Leading the Way on Regulation

Speaker: Karina McTeague, Director of General Insurance and Conduct Specialists Supervision
Event: BIBA Conference 2019, Manchester
Delivered: 15 May 2019
Note: this is the speech as drafted and may differ from the delivered version

Highlights

• Business models should be sustainable and analysed against the risks and opportunities of rapidly evolving customer expectations.
• Meeting the requirements of the Insurance Distribution Directive (IDD) contributes to enhancing trust in the insurance industry.
• The clarity provided through Senior Managers and Certification Regime (SM&CR) is not simply a matter of regulatory compliance, it is also good business practice and beneficial for firms of all sizes.

I have a personal, as well as professional reason for being particularly pleased to have been asked to talk about ‘Leading the Way on Regulation’. As someone who spent more than 20 years in the private sector, I’m often asked why I moved to the regulator.

Six years ago, I returned from the US where I’d been chief risk officer (CRO) for Lloyds Banking Group. Like everyone else in banking, I’d lived through the trials of the financial crisis. I had also seen the difference in approach between the US and the UK in the aftermath. I returned to the UK determined to play a part in restoring trust and confidence in UK financial services.

The UK Parliament had just taken a decisive lead in the regulation of financial services by establishing the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA) under the Twin Peaks model. The UK’s Twin Peaks model was particularly innovative. It acknowledged that we need a holistic approach that balances consumer protection, market integrity and competition in the interests of consumers.  

To join the FCA in its first year was inspiring. It is no coincidence that, from such innovative roots, the FCA has continued to set a high standard globally. For example:

• Overseas regulators beat a track to our doors to find out how our Twin Peaks model works.
• We are recognised globally for our work on culture, as a leading driver of whether customers will be treated fairly.
• Other major regulators have imitated our Innovation Hub and Sandbox.

But let me stop this, for a regulator, this uncharacteristic self-appreciation.

Aged 6 this year, the FCA is still a young organisation, in the relatively young discipline of conduct regulation. Our mission is to be forward-looking, proactive and innovative. At the same time, we must be proportionate, predictable, and apply our resources to where they will have the most positive impact. And we have to be all these things, and more, in a disrupted, disruptive and uncertain environment.

The material advertising this particular session is proof, if any were needed, of the 360° uncertainty affecting every aspect of financial services, and its regulation – especially insurance. To quote from the conference brochure:

‘With the UK having officially left the European Union before the 2019 BIBA Conference takes place…’

Need I say more?!

So how do we, at the FCA, lead the way in these uncertain times? And what are our expectations of the insurance industry?

As a conduct regulator, we see an alignment between our expectations and the expectations of the Boards, Executives and owners of well-run firms. Specifically:

• sustainable strategies and business models, underpinned by customer trust
• a healthy customer- focused culture supported by open-ness, honesty and professionalism that mitigates against the risks of consumer harm

Turning first to sustainable strategies and business models.

Sustainable business models

Andrew Bailey, the FCA’s Chief Executive, has previously talked about the UK having had two financial crises:

• the first, was prudential
• the second, was conduct

In an environment where lighter touch regulation was encouraged, this provided fertile ground for both crises.

A keystone of any sustainable business model and strategy must be customers’ trust.

The seeds of the conduct crisis were sown when banks were chasing increasing returns, their focus distracted away from what the right thing was for their customers. Payment Protection Insurance (PPI) is but one example of a cash cow product that milked the consumer. London Interbank Offered Rate (LIBOR) and foreign exchange (Forex) are two other examples where the pure profit motive rode rough-shod over ethics.

I’ve heard it said that the insurance sector had a good financial crisis – that you escaped the prudential issues, and escaped the consequential public opprobrium (although that, in itself, may only be true to an extent. Arguably, the insurance industry is suffering indirectly from the contagion of public cynicism about financial services, generally).

But, regardless of the causes and effects of the financial crisis, there are lessons to be learned which the insurance industry can benefit from.

Coming from the Retail Banking Sector, bringing a different perspective to the Insurance Sector, I see a number of common features relatable to the insurance industry and their business models.

So, for example:

• Rapid technological change – that goes beyond digitisation - into the realms of Artificial Intelligence, Big Data and machine learning. To what extent will incumbents be disrupted, or even dislodged, by InsurTech or the Tech Giants such as Amazon, Apple and Google? Who will be the winners and losers?
• Societal change – customers’ expectations are now more than speed and convenience. Customers expect fair treatment, and customer displeasure can be swiftly vented through social media.
• The ‘new normal’ of low interest rates and the impact this has had on the returns insurers are able to generate through investment activity.

As a regulator, we expect firms to look forward, by testing the sustainability of their business models and strategies in light of these threats - and opportunities.

Their analysis should include consideration of possible consumer harm arising from:

• operational resilience
• fraud
• the impact of incentives and rewards on individual’s behaviours, such as driving inappropriate sales
• budget pressures on critical functions such as risk, compliance and HR

A keystone of any sustainable business model and strategy must be customers’ trust.

