oliver Wyman
We interviewed twenty two CEOs and senior executives from across the UK insurance industry to understand their views on, and response to, the FCA’s Conduct Risk agenda. Participants covered a broad representation of the industry, including life insurers, general insurers, health insurers and composites.
Thisreportpresentsourfindingsfromtheresearchandoutlinestheactionswebelieveinsurersneedto
takeinordertorespondtotheFCA’smainareasofconcern.
Wehopethatyoufindthereportusefulforunderstandingtheimplicationsforinsurersofamoreopen,
transparentandaccountablemarket,andinconsideringyourapproachtomanagingConductRisk.
Sean McGuire Tim Kirk
Partner,OliverWyman Partner,OliverWyman
Richard Thornton James Bryan
Partner,OliverWyman Partner,OliverWyman
welcom
e
4
welcom
eMessage from the CII
Dr Sandy Scott
ChiefExecutive,CII
There is no doubt that both the Prudential Regulation Authority and the Financial Conduct Authority have put conduct, culture and public interest at the very heart of their approach following their formation back in April this year.
AsthelargestprofessionalbodyintheUKfinancialservicessector,theCharteredInsuranceInstitute
welcomesthisfocusonimprovingthecultureofthewholefinancialservicessectorandwebelievethat
howprofessionalsbehaveisasimportantaswhattheyknow.WeattheCIIhaveactivelypromoted
higherprofessionalstandardsacrossourmembershipandinitiativesincludingtheAldermanbury
DeclarationandCorporateCharteredInsurersandBrokersareexamplesofourdesirefortheinsurance
sectortoattempttomakeitsownweatherratherthanrelyonmeetingacompliancerequirementculture.
Asabodythatchampionshigherstandardswebelieveitisrightforustoofferchallengetoour
professionandtheinsurancesectoratlargeonconductissuesparticularlyontopicswherethepublic
andregulatoraredemandingmore.
Thisreport,producedbyOliverWyman,isdesignedtohelpraisethelevelofdebateonthekeyconduct
issuesemergingacrosstheinsurancesector,andwhilsttherewillbearangeofresponsestothe
analysisandrecommendations,itdoescapturethecurrentthinkingofleadingpractitionersoninsurance
conductrisk.Itshouldalsoactasastimulusforfuturethinkingandactionacrosstheinsurancesectors–
aswellassupportingthedialoguewithournewregulators.
Wehopeyoufindthisreportagoodstartingpointforadebatetheprofessionneedstohavewithinitself,
withtheregulatorsandultimatelypartofalargerconversationwiththewiderpublic.Letushopeitwill
leadtoabetterdialogueandultimatelybettersolutionstomeetthepublicinterest.
Conduct risk for insurers: Respondingtoafundamentalshiftinregulatoryexpectations
5 Conduct risk for insurers: Responding to a fundamental shift in regulatory expectations
Executive summaryMartinWheatley,ChiefExecutiveoftheFinancialConductAuthority(FCA),promisedattheABI’s2013
BiennialConferencethattheFCAwouldbe:“averydifferentanimaltotheFinancialServicesAuthority
(FSA).”Hesetoutapositivevisionofasuccessfulandcompetitivemarketwhereregulationisnotazero-
sumgame,andwherecustomersandthebestfirmscanbenefitfrommorecompetition,betterproducts
andbetterservice.
Initsfirstmonthsofexistence,theFCAhasundoubtedlybeenactive,withmarketstudiesandthematic
reviewsofinsuranceproductsandoperations.Andthereisnodoubtthatthereissomeanxietyamongst
insurersinrelationbothtotheworkloadcausedbythesereviews,andalsototheirpotentialimpact
onexistingwaysofdoingbusiness.However,itisalsotheFCA’sintentionthatthematicreviewsdo
notsimplyadduptoasuccessionofbadnewsstories;goodpracticeandimprovementshouldalsobe
recognisedandhighlighted.
InordertounderstandtheviewsoftheUKinsuranceindustrytowardsConductRiskmoreclearly,we
interviewed22CEOsandotherseniorinsuranceexecutives.Theseinterviewsprovedtobeinformative,
andexhibitedabroadrangeofviews.Insummary,wefoundthat:
• ThereisamismatchofexpectationsbetweeninsurersandtheFCA
• Therehasbeenaninconsistentresponsefrominsurersinbothpaceandcontent
• Therearefourkeyemergingissueswhichwillbeparticularlychallengingtoaddress.
“ a very different animal to the Financial Services Authority (FSA)
”
executive summ
ary
6 Conduct risk for insurers: Responding to a fundamental shift in regulatory expectations
Mismatch in expectationsOurinterviewsrevealedthat,forsomefirmsatleast,ashifttoamoretransparentandcompetitive
marketisregardedaspositive.However,ingeneralwefoundamismatchinexpectationsbetween
insurersandtheFCAinthreekeyareas:
1. Theroleoftheregulator,andlevelofregulatoryintervention,requiredtoaddressdeficiencies
inthemarket.
2. Thepracticalimplicationsofthenewregulatoryregimeforfirms,andtheextentofchange
requiredtocomply.
3. Thelevelofpreparednessandprogressbyinsurersinadaptingtothenewregime.
Emerging issuesAsweconsiderthespeedanddirectionofthejourneytowardsamuchmoreopen,transparentand
accountablemarket,weseefouremergingtrendsthatmaybecomeparticularlychallengingforinsurers:
1. Afocusongoodcustomeroutcomes,ratherthanonactionstakenbyregulatedentitiesto
influencethoseoutcomes.Followingtherulesisnotenough.
2. Definingandprovingthevalueformoneyofproducts.Bothpriceandvalueneedto
standuptointensepublicscrutiny.
3. Pressuretoensuregreaterequality.Thiswouldinvolvemanagingthetrade-offbetween
individualunderwritingandpoolingofriskstoensureuniversalaccesstoinsurance,andreducing
discriminationbetweengroupsortypesofcustomers.
4. Settingtheboundariesfortheuseandmanagementofcustomerdatatoensurethattechnological
progressdoesnotoutstripregulators’andcustomers’appetiteforintrusion.
Insurer responsesInordertorespond,wethinkthatinsurersshouldcarryoutthefollowingfivesteps:
1. Definetheirconductriskappetiteandobtainseniorstakeholderbuy-in.
2. Performaconductriskdiagnostictoidentifychangesrequired.
3. Strengthentools,processesandcontrols.
4. Realigntheirbusinessmodelwithgoodcustomeroutcomes.
5. Reinforcethroughleadershipactions,culture,trainingandincentives.
executive summ
ary
7
1. the conduct era: more than just a risk type
1. The conduct era: more than just a risk type
Consumerprotectionregulationisnotnewtothefinancialservicesindustry,andfewwouldargue
againstsomeformofregulationbeingbeneficialtobothconsumersandfirms.However,weconsider
thattheconductriskagendabeingpursuedbytheFinancialConductAuthority(FCA)representsa
majorchangeinexpectations,andismuchmorethanjustanewversionoftheTreatingCustomers
Fairly(TCF)principles.
Despitesignificantprogressandpositiveintentionsbymanyfirms,acontinuationofincidentsrelatedto
conductriskpointtowardsdeficienciesinthewaythefinancialservicesmarketoperatesandintheway
somefirmsmanagetheirproductsandcustomerrelationships.Theseinclude:
• Targetcustomermarketsandproductvaluepropositionscanbepoorlydefined,preventingfirms
frommonitoringgoodcustomeroutcomeseffectively.
• Thesuitabilityofindividualcustomersdoesnotalwaysreceivesufficientattention,asprocesses
tomatchproductsandclientsmaylackrigourandareinsufficientlysupportedbyevidence.
• Productcomplexityandbundlingremaincommon,makingitharderforcustomerstomake
decisionsintheirownbestinterestswithoutdetailed,structuredadvice.
• Toolsandinfrastructureareunderdeveloped.Withconductriskregulationmovingtheindustry
evenfurtherawayfromasimplecaveatemptorregime,evidenceofdueprocesswhichsucceeds
indeliveringgoodcustomeroutcomesisparamount.
• Employeeincentivesarenotalwaysalignedwithprovidingappropriatecustomersolutions.
Givenmulti-billionpoundtaxpayerbailoutsandsignificantpoliticalpressure,thesedeficienciesareno
longerbeingtolerated.RegulatorsinkeymarketssuchastheUS(ConsumerFinancialProtectionBureau
(CFPB))andtheUK(FCA)areconcentratingtheirconductoversightindedicatedteamsorseparate
agencies,whileenactingsweepingregulationthatcoversbothabroadarrayofconduct-relatedissues
andanewmodelforsupervision.
IntheUK,theFCAisheavilyfocusedonensuringthatcustomerinterestsareembeddedthroughout
allareasoffirms,andthatallcustomersexperiencegood–ifnotthebest–outcomes.Thisisamatter
ofstrategyandcultureformanagement,muchmorethansimplyanissueofprocessandcontrol.
Yetwestillseethattoomanyfirmsarepreoccupiedwiththedefensivecontrolsrequiredtomanage
theregulatoryrisk(ratherthancustomerdetriment),andwithseekingtocomplywiththenarrowest
interpretationoftherules.
