Speech by Clive Adamson, Director of Supervision, the FCA, at the General Insurance conference, London. This is the text of the speech as drafted, which may differ from the delivered version.
We want to see an industry that operates to the highest standards of integrity from top to bottom; that is genuinely built around the interests of its customers; that delivers products and services that meet customer needs, are easy to understand and provide value for money; that will deliver on its promises to these customers; and finally, where customers benefit from, and firms thrive in, a competitive environment.
A very warm welcome to all of you to what is our first conference for the general insurance industry. The aim of today is for us to share with you our views about the industry, our overall strategy and within that more specifically, our agenda for your sector. In my opening speech I will cover what we have achieved in our first year, the key aspects of our new approach and how our experiences over the last year have informed our strategy and agenda for the sector over the next period. Following this, Martin will give an overall FCA perspective and later on Chris Woolard will cover how we see our work on competition adding a further dimension.
Firstly though, I would like to talk about why we are having this conference now. Partly, the timing reflects the fact that we are now one year in as a new regulator and that makes it a good time to take stock, reflect back to the industry what we have seen so far, and to re-iterate what our supervisory approach will be. It also though reflects the importance of your industry, the consequent need to have a shared understanding of what we are trying to achieve and to build an approach, where we can, of working with the industry to solve problems.
A few words then about your importance. The UK insurance industry is the largest in Europe and the third largest in the world. UK authorised insurers write insurance premiums of around £115 billion in the UK and overseas. The protection provided by insurance products and services to consumers, small businesses and large companies is vital in providing peace of mind, economic continuity and management of risk and is therefore integral in oiling the wheels of a modern growing economy. Not only that, but of course the industry contributes to the economy through its employment of very significant numbers of people, through its contribution to the balance of payments through overseas earnings, and to the reputation of the UK as a key financial centre through the long and distinguished history of the London insurance market.
The environment though within which the industry operates is changing and in certain respects is changing rapidly. Declining state provision means risks are shifted back to consumers and markets, technological revolution gives more power to consumers, changing consumer tastes mean different distribution channels are necessary and the decline in trust in institutions means integrity is all important.
All of this means that, as the conduct regulator, we have a strong interest in the whole general insurance market and the different sectors that operate within it. So, what is it we are trying to achieve strategically? Put simply, we want to see an industry that operates to the highest standards of integrity from top to bottom; that is genuinely built around the interests of its customers; that delivers products and services that meet customer needs, are easy to understand and provide value for money; that will deliver on its promises to these customers; and finally, where customers benefit from, and firms thrive in, a competitive environment.
What have we seen so far?
Before I reflect on the work we have done so far and what it tells us about where the industry is, I would like to say something more generally about what we are seeing across financial services in response to the conduct agenda and how that plays into our supervisory approach.
The key point is this - I have seen a sea-change in the attention being paid to the conduct agenda. Two or three years ago, conduct was something that most firms thought of as a compliance issue and so delegated it to compliance functions. Now, I would say that conduct is very firmly on the agenda of executive management and boards and we welcome that.
Part of the reason for this is that firms have come to realise the cost of getting this wrong in terms of potential regulatory fines, redress costs and litigation costs but also reputational damage. However, aside from managing the downside, firms are also realising the benefit of good conduct performance in terms of building customer trust. This is more than the traditional focus on customer satisfaction but about building a positive reputation for fairness.
What are we trying to achieve as a conduct regulator?
In answering this I would start by saying that, if the market worked perfectly and consumers were completely rational, then there would be no need for us. In that world firms would treat their customers fairly because it was in their interest to do so and consumers would buy products and services that were in their best long-term interest.
In many other sectors we see this happening with companies that are trusted and provide good value products and services that consumers want, gaining customers and business from competitors that aren't so effective at this. We all experience this first hand and see for example how a company like John Lewis prospers while others don't.
In an ideal world the same would be true in financial services, so that firms who provided poorer value products and lost trust because they didn't treat their customers fairly would lose business until they either went out of business or competed their way back.
The reasons that this market solution doesn't work in financial services is a combination of a number of factors – many of the products are complex and hard for a consumer to fully understand, many are long-term in nature and judging fairness for a consumer is difficult, consumer understanding is poor, there is substantial consumer inertia, consumers have behavioural biases, providers are not significantly differentiated and some markets are not sufficiently competitive. These are the reasons why a regulator is needed to act on behalf of consumers and investors to ensure that the financial services market operates fairly and, by so doing, redress the balance that is otherwise biased against the consumer.