Trust underpins the entire insurance industry. ‘Trust’ is not just a firm-specific thing. It is fragile and ethereal and can only be built up over time; but trust can be lost through gradual erosion, or suddenly with one significant event - and its loss is often high impact and viral. Each firm in the insurance industry relies on each other to maintain standards – whether insurer or intermediary.

This point is well illustrated through the results of the Chartered Insurance Institute’s (CII) Public Trust index which has highlighted the impact that loyalty pricing is having on public trust in the industry.

Arguably, from a reputational perspective, no firm in the distribution chain should want to be associated with the manufacture and distribution of a product where the inherent value to the customer is salami-sliced away; where each player in the chain takes ‘their cut’; but that cut bears little or no relation to the value that the player brings to the end-user.

IDD requires insurers and brokers alike to exercise sound judgement in the interests of their customers. A tick-box compliance approach isn’t the answer.

Any incentive for the industry to protect its reputation by self-policing has now been overlaid by the imperative of the IDD. IDD now precludes insurers and intermediaries from shrugging and declaring ‘not our problem’. Our Implementation of the Insurance Distribution Directive has introduced requirements to enhance the design, targeting and selling of insurance products regardless of the insurer’s or intermediary’s position in the distribution chain, and whether or not they have direct contact with the end customer.

IDD is a regulatory manifestation of changes in society’s expectations:

• An expectation that as a consequence of the insurance sector’s information and skills advantages, they have greater responsibilities to ensure the products and services they provide are in their customers’ best interests.

The introduction of IDD is, essentially, a regulatory statement of how to be trustworthy – which translates into good customer outcomes:

• Customers are directed to products that meet their demands and needs.
• Customers pay a price that is fair – and not augmented by a ‘cut’, or multiple ‘cuts’, paid to firms further down the distribution chain for little or no added value.

IDD requires insurers and brokers alike to exercise sound judgement in the interests of their customers. A tick-box compliance approach isn’t the answer.

Regrettably, we have observed areas of the markets falling short of certain IDD requirements. For example:

• Firms failing to ask appropriate questions to identify the customer’s needs (such as failing to ask whether the customer has alternative cover or would be willing to make a contribution to the cost of a claim).
• Firms overloading the customer with product information rather than focusing on disclosing the key, appropriate and relevant product information.

Firms must address any shortfalls in compliance quickly. To be clear, we will take action if we identify harm occurring.

I also encourage you to read our recent Dear CEO letter concerning the GI Distribution Chain[1] to ensure that your firm is not falling short in any of the areas identified in that letter. The sort of harms we’ve observed include:

• Customers being offered products with limited value.
• Customers paying potentially excessive prices due to the remuneration taken by various parties in the distribution chain.
• Customers receiving poor service where lack of clarity on roles and responsibilities means no-one in the distribution chain takes ownership for dealing with a customer issue.

These potential harms can often be traced back to shortcomings in firms’:

• systems and controls
• governance, including clarity in relation to firms’ roles and responsibilities as manufacturers and distributors of GI products
• culture and purpose

Which leads me to the second area where there should be alignment between the FCA and the Boards, Executive and owners of well-run firms.

A customer-focused culture

Since I moved from supervising retail banks to supervising the insurance industry last October, I’m often asked for my view on how the two sectors compare from a conduct perspective.

Culture is an acknowledged key root cause of the major conduct failings across financial services in recent history.

My initial impression is that the insurance industry is on a similar journey that the banks have been on, albeit insurance is arguably progressing more slowly in relation to maturity of understanding and implementation of the FCA’s conduct agenda, in particular culture.

The follow up question I’m then usually asked is ‘Why do I think there is that lag?’

I suggest two reasons:

• Firstly, the financial crisis has put banks under the spotlight, revealing behaviours which have caused public indignation. This has created a burning platform for cultural change in banking.
• Secondly, the SM&CR, which was applied to banks back in 2016, has clarified responsibility and accountability at senior management level.

Culture is an acknowledged key root cause of the major conduct failings across financial services in recent history.

We all know in business that successful delivery usually goes hand in hand with a healthy firm culture, that delivers good consumer outcomes. This is why we focus on four drivers of culture through our approach to supervision:

• purpose
• leadership
• approach to rewarding and managing people
• governance

My wish is that the insurance sector can make a step change in its approach to conduct and culture, with the support of the SM&CR.

As an organisation, we will support firms to make that step change towards embedding a healthy culture, with customers at its heart, drawing on the lessons of the banks, and hopefully avoiding their mis-steps.

So, what are some of those lessons?