TheFCAispresentingmuchmorethananewrisktype.Boardsandexecutiveteamsmustgraspthe
scopeandextentoftheregulator’sagenda,andthesocialandpoliticalexpectationsthatdriveit.If
theydonot,theyruntheriskofmissingthestrategicimplications,andthepotentialforsignificant
disruptionsinthemarket,astheFCA’sinterventionsstarttochangethenatureofcompetition,andnew
businessmodelsevolve.
Conduct risk for insurers: Respondingtoafundamentalshiftinregulatoryexpectations
8 Conduct risk for insurers: Responding to a fundamental shift in regulatory expectations
2. insurer perspectives and industry reaction2. Insurer perspectives and industry reaction
TherequirementtoTreatCustomersFairly(TCF)wasenshrinedintheFSA’soriginalPrinciplesfor
Businesswithwhichallfirmswererequiredtocomply.Overtheyears,theconceptoftreatingcustomers
fairlywasenhancedandcodifiedbytheFSA,culminatinginfirmsbeingrequiredtodemonstrate
evidencethattheyhadembedded“fairness”before31stDecember2008.
Afteraslowstart,managementteamsinvestedheavilyinrespondingtotheregulator’sagenda.
However,lookingbackoverthepastdecade,twothingsareclear:
1. Theregulator’sexpectationshavecontinuouslyevolvedandincreased,leadingtonewareasof
regulatoryfocusandintervention.
2. Ateachstage,whileprogresshasindeedbeenmade,theindustry’sresponsehaslaggedbehindthe
regulator’sexpectations.
FollowingthecreationoftheFCAinApril2013,weareseeinganewwaveofconductscrutiny.While
thesixconsumeroutcomesexplainingwhattheFSAwantedTCFtoachieveforconsumersarestill
applicable,weviewtheFCAagendaasbeingsubstantiallymorethansimplyafewtweakstotheTCF
regime.
TheFCAhasannounceditsintenttomovetoanewandmorefocusedsupervisorymodel.
Thisentails:
•Movingfromareactiveapproachtoapre-emptiveandjudgement-basedapproach.
•Movingfromdealingwithsymptomstoaddressingunderlyingcauses.
•Movingfromanapproachfocusedonlyonensuringcompliancewithrules,toanapproachthat
encouragesfirmstodotherightthinginrespectoftheircustomersandthemarketstheyoperatein.
Againstthisbackground,theoverwhelmingconclusionfromoursurveyisthatthereisasignificant
mismatchbetweenFCAexpectationsandtheviewsofmanyinsurerswithregardto:
1. Theroleoftheregulator,andthelevelofregulatoryinterventionrequiredtoaddressanydeficiencies
inthemarket.
2. Thepracticalimplicationsofthenewregulatoryregimeforfirms,andtheextentofthechanges
requiredtocomply.
3. Thelevelofpreparednessandprogressmadebyfirmsinadaptingtothenewregime.
Theseissuesareexploredonthefollowingpages.
“ The FCA will continue to focus on how firms are managed and structured so that every decision they make is in the best interests of their customers
”FCARiskOutlook2013
“ Our approach to risk will enable us to become more proactive and intervene earlier, focusing on the sources of detriment such as product design, governance and incentives
”MartinWheatley,FCA,ChiefExecutive
9 Conduct risk for insurers: Responding to a fundamental shift in regulatory expectations
2.1. The role of the regulator
UptotheendofNovember2013,theFCAhaspublisheditsfindingsfromseventhematicreviewswhich
affectinsurers.
Someinsurersarguethatthisistoomuch,toosoonfromtheFCA,andthatincreasedregulationmay
resultinalossofinnovation,greaterfinancialexclusionandcustomerdetriment.Asevidence,they
pointtotheimpactoftheRetailDistributionReviewprogramme(RDR)andtheresultinglossofaccess
tofinancialadviceforlowandmiddleincomeearners.Somearguethatastheregulatoryburdenrisesin
otherareasofinsurance(suchasgeneralinsuranceproducts)wewillseeasimilarimpact.
TheFCA’sobjectivesoncompetitionandvalueformoneyrepresentamajorareaofconcernformany
insurers.SomeworrythattheFCAmaypotentiallytrytobecomeapriceregulator,andarguestrongly
thatthisisunlikelytoimprovemarketefficiencyorleadtobettercustomeroutcomes.
TheFCAhaspreviouslymadeitsstanceclearinthisregardbysayingexplicitlythatitdoesnotwantto
becomea de jurepriceregulatorofinsuranceproducts.
However,recentUKGovernmentproposalssuggestingthattheFCAshouldsetacaponthecostof
paydayloanshavethepotentialtochangethelandscape.TheFCAhasgenuineconcernsoverthe
valueformoneyofferedbysomeproductsonthemarket.Mobilephoneinsuranceandlegalexpenses
insurancehavecomeunderthespotlight,andpressureismountingontheannuitiesarea.
AstheFCAtakesactiontoimprovecompetition(whichwebelievewillmeanmuchmoretransparencyin
howproductsperformforcustomers)andvalueformoney,thereisariskofde factopriceregulationof
insuranceproductsasjudgementsaboutproductdesignandvalueplayagreaterroleintheregulator’s
supervisionoffirms.Wealsoenvisagemoredirectpoliticalpressuretoregulatepricingin
theinsurancesector.
WhiletheFCA’sconductriskmanagementapproachhasbeendistilledintoasetofforward-looking
priorities,clarityisstillrequiredinsomeareas.Forexample,howisvalueformoneytobedefined?
Whatpreciselyaretheresponsibilitiesofinsurersanddistributorsinensuringgoodcustomeroutcomes?
Whiletheregulatormayprovidefurtherguidanceinsomeareas,thisisunlikelytobedetailedor
prescriptive.Itwillbeuptoeachinsurertosetoutwhat“goodconduct”meansfortheirbusiness.
Webelievethisprocessneedstostartwithdebateattheverytopoftheorganisationabouthow
itwishestocompeteinthemarketplace,andtherelationshipitwantstohavewithitscustomers,
distributorsandtheregulator.
“ Conduct risk should be a “top 3” issue for all UK insurers
”CEO,UKLifeInsurer
“ The current situation of “pseudo regulation of price” is very confusing for consumers and firms generally
”CEO,UKGeneralInsurer
2. insurer perspectives and industry reaction
10 Conduct risk for insurers: Responding to a fundamental shift in regulatory expectations
2. insurer perspectives and industry reaction
“ Important that regulation does not become a barrier to entry into markets and that it does not cause firms to withdraw from markets, reducing competition and customer choice.
”CEO,GeneralInsurer
2.2. Practical implications and extent of changes required
Inadditiontodifferingviewsontheextentofregulationandinterventionrequired,webelievethereisa
disparitybetweentheFCAandmanyinsurersonthepracticalimplicationsofthenewconductagenda,
andontheextentofthechangesthataregoingtoberequired.Manyinsurersviewthechangestobe
relativelyminoradjustmentstotheirexistingbusinessandoperatingmodels.
IfwecomparetheresultsofourUKinsurersurveytoasimilarsurveyweconductedwithUKretailbanks,
weseethatthebanksaremuchmorealerttotheneedforchangeandtotheextentofchangesrequired.
Insurancecompanyexecutivesarekeentopointoutthatthebanksareverydifferenttoinsurers,and
thatconductriskisthereforelessofanissueforinsurers’customersthanitisforbanks’customers.
Whileweagreethatinsurersareverydifferenttobanks,wedonotbelievethatinsurersaregoingto
getofflightly.Indeed,manyexecutiveswespeaktoareabletopointoutwherecurrentproducts,orthe
market,donotperformwellforconsumers.Wethereforeexpectsignificantchangestoinsurerbusiness
andoperatingmodelswillberequired,albeitwithdifferentareasoffocusfromthebanks.
OneofoursurveyquestionsaskedinsuranceCEOswheretheythinkthemostsignificantimpactwillbe
feltacrosstheoverallinsuranceindustry.Thetopthreeareashighlightedwere:
1. Productofferingsanddesign
2. Incentivestructures(atpointofsale)
3. Organisationalculture.
“ The main difference is that insurers have long recognised a duty of care to policyholders that does not seem to have a cultural equivalent in banking.
”CEO,UKLifeInsurer
11 Conduct risk for insurers: Responding to a fundamental shift in regulatory expectations
Figure 1. FCA and conduct impact on insurance industry – responses from survey recipients
Onproduct offerings and design,manyinsurershaverecognisedtheneedtoreviewtheirexisting
businessandplannedproductlaunchestoidentifypotentialhighriskproductsfromaconduct
perspective(thosethatposemostriskofcustomerdetriment),andthentaketheappropriateaction.
Suchreviewsareexpectedtoresultinchangestoproductdesign(suchastermsandconditionsand
policyexclusions),salesandtargeting,supportprocesses(suchasclaimsmanagement),
andgovernance.Insomecases,thereviewislikelytoleadtothewithdrawalofproducts,eitherthrough
thefirm’schoice,orwiththeactiveencouragementoftheFCA.Wehavealreadywitnessedsignificant
changesinthebankingsector,andarestartingtoseemoresignsofthisininsurancetoo.Inmostcases,
wefeelinsuranceproductscouldbeadapted,andwithdrawalwillbeunnecessary.
InsurersbelievethatIncentive Structureswillalsobeaffected,butthatanychangeswillbemainly
limitedtofront-linesalesstaff.Insurerswillneedtotrytoachieveabalancebetweenmeetingsales
targetswhilealsoensuringgoodcustomeroutcomes.Wehavealreadystartedtoseethisinpractice,
withseveralinsurersremovingsalesvolumecommissionsfortheirfront-linesalesstaff,andinstead
givingcreditforqualityofcustomerserviceandforensuringthatcustomers’needsaremet.
Weagreethatfront-linesalesincentivestructureswillneedtobereviewedandalignedwithgood
customeroutcomes,althoughwedonotconsiderthatremunerationstructuresthatincludecommission
areinappropriateperse.However,theywillneedstrongcontrolsanddifferentstructures,suchasthe
removalofcommissionpaymentsifqualitytargetsarenotachieved.
Wethinkthatconduct(andcustomer-focusedperformance,moregenerally)couldalsoplayamuch
strongerroleinthedeterminationofexecutivebonuses.Forexample,whiledeferralofbonusesisnow
mandatoryinbanks,wenotethatitisnotyetcommonpracticeforinsurers.Thiscouldleaveinsurers
exposedtothepossibilitythatstaffchaseshort-termprofitswithouttakingintoaccounttheriskof
subsequentcostsinregulatoryfinesorcompensation.
Amongtheexecutivesweinterviewed,organisational culturewasconsideredtobethethirdmost
significantareaforchange.Thistallieswithourownexperiencethatcultureandleadershiphavenot
yetreceivedsufficientattentionfromfirmsseekingtomeettheexpectationsofconsumersandthe
regulator.
Insurersneedtosetoutatonefromthetopthatmovesbeyondbroadcorporateaspirations,and
isbroughttolifethroughleadershipactions,decisionmaking,businesspracticesandstandards,
recruitment,rewardsandclearcommunicationtostaffaboutwhatconstitutesacceptableand
unacceptablebehaviour.Aboveall,thetonearticulatedbyleaderstotherestoftheorganisation
needstobeseenasauthentictostaff(aswellastocustomersandtheregulator)andhastobeapplied
rigorously,ortheunwrittengroundrulesthatexistintoday’smarketwillpersist.
TheFCAarticulatedthisconceptinadifferentway,askingcompaniestoconsider“shouldwe”carryout
acertainactivityorbehaveinacertainway,aswellas“couldwe”.
Least significant change Most significant change
Distributionmodels
Governance&controls
Organisationalculture
Incentivestructure
Productofferings/design
Organisationdesign
2. insurer perspectives and industry reaction
12 Conduct risk for insurers: Responding to a fundamental shift in regulatory expectations
2. insurer perspectives and industry reaction2.3. Level of preparedness and progress in
adapting to the new regime
Inouropinion,theregulatorwillexpectfirmstore-examineand,ifrequired,realigntheirbusinessand
operatingmodels,includingstrategy,systemsandcontrols,skillsets,cultureandincentives.TheFCA
haspubliclystatedthatfromtheboardrightthroughtofrontlinesalesstaff,firmbehaviour,attitudes
andmotivationsmustchangetoembracegoodconductandensurethatcustomerexperiencesand
outcomesmeetexpectations.
Whilesomeinsurersarestartingtotakeaction,webelievethattheinsuranceindustryasawholeisstill
somewayfromdefiningandembeddingasetofcommongoodconductpractices.Inourexperience,
manyinsurersdonotyethaveaclearviewonwhatgoodconductlookslikefortheirorganisation.Even
incaseswheretheydo,insurerssometimesfacecommercialchallengesinachievingrelevantgoals,and
feelthattheycannotmoveforwardbythemselvesinsomeareas.Forexample,pricingnewandexisting
motorinsurancecustomersatthesameprofitmarginwouldresultinmassivefirstmoverdisadvantage.
Althoughthevastmajorityofinsurershavealreadycommencedpreparationsforthenewregulatory
environment,manystilldonotyetrecognisethelarge-scalechangesrequiredtomeettheFCAagenda
onconductrisk.Oursurveysuggeststhatveryfewinsurerscurrentlyhaveinplacesuchacomprehensive
approachtoconduct.Fewhaveintroduceddedicatedconductriskprogrammesorteamstodevelop
robustprocessesforidentifying,monitoringandmanagingconductrisk.Thisisincontrasttotheir
bankingcounterparts,whichhaveinvestedheavilyinaligningtheirbusinessmodelsanddemonstrating
evidenceofgoodcustomeroutcomes.
Weaskedinsurerswheretheyfelttheir companycurrentlyhadgoodconductriskcapabilities,and
wheretheyneededtodothemostworkoverthecomingmonths.Figure2,below,summarisesthe
answerstothisquestion.
Figure 2. Assessment of current conduct risk capabilities vs. priority area of focus for the next
12 months – responses from survey participants
Averagecurrentconductriskcapabilities
Aver
age
prio
rity
are
aof
focu
sov
ern
ext1
2m
onth
s
Veryhigh
High
Med
LowNot
developedInitiativestarted
Partiallycomplete,notyetembedded
Fullyembedded
Largely under control
• Board and Executive MI
• Conduct risk mangement strategy
• Risk appetite statements
Fair value exchange • • Evidence of customer
suitability
Ability to identify risks •• Seller incentives
• Conduct risk definition
Complaints handling •
Executive compensation •
Product development process •
Key areas of focus
13 Conduct risk for insurers: Responding to a fundamental shift in regulatory expectations
Accordingtotheinsurerswespoketo,thefollowingareaswerethoughttobebroadlyundercontroland
requiringlimitedadditionalfocus:
•Executivecompensation
•Complaintshandling
•Definitionofconductrisk
• Abilitytoidentifyconductrisks
• Sellerincentives.
PerhapssurprisinglygivenwhatweseeandhearfromtheFCA,almostallinsurersinoursurveyfeltthat
conductriskmanagementwasalmostfullyembeddedinexecutive compensation,andthatthisareadid
notrequireanyadditionalfocus.TheFCAisveryclearthatgoodconductstartswiththe“tonefromthe
top”.Indeed,experienceteachesusthatoneofthemosteffectivetoolsforincreasingexecutivefocuson
aparticularareaistoalignincentiveswiththatgoal.Insurersshouldthinkcarefullyabouthowconduct
influencesexecutivecompensation,ensuringthatexecutivesarerewardedforgoodconductwhilealso
introducingothermeasures,suchastheabilitytoclawbackbonusesinfutureyearsforpoorconduct.
Complaints handlingwasanotherareawhereinsurersfeltcomfortablethattheywerebroadlywhere
theyneededtobe,andthatlittlefurtherattentionwasrequired.Twokeyreasonsexplainthisfinding.
Firstly,insurershavealreadyplacedastrongfocusonthisareaforanumberofyearsundertheTCF
regime.Secondly,complaintsandcomplaintshandlingperformanceistypicallytrackedasaKey
PerformanceIndicator.Whilesomefirms’complaintshandlingprocessesmaynotneedtobeoverhauled
(althoughFinancialOmbudsmanService(FOS)upholdratesindicatethatissuesremaininsomeareas),
insurerscouldreassesswhethertheircomplaintsfeedbackprocessesareeffective.Complaintscanbea
greatearlywarningindicatorofpotentialfutureconductrisks.Oursenseisthatmanyinsurersdonotdo
asmuchastheycouldtounderstandtherootcausesofcomplaintsandremedythem.
Onthedefinition of conduct risksandtheability to identify conduct risks,mostinsurersfeelthey
haveagoodunderstandingofwhatconductriskis,andhavecarriedoutsomeworktosingleoutwhat
theybelievetobetheirmostmaterialconductrisks.However,inourview,theinterpretationandfocus
ofconductriskisevolving.Aswediscussinthefollowingchapter,webelievethatfourareaswillbe
prioritisedinthenextwaveofconductrisk.Fromourresearch,manyinsurersareatpresentpoorly
preparedtorespondtothesefutureareasoffocus,andhavenotadequatelythoughtthroughwherethey
standoneachissue.
Insurersrecognisethatseller incentivesrequirecarefulrealignmentwithgoodcustomeroutcomes,
althoughmostfeelthattheirfirmhasalreadytackledthisissue.Someinsurersareremoving,orhave
removed,incentivesforsalesvolumeorvaluefromthefrontline.Thiscontrastswiththeindustry-wide
viewdepictedinfigure1whichindicatesthatexecutivesconsiderincentivestobeanareathatwill
requiremajorchange.
2. insurer perspectives and industry reaction
14 Conduct risk for insurers: Responding to a fundamental shift in regulatory expectations
2. insurer perspectives and industry reactionInsurersidentifiedthefollowingareasasthoserequiringmostatttentiontoaddressandembedfully:
• Developingboard and executive managementinformationspecifictoconductrisk.