• Set the tone from the top. Have a clearly articulated purpose and supporting values.
• Match words and actions. Encourage and reward the behaviours and outcomes that align with your firm’s purpose and values.
• Create a working environment which encourages everyone to speak up. Your staff should be the custodians of your firm’s reputation and integrity. The risk that poor behaviours or poor customer outcomes go undetected are reduced when everyone feels they can speak up. But ‘speaking up’ will only work when it goes hand in hand with ‘listening up’. If a firm fails to listen and react appropriately when someone has been brave enough to speak up, then their staff are much less likely to continue to speak up. On this point, let me plug a webinar we hosted[2] in November last year on the topic of Psychological Safety. This contains ideas on how even a small change can achieve positive change.

My wish is that the insurance sector can make a step change in its approach to conduct and culture, with the support of the SM&CR.

Whilst we undoubtedly encountered some initial resistance to the SM&CR, once firms in other sectors started to implement it, I was struck by how quickly Boards and Executive Committees welcomed the clarity of responsibilities and accountabilities that the SM&CR has given them. This clarity is not simply a matter of regulatory compliance, it is also good business practice and beneficial for firms of all sizes.

Drawing on the lessons learned from rolling the regime out to banks and building societies, I hope you may find the following observations useful:

• Think beyond the implementation date. Gather together a multi-disciplinary team to plan how the regime will work as ‘business as usual’.
• Make sure everyone in your firm understands the Conduct Rules – and what those rules mean for them as individuals. These are the foundation stones that set the standards of behaviour for everyone in financial services.
• Most importantly, the SM&CR is about culture. We look to firms’ senior management to nurture healthy cultures in their firms that will reduce the risk of harm to customers.

Brexit

Last, but by no means least, let me say a few words on Brexit.

I say a ‘few words’ because, as a non-government agency, the FCA’s role is to advise government on the financial services implications of Brexit, and then to implement Parliament’s directions. So there is a limited amount I can say.

I’d like to start with an acknowledgement, based on my own experience, of how generally responsive the insurance sector has been in working with us to understand the consumer implications of Brexit, in particular a hard Brexit. I’ve been impressed by firms’ planning, and how firms have thought through the support they will provide to their customers, including communications.

That customer- focused approach is a welcome sign of the sort of culture we want to see more widely across the insurance sector.

I encourage firms to continue to plan for a range of scenarios, including one in which we leave with no-deal on 31 October, or in which we leave sooner with a deal and an implementation period. Firms should understand the impact of these scenarios on their contingency planning and, where appropriate, revise their plans accordingly. To reiterate our messages[3]:

• All firms should understand what a no-deal Brexit might mean for them and their customers, and be communicating accordingly.
• All firms should be prepared, for whatever and whenever the outcome.
• UK insurance intermediaries intending to continue their distribution activities to the European Economic Area (EEA) policyholders and for EEA risks, should agree arrangements with local regulators and seek legal advice as appropriate. There are various models proposed for the continuation of this activity and it is a complex area.

Complexity accompanies much of the discussion on Brexit. However, we expect firms to be able to translate that complexity into communications which their customers can understand. As intermediaries, you are often the first point of contact for your customer. Therefore, it is critical to have a clear strategy for communicating with your customers so they fully understand what (if any) the implications are for them.

Please do continue to visit the FCA’s Brexit pages[4], which has a page specifically dedicated to general insurers and intermediaries[3]. We update this so you have a single source of information, can understand our expectations, and signals areas for you to consider.

As with other organisations, we have been planning for a range of scenarios. And, as with other organisations, we used the lead up to 29 March and 12 April to test and refine our plans.

We have been working with individual and pan-European authorities to mitigate the potential harms caused by a no-deal Brexit, as addressed by the European Insurance and Occupational Pensions Authority (EIOPA) recommendations published in February.

We have also been taking the lead in preparing for a transition period, and envisaging a post-Brexit regulatory environment.

You may have seen Andrew Bailey’s recent speech to Bloomberg[5] focused on the future of regulation and how Brexit will clearly be a defining factor for the UK.

Stronger prudential and conduct regulation has been built globally in the ten years since the financial crisis. Brexit will not significantly impact on this global initiative.

There will be no bonfire of our rules in any post-Brexit scenario. However, there will be opportunity for the UK to consider a regulatory system based more on principles and less on detailed rules.

There are still questions to be answered on a number of Brexit topics, regulatory equivalence arrangements being just one. We are clear that any equivalence arrangement must have substance behind it to provide a framework that creates predictability for financial markets, the firms operating within these and ourselves as regulators.

Wherever we end up, our markets will remain closely linked with the EU and we expect you to remain close to developments in this area and support your customers throughout the coming months.

Current work in the insurance sector

There is a lot going on in the insurance sector from a conduct perspective:

• the recent thematic work on General Insurance Distribution Chains[6] and Delegated Authorities[7]
• the introduction of IDD[8]
• publication of the findings from the Wholesale Intermediaries Market Study[9]
• the current Market Study in General Insurance Pricing Practices[10]
• Brexit[11]

As you seek to navigate through all of this, I would simply encourage you to hold to your North Star of:

• sustainable and trustworthy strategy and business models
• a customer-focused culture supported by openness, honesty and professionalism