• Developaholisticconduct risk managementstrategyandapproach.
• Updaterisk appetite statementstoincludemoreofaconductriskfocus,includingthedevelopmentof
conductriskappetitestatementsandappropriateintegrationwithexistingriskappetite.
• Demonstratea‘fair value exchange’betweentheinsurerandthepolicyholder(webelievethatthis
needstobeahigherprioritythanourresearchindicatesitcurrentlyis).
• Demonstrateevidence of customer suitabilityandunderstanding(althoughsomeparticipantsdidnot
believethiswasapplicabletotheirbusiness).
Almostallinsurersstatedthattheyneedtodomoreworktoimprovethereportingofconduct-related
measuresinboard and executive management information.Weagreethatmanagementinformation
doeshelpinhighlightingwheretheremaybeconduct-relatedissues.However,itisjustonepartofthe
solution.Conductmanagementinformationcanassistinidentifyingwheretherearealreadyconduct
issues,butcanalsobeforward-looking,helpingtoidentifywherepotentialconductissuesmayemerge
inthefuture.
Conduct risk management strategyincludesdefiningwhatconductriskisfortheinsurer,andtheir
overallapproachtomanagingconductrisk.Mostinsurersthinkofconductriskasbeingembeddedin
everythingtheydoasabusiness,cuttingacrossalldepartmentsandprocesses.Assuch,itislessabout
havingasinglestrategyonhowtomanageconductrisk,butmoreaboutembeddinggoodconductin
thepolicies,processes,businesspracticesandculturerightacrosstheorganisation.Giventheall-
encompassingnatureofconductriskmanagement,thisisanareawheremanyfeeltheyhavesomework
todo.
15 Conduct risk for insurers: Responding to a fundamental shift in regulatory expectations
3. moving beyond TCF
3. Moving beyond TCF
ImportantdifferenceshavealreadyemergedbetweentheFCA’scurrentagendaandexpectations
andthoseundertheFSA’sTCFregime.Whenweconsidertheoveralldirectioninwhichthemarket
andregulationaremoving,weseethefuturetobecharacterisedbysignificantlymoreopenness,
transparencyandaccountability.Thiscreatesfouremergingissuesthatmaybecomeparticularly
challengingforinsurers.Theseare:
1. Followingtherulesisnotenough.Therewillbeamuchgreaterfocusoncustomersgettinggood
outcomes,ratherthanontheactionstakenbyregulatedentitiestoinfluencethoseoutcomes.
2. Ultra-transparencymeansthatallproductsandserviceswillneedtostanduptogreaterpublic
scrutinytoprovethattheyoffer value for money.
3. Therewillbemorepressuretobalancecommercialdecisionswithsatisfyingdemandsfor
equalityofaccesstoinsuranceandfortheremovalofdiscriminationinpricing.
4. Companieswillneedtoensurethatthepotentialadvantagesfromrapidadvancesintechnologyand
BigDataarenotjeopardisedbytheinappropriateuseandmanagementofcustomer data
andinformation.
3.1. A focus on customer outcomes
TheFCAhassaidveryclearlythatanimportantelementof“goodcustomeroutcomes”isthatproducts
shouldbesuitablefortherelevantcustomers,whoshouldinturnunderstandwhattheyhavebought.
Whilenoinsurerislikelytodisputethatthisistherightaim,thekeydebatenowconcernshowfaran
individualinsurerneedstogotoensurethatthegoalisrealised.Thereareanumberofinteresting
questionsrelatingtothistheme:
•Whataretheinsurers’responsibilitiesinensuringthatitscustomersunderstandtheproductstheyare
buying,andthattheseproductsaresuitable?
•Atwhatpointdoesthecustomerhavetotakeresponsibilityforensuringthattheyunderstandthe
products,andthattheproductsaresuitable?
•Whataretheinsurer’sresponsibilitieswhentheproductisbeingsoldbyathird-partydistributor,and
towhatextentdoestheinsurerneedtoensurethatdistributorsarealsodemonstratinggoodconduct
andachievinggoodcustomeroutcomes?
•Towhatextentdoinsurershaveadutytoensuregoodconductwithregardtocompetitors’customers
(suchasontheissueofreferralfees)?
Manyinsurerswillalreadytestcustomercommunicationstoensurethattheyareunderstandableforthe
targetaudience,butistherearesponsibilitytocheckthatthecommunicationisbeingread,andthatitis
beingusedtomakeareasonabledecision?
16 Conduct risk for insurers: Responding to a fundamental shift in regulatory expectations
Howmanycustomerscanbeobservednotmakingalogicaldecision,suchasbuyinganannuitypriced
significantlyhigherthanleadingmarketrates,orcontinuingtoautomaticallyrenewhomeinsurance
eventhoughthepremiumiswellabovewhatcouldbeobtainedelsewhere,beforeaninsurershouldtake
someaction?Andwhatshouldthisactionbe?
Wecannotstatewhattherightactionwillbe–itwillvarybyspecificproduct,channelandcustomer–
butitwillbecomeincreasinglyunacceptableforinsurerstoobservepoorcustomeroutcomesandtake
noaction,particularlywhenthisoccurssystematically.
Thequestionofinsurerresponsibilityfortheconductofdistributorshasbeenonthetableforalong
time,andinsurerviewsinoursurveyrangedfrom“It’snotourjobtoregulatetheIFAsandbanks”,
throughto“It’sabsolutelyourresponsibilitytoensurethatourdistributorshavethesameconduct
standardsaswedo–ultimatelyit’sourbrandthatisatriskifcustomersreceivepooroutcomes.”
Wehaveseenexamplesofprovidersbeingmoremuchproactiveinmonitoringdistributors.Significantly
forinsurers,wearealsoseeingdistributorsbeingmuchmoreactiveinsettingandmonitoringconduct
standardstheyexpectfrominsuranceproductproviders.
Webelievethatinsurerswillincreasinglybeexpectedtomonitor,andbeaccountablefor,distributors’
goodcustomeroutcomes.Iftheinsurer,asproductprovider,isawarethatmanycustomersarenot
receivinggoodoutcomes,theywillbeexpectedtotakeaction.Iftheyarenotawareofawidespread
failingbyadistributor,theywillbeaskedwhytheydidnotdomoretocheckthatgoodcustomer
outcomeswerebeingachieved.
Thesamefocusonoutcomeswillapplytoanysituationwheretheinsurerusesdelegatedauthoritiesor
outsourcedserviceproviders.AsCliveAdamson,DirectorofSupervisionattheFCAputitinaspeechto
theInsuranceInstituteofLondoninNovember2013,“whereinsurersareoutsourcingservicestoother
companiesactingontheirbehalf,theyremainresponsiblefortheactionsoftheiragents.”
Inaworldfocusedonoutcomes,adefencethat“wedidnothingwrongbecausewefollowedtherules”
willbeoflittleconsequenceiftheoutcomeforcustomerswaspalpablypoor.
Levels of responsibility for insurers to ensure customers get positive outcomes:
Rising expectations but no clear bar
Information for customer is...
Correct
Understandable
Accessible
Read
Understood
Usedtomakealogicaldecision
3. moving beyond TCF
17 Conduct risk for insurers: Responding to a fundamental shift in regulatory expectations
3. moving beyond TCF
3.2. Value for money
Thiswasoneofthemostkeenlydebatedtopicsinourinterviews.Therewasageneralconsensusthat
productsshouldbefairlypricedandoffervalueformoney.However,wealsosawthelesscommon
opinionthatifpriceandtermsandconditionsarefullyexplained,anypriceormarginisacceptable.
Accordingtothisview,itisuptothecustomertodecideforthemselveswhatrepresentsvaluefor
money.Forexample,apricepremiumcouldbejustifiedbythetimesavedinnotshoppingaround,orby
thepeaceofmindobtainedthroughbuyingfromaknownbrand.
Whenweexploredhowvalueformoneycouldbeassessed,therewasmuchlessclarityandno
agreementaboutwhetherhighpricesormarginsnecessarilymeanthatthecustomerhasgotpoorvalue
formoney.
Inourview,thevalueformoneyissueisgoingtobecomeincreasinglyimportanttotheregulator.
TheFCAwillseektoimprovecompetitionandtransparency,andwillintervenedirectlyonbehalfof
consumerswhoareunabletodetermineifapolicyrepresentsagooddeal.
Significantly,ourresearchshowedthatthisisnotseenasbadnewsbyallinsurers.Wesawaspectrum
ofattitudesonhowfirmsshouldcompeteandbehaveinthemarket,includinginsurerswhobelievethat
boththeyandtheircustomerswillbenefitfrommoretransparencyandfromeffortstomakevaluefor
moneyeasiertoassess.ThisconformswiththeFCA’sviewthatamorecompetitivemarketwhichtreats
itscustomersbetterisgoodfortheindustry.
Itisthereforeessentialthatinsurersputthemselvesonthefrontfootbyreviewingtheirproducts,and
bymakingsuretheycanjustifythevaluethatproductsoffer.Inmakingthisassessment,valuefor
moneyisnotjustaboutpriceorinsurermargin;itisunrealistictosaythataspecificmarginorclaims
levelisunfairtocustomers.However,whereprofitisunusuallyhigh,thiswillneedtobejustified.This
maybe,forexample,becauseitisanewproductwheretheriskinvolvesgreateruncertainty,orthat
claimsarevolatileoverthemedium-to-long-term,meaningthatashort-termassessmentofmarginis
inappropriate.
Inouropinion,eachmanagementteamneedstodevelopclearguidancewhichwillalertthemto
productsthatmayofferpoorvalueformoneyandwhereefficacymayneedtobereassessed.This
guidancecouldincludefactorssuchas:
• Whatvalueformoneymeansforcustomers.
• Thetimeframeneededtomakearealisticassessmentoftheproduct’sriskandmargin.
• Thedistributionofpremiumsandfeestoeachplayerinthevaluechain–distributorpaymentsand
commission,insurerprofit,andclaimspayouts.
• Policyconditionsthatreducethevalueoftheproduct,suchashighexcesses,exclusions,triggersfor
premiumincreases.
• Theimpactof“hiddencharges”thatincreasethetotalcostoftheproductforcustomers.
• Theimpactontotalcostandvaluewhensellingbundledproductsandadd-onstoimprovereturnson
low-margincoreproducts.
18 Conduct risk for insurers: Responding to a fundamental shift in regulatory expectations
Itisapparentthatmanyotherfactorsinfluencetheperceptionofvalueformoney.Thesemayinclude
thebrandoftheprovideranddistributor,thequestionofwhethertheproductmeetsthecustomer’s
needs,ortheservicelevelcustomersreceivebothduringandafterthesale,andwhethertheycould
haveobtainedanidentical(ornearlyidentical)productatasignificantlylowercost.Thereisalsoa
simplequestionofwhetheronecompany’sproductischeaperbecauseitoffersbettervalueformoney,
orbecauseithasmisunderstoodtherisk.
Societyismovingtooneofultra-transparencyandaccountability.Unlessafirmisconfidentitcanstand
uptopublicscrutiny,itisatrisk.Thetestforinsurersistoaskhowtheregulator,mediaandcustomers
wouldreactifallthedetailsofaproductwerefullytransparentandinthepublicdomain:charges,
commissions,claimslevels,margin,andsoon.Iftheanswertothisquestionfeelsuncomfortable,then
actionisprobablyrequired.
3.3. Equality
Infuture,weconsiderthattherewillbeincreasingpressureoninsurerstoensurethatthereisgreater
“equality”betweencustomers.Todate,thispressurehasarguablybeenexertedmorethroughpolitical
channels(andsubsequentapplicationsthroughthejudicialroute)thanthroughregulatoryinterventions,
suchasgenderneutralpricing.Weexpectoverallpressuretocontinue.
Whileinsurerscanacceptthatsomecustomergroupsarepricedoutofthemarketorareotherwise
disadvantagedduetothenatureoftheirrisk,thislogicisunattractivefromtheperspectiveofpublic
policy,whereinsuranceisviewedasasocialgood.Andaswehaveseeninrelationtogender-neutral
pricingandfloodinsurance,governmentwilldirectlyinterveneinthemarketundertheguiseof
promotingequality.
Giventhistrend,insurersneedtoconsiderwhethercurrentapproachestopricinganddistributionare
atriskfromregulatorsorlegislatorswhoarekeentoensureequalityandremoveanysensethatcertain
customergroupsarebeingdisadvantaged.
Oneareawhichmayneedtobereconsideredisthepricingofnewversusexistingcustomers.While
almostallinsurerswespeaktosaythattheywouldliketorewardloyalcustomers,itiscommonpractice
acrossmanyproductlinestoofferbetterratestonewcustomersthantoexistingcustomers.Thishas
beeninsurers’responsetomarketandconsumerbehaviour,andtheyappearfearfulofamassive
first-moverdisadvantageshouldtheytrytochangetack.Meanwhile,collectiveactionisconstrainedby
competitionissues.
Wedonotbelievethatregulatorsshouldprohibitdifferentialpricingasawayofinsurersgrowingmarket
share(orrewardingloyalty).Norshouldallcustomersberequiredtobeofferedanequalprice;lower-risk
customersshouldreasonablyexpecttopayless.
Inourview,itshouldbeacceptableforaninsurertotakeasmall,ornegative,marginintheearlyyears
ofacustomerrelationshipintheexpectationofahighermarginovertime.However,thereisclearly
aspectrumbetweenrecoveringinitialinvestmentinacquiringacustomeranddeliberatelyexploiting
customerinertiaoverthelongertermofacontract.Wesuggestthatinsurersneedtobeclearabout
wheretheirownriskappetitelies.Factorstheymaywanttoconsiderinclude:
3. moving beyond TCF
19 Conduct risk for insurers: Responding to a fundamental shift in regulatory expectations
3. moving beyond TCF
• Theextenttowhichthemarginprofileistransparenttocustomersatthepointofacquisition(e.g.by
advertisinganexplicitfirstyeardiscount).
• Theprofileofcustomermarginsovertime(forexample,whethermarginscontinuetoriseafterthe
pointatwhichtheoriginalinvestmenthasbeenrecouped).
• Themagnitudeofthegapbetweenthepriceofferedtoseasonedcustomersandthenewbusiness
pricetheywouldbeofferediftheyshoppedafresh.
• Theextenttowhichvulnerablesubgroupsareofferedvalueformoney(e.g.theelderly,andother
groupslessabletoshoparound).
Thereareotherpracticesthat,althoughlessobvious,couldalsobereviewedinordertodeterminehow
toensuretheyareappropriatefrombothanequalityandconductriskperspective.Forexample,ifa
customercallsamotorinsurer,theymighthaveaoneinahundredchanceofreceivingaquotethatis
5%higherthannormal,andaoneinahundredchanceofreceivingaquotethatis5%lowerthannormal.
Thisisacommonapproachtotestingpriceelasticity,butitisclearlyunequal.Whetherthisshouldbe
asourceofconcernisnotyetclear,andrepresentsanexampleofthedifficultjudgementsthatinsurers
needtomake.
Manypeopleinthebankingsectoraresayingthatitistimetoreturntowhattheyterm“old-fashioned”
banking.Insurersmaywishtoconsiderwhatthismaymeanforthem,andtheextenttowhichthe
originalpurposeofinsurance–thesharedpoolingofrisk–isstillrelevantandhowtobalancethiswith
theneedforpeopletopayafairpremiumcommensuratewiththerisktheycontributetothepool.
Eachinsurerwillneedtoadjusttheirowncomfortlevel,andensurethatanappropriatebalanceis
achievedbetweenindividualunderwriting,poolingofcustomersandtheprincipleofaccesstoinsurance
forallsectionsofsociety.Evenwheredecisionsmakesenseintheworldofunderwritingandcommercial
logic,managementneedstoconsiderwhatchallengesmayemergeinthenameofequality.
20 Conduct risk for insurers: Responding to a fundamental shift in regulatory expectations
3.4. Use of customer data and information
TheadvanceoftechnologyandBigDataopensupinnovationopportunitiesforinsurersinproduct
design,pricing,customertargeting,servicingandclaimsmanagement.However,evenwhileoperating
withintheboundariesofthelaw,therearestillquestionsaboutthelimitsofwhatisacceptableand
unacceptableuseofcustomerdata.ThereisbotharegulatoryandreputationalriskforinsurersifBig
Dataopportunitiesareexploitedfasterthancustomerswant.
Toensuretheadvancesintechnologyarenotjeopardisedbyinappropriatesourcing,usageand
managementofdata,insurersneedtodevelopclearguidanceandprinciplesontheuseofcustomer
information.
Forexample,itiscommonpracticeintheannuitymarkettoaskcustomersabouttheirhealthand
lifestyleinordertodeterminewhethertheyareeligibleforanenhancedannuity.Thisisacceptableifthe
customervoluntarilyprovidestheinformationdirectlytotheinsureraspartofthequotationprocess,
butisitacceptablefortheinsurertoobtainthisinformationthroughothersources?Isitappropriatefor
asupermarkettouseloyaltycarddataoncigarettepurchasestobeusedinpricingannuitiesfortheir
customers?Whatifaninsurercanseefromthecustomer’sFacebookpagethattheysmoke?
Onecouldarguethatthereisnoproblemiftheuseofthisinformationisdeliveringabetteroutcomefor
thecustomer(forexample,intheformofabetterannuityrate,ortodetectfraud),andtheinformation
isavailablewithinthepublicdomain(andaFacebookpostingisarguablyputtinginformationinthe
publicdomain).Butwhatiftheinsurerusesinformationthatislegallyavailable,butisobtainedwithout
customers’explicitconsent,inordertopriceaprotectionproduct,andthisadditionalinformationresults
inahigherpriceforthecustomerorcoverbeingdeclined?
Anotherinterestingareaistheuseofbehaviouraldata.Someinsurersareexperimentingwithusing
informationabouthowthecustomerbehavesontheirwebsiteasaninputintothequotationsgiven.
Forexample,theymaytakeintoaccounttheproductswhichcustomersview,andhowmanydifferent
combinationsofproductfeaturestheytryout.Acustomerwhotriesseveralalternativeamountsforan
excessonanonlinemotorinsurancepolicyquotationformisconsideredtobemoresensitivetoprice
thansomeonewhojustrequestsaquotewiththestandardexcess.
Otherexamplesofthisdilemmaincludewhetheritisfairtoloadthepremiumforonecustomerifthey
happentosharethesameaddressassomeoneonafrauddatabase.
Insurersneedtobeconfidentthatnotonlyaretheyoperatingwithintheletterandspiritofallrelevant
lawsandregulations,butthat,astheycaptureandmakeuseofnewsourcesofcustomerdata,theyare
happytodefendwhattheydotocustomerswhenasked.TheABIguideontelematicsmaybeauseful
exampleofhowtheseconcernscanbeaddressedinanopenway.
3. moving beyond TCF
21 Conduct risk for insurers: Responding to a fundamental shift in regulatory expectations
3. moving beyond TCF
Aswellasconsideringhowtheyusecustomerdata,insurersalsoneedtothinkabouthowtheystoreand
manageit.Forexample,
• Ifrelyingoninformationnotknowinglyordirectlyprovidedbythecustomer,howtoensurethat
itisverified?
• Howisdatakeptuptodatesothatonlythemostrecentinformationaboutacustomerisusedto
makeadecision?
• Howisdatakeptsecuresothatitisnotlostorstolen?
Astheamountofavailablepersonaldatabeingcapturedandstoredgrows,thechallengeincreases.
Weexpecttoseetheregulatorbeingmuchmorevigilant,andlesstolerant,inthisarea.
Todate,mostofthedebatehasbeendictatedbywhatistechnologicallypossibleandcommercially
useful.Thepotentialforsignificantreputationalandregulatoryriskassociatedwithcustomerdata
meansthatmorediscussionisrequiredaboutwhatisacceptable.
22 Conduct risk for insurers: Responding to a fundamental shift in regulatory expectations
4. the response4. The response
Aseachwaveofconsumerprotectionregulationhasbeenbroughtforward,theindustryhaslagged
behindtheregulator’sexpectations.Thisremainsthecasedespitethefactthatinsurershavemade
significantprogress,devotingconsiderableattentiontoensuringgoodcustomeroutcomes.
Itisclear,however,thatanyfirmswhichbelievethattheycancontinuetotakeanarrowcompliance
approachwillfinditincreasinglydifficulttoprovidetheevidencerequiredbytheFCA.Thismayleave
themexposedtosignificantregulatoryandreputationaldamage.Ultimately,someofthechanges
envisagedbytheFCA(resultingfromanincreasinglyconsumeristsociety,andaninterventionist
politicalbody)maymakesomebusinessmodelsobsolete.Iftheyeverwere,conductriskandconsumer
protectioncertainlynolongerrepresentabox-tickingcomplianceexercise.
Inordertomanageandembedconductandcustomer-relatedriskacrossthebusiness,insurersmust
ensuretheyhaveaclearandwell-definedapproachwhichisalignedtogoodconductandtheFCA’s
broaderrequirements.Thismustoriginatefromboardlevel,andthenbeclearlycommunicatedto
internalandexternalstakeholders.
Webelievethatastrongconductriskapproachembeddedintotheorganisationisacriticalsuccess
factorinthelonger-termviabilityofinsurancebusinesses.Inoursurvey,manyinsurerscitedother
industrieswheretheybelievecertaincompanieshavedemonstratedbetterconductthanmanyinsurers.
TheexamplesmostfrequentlyprovidedwereJohnLewisandAmazon.comintheretailsector,andVirgin
Atlanticintheairlineindustry.Theexecutiveswespoketobelievedthatthesecompaniespossessone
commontrait–theyhaveputcustomersattheheartoftheirstrategyandbusinessmodel,andthishas
beenanimportantfactorintheirprofitabilityandgrowth.Insurerswerealsokeentopointoutthatthere
arealsoplentyofexamplesofpoorconductinbothoftheseindustriestoo!
Someinsurershavealreadybeentakingboldactionoverthelastyearorso,forexamplebyremoving
allsalesincentivesforfront-linegeneralinsurancestaff,whileothershavetakenmoreofa“waitand
see”approach.Nowthatexpectationsongoodconductarebecomingclearer,andregulatoryscrutinyis
increasing,thesefirmswillhavetocatchup.Throughourworkonconductrisk,wehavecometoview
fivestepsascriticalinachievinglastingprogressinthisarea:
1. Defineyourconductriskappetite,andobtainseniorstakeholderbuy-in.
2. Performaconductriskdiagnostictoidentifychangesrequired.
3. Strengthentools,processesandcontrols.
4. Realignthebusinessmodelwithgoodcustomeroutcomes.
5. Reinforcethroughleadershipbehaviour,culture,trainingandincentives.
23 Conduct risk for insurers: Responding to a fundamental shift in regulatory expectations
Step 1.
Define your conduct risk appetite and obtain senior stakeholder buy-in
Theconductissueisnotblackandwhite.Eachinsurerneedstodecideitsownappetiteortolerancefor
conductriskandcommunicateitsconclusionsbroadlyacrossthefirminordertoinfluencebehaviour.
Indefiningriskappetite,managementneedstodefinehowfartheirfirmshouldgointermsofboth
knowing,andbeingabletodemonstrateevidencethat:
• Customersunderstandwhattheyarebuying.
• Productsaresuitableforthecustomerbuyingthem.
• Customersarereceivingacceptablelevelsofservice.
Insurersalsoneedtodefinewhatconductriskappetitemeansinpractice.Forexample:
• Towhatextentshouldallcustomersbeofferedthelowestpossibleprice?
• Howcanloyalcustomersberewarded?
• Towhatextentdoesconductriskappetiteextendtoincludethebehaviourofyourdistributors?
• Towhatextentdoesitincludetheoutcomesofotherinsurers’customers(suchasinrelationto
referralfeesinmotorinsurance)?
Thesearediscussionsthatshouldbeledbytheboard.
Oncetheconductriskappetitehasbeendefined,strongseniorstakeholderbuy-infortheriskappetite
hastobeobtained.Suchstakeholdersalsoneedtoaccepttheneedtochangetoalignwiththestated
appetite.Itisimportantthatseniorstakeholdersrecognisetheimportanceofgettingconductriskright.
Theymustalsounderstandthepotentialimplicationsofgettingitwrong,withpossiblefinesand
compensationpayments,aswellaspotentiallonger-termdamagefromtheimpactonthecompany’s
reputation.Insurersthathavebeenthemostsuccessfulatobtainingseniorstakeholdersupporthave
tendedtobethosewhereboardmembersfirmlybelievethatensuringtheirbusinessmodelisaligned
withachievinggoodcustomeroutcomesisnotonlytherightthingtodo,butisalsocommerciallythe
bestthingtodointhemedium-to-longerterm.
Accountabilitiesneedtobeagreedforconductriskmanagementandoversight,balancingthe
responsibilitiesofbusinessunitsandriskandcompliancedepartments.Oursurveyshowedthatthose
insurerswhichhadmademostprogressinimplementingaconductriskstrategyhadinvolvedboth
entitiesinabalancedway.Firmsmaywishtoidentifyanexecutivetotakeformalresponsibility.Indeed,
somefirmshaveappointedaHeadofConductRisk,orformallyincludedconductriskwithinthemandate
ofanexistingexecutive,suchastheRegulatoryRiskDirector.Responsibilitiesformanagingconduct
riskonaneverydaybasiscanthenbeintegratedintoexistinggovernancestructures,alwaysensuring
significantfront-lineinvolvementandaccountability.
4. the response
24 Conduct risk for insurers: Responding to a fundamental shift in regulatory expectations
4. the responseStep 2.
Perform a conduct risk ‘diagnostic’ to identify changes required
Intheshortterm,firmsshouldhaveacredibleandeffectiveresponseforconductriskinplaceasa
matterofpriority.Someinstitutions’instinctiveresponsehasbeentoviewconductriskjustasyet
anothersalesprocesscomplianceprogramme.However,wefeelthatthisresponsefailstounderstand
thescaleofchangethatisrequiredacrosstheirvaluechains,astheindustrymovesintothenew
Conductera.
Inourwork,weregularlycarryoutriskidentificationusinga“follow-the-money”approach,exposing
potentialareasofcustomerdetrimentbylookingatthoseareasoftheinsurer’sbusinesswhere
significantrevenuesandprofitsaregenerated.Thishasprovedtobeausefulapproach,andconduct
regulatorssuchastheUKFCAarelookingtofollowsuit.Itisimportanttonote,ofcourse,thatstrong
profitabilitydoesnotnecessarilyindicatethatthereisaconductissue.Itmerelyservesasanindicator
(oneofmany)thattheremaybeconductissuesthatshouldbeinvestigatedfurther.
Thereareanumberofpotentialcontributingfactorstopoorcustomerconduct.Itmaybehelpfulfor
insurerstogothroughthesetohelpthemidentifypotentialconductissueswithintheirportfolio.Key
factorscaninclude:
• Complexityofproduct,andtherelativesophisticationofthecustomer.
• Pricetransparencyandeaseofswitching.
• Whetherthepolicyistheactivelysoughtproductoranancillary,add-onorpolicy.
• Universalityoftheproductandsizeofthesuitablemarket.
• Irreversibility:theeasewithwhichacustomerandtheinsurercanwithdrawfromthecontract
withoutnegativeimpact.
• Thequantumofthedownsideriskforthecustomerandinsurerasaresultofpoorconduct.
• Importanceoftheproducttotheinsurer’soverallbusiness.
• Levelofcommissionbeingpaid.
• Levelofcompetitionwithintheproductline,andprofitability.
Inadditiontoachievingclarityonthecustomersegmentsandproductclassesatrisk,sixmajor
processesalongthevaluechainneedtobereviewed:
1. Product development and governance: Integrationofconductriskcriteriaintonewproductapproval
andgovernanceprocesses,includingthedefinitionofpositiveoutcomesandcorrespondingmetrics,
aswellasongoingmonitoringoftheproduct’sperformanceandindicatorsofemergingrisks.
2. Customer segmentation: Upgradingofsegmentationandprofilingtoolstocoverneeds,riskappetite,
financialexperience,eligibilityandlosstolerance.
3. Customer proposition:Increasingthedetailandsophisticationofproduct/customermatching,and
aligningcommercialtermsmorecloselytotheconceptofapositiveoutcome.
25 Conduct risk for insurers: Responding to a fundamental shift in regulatory expectations
4. Sales: Formalisationandupgradeofsalesforcestandardsandtraining,linkingqualification
levelstoproductsalesauthority,bothinternallyandatdistributors.Upgradingofsalesprocess
documentationtodemonstrateevidenceofsuitability.Developmentofoutcometestingprocedures,
suchasmysteryshopping.
5. Post sales, including claims and complaints: Activemonitoringofproductperformancetoidentify
customerdetriment.Upgradingofcustomerreportingtoincorporateriskcontent,andincreasing
dynamicreportingfrequencytoreflectrisklevels.
Muchoftheaboverelatestofront-linetoolsandprocesses,andindeedtheonusshouldbeonthefront
linetoensureitsalignmentwiththeprinciplesofgoodconductofbusiness.Ontheonehand,thisis
goodnewstothoseinstitutionsaspiringtogreaterefficiencyinriskandcompliance.Ontheotherhand,
suchfront-lineactivityrequiresoversightandmonitoring.Forthistobeeffective,firmsshouldensure
thatconductriskbecomespartoftheiroverallrisktaxonomy,andisthusfullyintegratedintorisk
identification,assessmentandmanagementprocesses.
Oversightrequiresinformationthatcansupportmanagementdecision-making.Suchinformation
shouldbebasedonmetricswhichfocusoncustomeroutcomesaswellasoninputstotheconduct
riskmanagementprocess.Asboardsincreasinglyseekoversightofconductriskperformance,we
havefoundthatindicatorssuchasmysteryshoppingresults,customeroutcometesting,profitability
metrics,customersatisfactionandadvocacy,andproductperformancestatisticscanallbeusefulin
substantiatingthecontentofreportstoboardlevel.
Incarryingouttheconductriskdiagnostic,insurersmustquantifyandprioritisethegapsidentified,for
examplebyemployingameasureofcustomervaluedetriment.Theyshouldalsoclassifyeachgapinto
oneofthreecategories:
• Gapsthatshouldbeaddressedassoonaspossible,duetoashort-termriskofFCAactionagainstthe
firm,significantconsumerdetrimentorreputationaldamage.
• Othergapsthattheinsurerisabletoaddressbyactingalone,despitethefree-riderriskandpotential
forfirstmoverdisadvantage.
• Gapsthatcanonlybeaddressedifotherinsurersdosoatthesametime(althoughiftheindustry
waitstoolongforacollectiveresponse,itmayfindthatithasalessattractivesolutionforceduponit).
Havingagreedthethrustoftheapproachanditsprincipalcomponents,firmscanthendetailthe
initiativesthattheywillpursuetoembedgoodconductofbusinessintotheirproductsandprocesses.
Theensuingworkwillinvolvetwoelements.Firstly,tools,processesandcontrolsarelikelytoneed
strengtheningtoprovideassuranceandevidencethatthoseoutcomesarebeingachieved.Secondly,
businessmodelswillneedtobereviewedtoensuretheyarefundamentallyalignedwiththeconceptof
ensuringgoodcustomeroutcomes.
4. the response
26 Conduct risk for insurers: Responding to a fundamental shift in regulatory expectations
4. the responseCase study – A life insurer has implemented a dedicated conduct programme
Alifeinsurerhasestablishedadedicatedconductriskprogrammewithaclearobjectivetoidentify
andreduceanypoorcustomeroutcomesacrosstheirbusiness.Theprogrammeissponsoredbythe
CEOandinvolvesthe1stand2ndlinesofthebusinessworkingcloselytogether.Theprogramme
hasstrongseniorstakeholdersupportandhasbeenupandrunningforthelast6months.
TheInsurerbroadlyfollowedafivestepprocess:
1. Definedconductriskstrategyandwhat‘good’lookslikefortheorganisation,includingaclear
definitionofa‘customerdetriment’measurewhichconsiderscustomeroutcomesrather
thanjustbusinessprocesses.
2. Establishedaconductprogramme,includingaformalprogrammestructure,dedicated1stand
2ndlineresourcesandaclearsetofobjectivesandmeasuresofsuccess
3. Carriedoutareviewacrossthebusinesstoidentifythemostmaterialareaswherecustomers
–generallyasaresultoftheirbehaviourorunderstanding–maynotbegettingwhatinformed
professionalsmightdeemappropriateoutcomes.
4. Foreacharea,identifiedtheleversrequiredtoreducethequantumofcustomerdetriment,
developedabusinesscaseformakingthechangesrequiredtoaddresstheissueandsetclear
targetsforreducingthisoverthenextthreeyears.
5. Implementedtheidentifiedchanges,trackedtheimpactonthevalueofcustomerdetrimentand
nowregularlyreportonprogresstotheboard.
Bywayofexample,withinitsannuitiesbusinesstheInsurerestimatedthat20%byvalueof
itsDefinedContributionpensioncustomerflowswerepurchasingastandardannuity,whena
proportionwouldhavebeeneligibletopurchaseanenhancedannuitywhichthefirmdoesnot
offer.Whilsttheannuityratesofferedwereverygoodwhenmeasuredagainstconventionalrates
inthemarketfortheOpenMarketOption,anddisclosuresincustomercommunicationsarefully
compliant,effectivelyasmallproportionofthesecustomersweremakingapotentiallyuninformed
choiceandthiswasleadingtocustomerdetriment.Thefirmestimatethatthevalueofthelossto
impactedcustomerswasgreaterthan£5mperannum.
Theleversforaddressingthiswereidentifiedandaprojecthasbeensetuptoclosethegapin
aphasedmanner.Thebenefitsincludedwithinthebusinesscaseincludeelementsforboththe
companyandthecustomer.
TheCEOfeelsverystrongly(andhastheboard’ssupport)thatthevastmajorityoftheseissuescan
beaddressedinwaysthatare‘NetPresentValue(NPV)positive’oratleastclosetoNPVneutral
intermsofprofitstotheinsureroverthemediumterm.So,notonlyisfindingwaysofimproving
customeroutcomestherightthingtodo,theyalsobelieveitiscommerciallyattractivetodoit.
27 Conduct risk for insurers: Responding to a fundamental shift in regulatory expectations
Step 3.
Strengthen tools, processes and controls
Insurersneedtodeveloptheirmanagementinformationanddevelopkeymonitoringmetricstobe
abletodemonstrateevidenceofstrongcustomerserviceandgoodcustomeroutcomes.Someinsurers
haveintroduceda“conductrisktolerancescore”,whichislinkedtotheirstatedconductriskappetite
andisregularlyreportedtotheboard.Thescoreincludesmetricsrelatedtofeaturessuchasproduct
characteristics,customerexperience,customeroutcomes,salesincentivesandstaffcapabilities.While
theexistenceofthismetricinitselfwillnotnecessarilyimproveconduct,itcanbeausefultoolin
promptingdebateonconductamongtheexecutiveteamandtheboard.
“ Insurers need to find business models that really reward customer loyalty
”CEO,CompositeInsurer
4. the response
28 Conduct risk for insurers: Responding to a fundamental shift in regulatory expectations
4. the responseStep 4.
Realign business model with good customer outcomes
Themoredefensivemovesoutlinedabovearethenecessaryactionsrequiredtoavoidfines,litigation
andreducecustomercomplaints.Butacontrolframeworkisdesignedtocurtailactivityinareasdeemed
risky,notsuggestwaysinwhichtosustaintherevenuestreamsfromthoseactivities.Thereisthusarisk
thatfocusingondefensivemovesleavesastrategicvacuumatatimewheninsurerscanexpecttosee
significantdisruptionsinthemarketwithConductofBusinessprinciplesbecomingfullyembedded.
Insurersshouldthereforeprepareforthestrategicimplicationsofabusinessmodelmoreclosely
alignedwithconductriskconcerns.Webelievethatthesestrategicimplicationswillbefeltinatleast
threeareas:
• Ensuringsuitabilityandappropriatetargeting.
• Deliveringvalueformoney.
• Respondingtoagrowingagendaforequality.
• Harnessingtechnologicalinnovationatapaceacceptabletoconsumers.
ItislikelythatabusinessmodelmorecloselyalignedwithgoodConductofBusinesswillinvolvea
simplerandmoretransparentlypricedproductrange,andanarguablyfairerdistributionofinsurers’
costsandrevenuesacrosstheircustomerbaseasaresult.Suchchangescanresultinsignificantshifts
ofmarketsharebetweenfirmswhicharewellpreparedforchangeandhaverelevantplansinplace(such
asthroughusingcustomeranalyticstogainabetterunderstandingoftheirneeds),andfirmswhichare
merelyreactive,remainingresistanttochangebeforedeliveringanuncoordinatedresponse.
Onespecificexampleconcernsgeneralinsurers.Currentlythestrategyofmostgeneralinsurersinvolves
offeringlowerpremiumstonewcustomers,assumingtheycanmakeprofitsonthisbusinessinlater
yearsaspremiumsincreaseforthosecustomerswhoremain.
Likewise,itisclaimedthatmanyannuitycustomersfailtogetagooddealastheydonotshoparound,
andprovidersknowinglyexploitthisinertia.
Inboththese,andother,examples,theremustbeariskthatthesepracticeswillnotbesustainable,and
thereforethatbusinessmodelsbasedonthesepracticeswillnotbesustainable.
Webelievethatboards,andspecificallynon-executivedirectors,havearoletoplayinchallenging
existingmodelsandunderstandingthesensitivityofthebusinesstosignificantchangestothestatus
quo.Forexample,whatwouldhappenifpricedifferentialsbetweennewandexistingcustomerswere
projectedtoshrinksignificantlyordisappearwithinthenextfiveyears?Oriftherewasasignificant
increaseinconsumerstakingadvantageoftheopenmarketandshoppingaroundforthebestannuity
solution?Wouldtheboardbewillingtocontinuetowritebusinessinthesameway?Wouldtheinsurer’s
operatingmodelbecost-effective?
29 Conduct risk for insurers: Responding to a fundamental shift in regulatory expectations
Step 5.
Reinforce through leadership behaviour, culture, training and incentives
Conductriskmanagementwillfailifthetoneatthetopandthemessagesgiventostaffthroughhiring,
trainingandperformancemanagementdonotreinforcethestrategicpositioningonconductrisk.
Organisationsneedtoformarealisticviewofthecultureintheirorganisation,andseektounderstand
theunwrittengroundrulesandrelationshipswhichinfluencethewaydecisionsaretakenthroughoutthe
organisation.Ahelpfulstartingpointcanbea“culturalthermometer”testtounderstandtheunderlying
cultureofthefirm,comprisingsurveys,interviewsandfocusgroupswhichinvolveseniormanagement,
thefrontline,themiddleandbackofficeandclients.
Aseriesofactionscanthenbeidentifiedrelatingtoleadershipdevelopment,incentives,trainingand
development,recruitmentandrewards,toolsandprocesses,allseekingtoembedandreinforcethe
desiredculturalvalues.Theseactionswillhelptoensurethatpeopledowhatisrighteveninsituations
thatarenotforeseenbypolicyandprocess,therebyreducingexposuretoconductrisk.Theywillalso
servetokeepoverallriskandcontrolspendingincheck.
Inthesalesarena,incentivesareoneofthemostcriticaldeterminantsofbehaviourandhavebeen
identifiedasasignificantcontributortopastfailings.Wecontinuetofindthroughourworkthat
incentives,intheirsimplestform,canleadtogoodstaffbehaviours,encouragingstafftounderstand
customerneedsandtodirectcustomerstosuitableproducts.Forexample,conductcouldbemanaged
byonlygivingcreditforhigh-qualitysaleswherecustomerneedsandsuitabilityhavebeenclearly
demonstrated,andbyensuringrewardsarebasedonabalancedsetofmetrics(forexample,through
meetingneeds,anddisplayinggoodserviceandgoodcolleaguebehaviours).
Notwithstandingtheabove,however,itistheseniorleadersofthefirmandhowtheybehave,act,
makedecisionsandcommunicatethatwillhavethemostimpactoncreatingandreinforcingthe
cultureofthefirm.
4. the response
30 Conduct risk for insurers: Responding to a fundamental shift in regulatory expectations
5. the insurance industry working together
5. The insurance industry working together
Whileeachindividualinsurermustdevelopitsownresponsetothemarketconditionscreatedby
theFCA,thereisscopeforcollectiveactiontohelpcreatetherightregulation,andhelpensuregood
customeroutcomes.
Overtheyears,collectiveaction,ledbytheAssociationofBritishInsurers(ABI),hassoughttopush
throughimprovementstocustomeroutcomes.Forexample,theRaisingStandardsprogrammeandthe
CustomerImpactScheme,whicheachenjoyedbroad,ifnotfull,participationfrominsurers,wereright
fortheirtime,andcouldpointtorealimprovementsintheirwake.
Weconsiderthatindustry-drivencollectiveactionthereforeremainsbeneficialinthefollowingareas:
1. Scrutinisingproposedregulationtoensurethatmarketreformsarenotagainsttheinterestsof
competitionandcustomers,forexamplethroughidentifyingthepotentiallosersaswellasthe
potentialwinnersfromregulatoryproposals.
2. CreatingCodesofConductthatactasaguidetoensurethatinsurersdelivergood
customeroutcomes.
3. Providingaforumtodiscusshowtoaddressissueswhichinsurerswillnottackleontheir
ownduetotheriskoffirst-moverdisadvantage.
WeacknowledgethattheABIisamemberorganisationandnotanaccreditingbodyorsupervisorand
thatCompetitionLawlimitscollectiveactioninsensitiveareassuchasduelpricing.However,theFCA
hasclearlysetoutthatitwillintervenetoimprovetheoperationofthemarket,anditislikelythatany
responseoutlinedandpromotedbytheregulatorwouldbelesswelcometotheindustrythansomething
itwasabletodesignitself.
31 Conduct risk for insurers: Responding to a fundamental shift in regulatory expectations
6. conclusion6. Conclusion
OurdiscussionswithCEOsandseniorexecutivesfromacrosstheinsuranceindustrywereopenand
informative.Theyrevealedthatmostinsurershavemadesignificantinvestmentstoimprovecustomer
outcomes,butalsothatinsurersdonotgenerallysharethesameviewsastheFCAabouttheextentof
customerdetrimentandthescaleofchangerequired.Indeed,thereisarealconcernintheindustrythat
toomuchregulationcouldreducecompetitionandinnovationtothedetrimentofconsumers.
Itisimportantforinsurerstoidentifythesignificanttrendsofopenness,transparencyandaccountability
thatwillshapethenatureofconductregulation.Eachinsurer,withtheactiveinvolvementoftheirboard,
willneedtodecidewhatimpactthesetrendsmayhaveontheirbusinessmodel,howtheywantto
respondandtheirappetiteforregulatoryandreputationalrisk.
Inourexperience,thisexerciserequiresastructuredapproachtoassesstheviabilityofcurrentbusiness
models,andtoidentifywhatbusinesspracticesandoperationsneedtochange.Allofthismustbe
supportedbyastrongfocusonensuringthefirm’sleadersandculturesettherighttoneforthebusiness.
InsurerswhoconsiderthatconductriskisnomorethananevolutionofTCFarelikelytofindthemselves
onthewrongsideoftheFCA.Theywillalsofallbehindasotherinsurersdevelopbusinessmodels,
productsandculturesmoreattunedtotoday’smarket.
32 Conduct risk for insurers: Responding to a fundamental shift in regulatory expectations
appendix: list of participating firm
sAppendix: List of participating firms
Wearegratefultothefollowingfirmsfortheirparticipatinginourresearch.
• AegonUK
• AgeasUK
• AllianzUK
• Amlin
• AvivaUK&IrelandGI
• AvivaUK&IrelandLife
• AXAUK
• BUPA
• Catlin
• DirectLineGroup
• FriendsLife
• Hiscox
• LegalandGeneral
• LVGI
• LVLife
• PartnershipAssurance
• PrudentialUKandEurope
• ReAssure
• RoyalLondonGroup
• StandardLife
• ZurichUKGI
• ZurichUKLife
33 Conduct risk for insurers: Responding to a fundamental shift in regulatory expectations
who to contactCIIDavid Ross
DirectorofCommunications
CharteredInsuranceInstitute
20Aldermanbury
LondonEC2V7HY
Email:[email protected]
About the Chartered Insurance Institute (CII)
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34 Conduct risk for insurers: Responding to a fundamental shift in regulatory expectations
About the authors
Sean McGuire, Tim Kirk, Richard Thornton andJames Bryan areLondon-basedPartnersin
OliverWyman’sFinancialServicespractice.
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