So, what is the approach we should have?
Essentially, following on from the arguments I have made, we are about making markets work so that retail consumers achieve fair outcomes and wholesale markets operate with integrity. If these can be achieved, then the market imbalance will be corrected and, as a by-product but a very important one, the trust in financial services that I referred to earlier that has been eroded and is so important for a modern growing economy, will be restored.
Our approach to achieving this is to be a regulator that is judgement-based, pre-emptive and pro-competitive and prepared to be tough when things go wrong. This approach though is based on an outcomes-focused philosophy.
I would like to explain further what this means and in particular what I mean by outcome-focused. Regulatory philosophy has coined various phrases such as ‘principles-based’, as opposed to ‘rules-based’; ‘intrusive’ as opposed to ‘light touch’ and ‘credible deterrence’ as opposed to the ‘Governor's eyebrows’. These may seem like variations on a theme but they do in reality encapsulate quite different approaches and this is true for an outcome-focused approach.
What it means is that we are fundamentally interested in what consumers actually experience as outcomes and then try to fix the causes of what is leading to outcomes that are not, or may in the future may not be, fair. This translates to a model where:
- firstly, we look at whole markets to see whether they are working in the interests of consumers and where market studies are the methodology to determine whether lack of competition is the driver of problems and where structural solutions may be needed
- secondly, at sectors where we use thematic work to look at specific problems where the right outcomes may not be being achieved and where changes in firms' behaviours may be needed, and
- lastly, at individual firms where we are looking for key drivers of potentially poor conduct behaviour
This means at the firm level, particularly for the large firms that have the biggest consumer and market footprint, we are looking at how the interests of the customer and market integrity are at the heart of how their business is run – this means our focus is on the firm's business model, culture and front-line activities such as product governance and less on second-line controls. This focus on how the business is run, rather than how it is controlled, is a fundamental change and is directly linked to our outcome-focused philosophy.
What do we expect firms to be doing?
We have said that we want firms to put consumers and market integrity at the heart of how they run the business. Unpacking this means that we expect firms to treat customers fairly while maintaining prudential strength and achieving an adequate return for their owners. In other words, we don't expect that the interests of customers should be subjugated either to prudential strength or the interests of shareholders.
This raises two questions: firstly, how should firms best ensure that customers are at the heart of how the business is run and secondly, how can the balance between customers, shareholders and prudential authorities be maintained on an ongoing basis?
So, what have we seen as firms have started to come to grips with these questions? We have seen that firms have reacted, perhaps not surprisingly, in a variety of ways, from strengthening compliance, to building in stronger consideration of customer fairness through the product life-cycle, to launching cultural and behavioural change programmes, to setting risk appetite, to changing incentive programmes and to thinking about business model changes. While I don't want to be prescriptive about what 'good' looks like, I do want to make some observations about what we have seen and what seems to us to be the key elements of an approach that may work.
I would start by saying that fair treatment of customers is not, in my view, something that can be reduced to a risk to be managed – that way leads conduct to be treated as a compliance question with ever-expanding armies of compliance people checking that process has been followed – in other words a tick-box compliance approach. This is not in my view likely to improve outcomes for consumers. While I support a strong ‘three lines of defence’ model, it seems to me that the conduct question is more a cultural and business model challenge and therefore should be firmly rooted in the first line.
The fundamental reason for this is that fair treatment of customers and proper behaviour in markets are inextricably linked with how businesses are run or, in terminology I have used before, it is about doing the right thing for the customer. The business model challenge – that exists for your sector as well as the rest of the financial services industry – is how to evolve current models into ones that are demonstratively 'safe' from a conduct perspective. -hese in my view are ones that have a lower cost base, so that there is less pressure to press for marginal income growth to support an inflated cost base; that don't overly rely on profits from back book customers to subsidise new customers; or have high degrees of cross-subsidisation between products; or rely on products that are highly profitable or that involve rapid growth rates.
Moving on to culture it is certainly my view that having the right culture is essential for achieving good conduct performance. This is not though a fluffy view of vague corporate aspirations or value statements, but a need for a more hard-edged embedding of business practices that define how decisions will be made through the firm at critical points of engagement with customers or dealing in markets. There are key drivers that re-enforce the right conduct-focused culture with the most important being clear and ongoing leadership from the top of the organisation, constant re-enforcement, incentive structures, effective performance management and penalties for not doing the right thing.
The other key aspect of front-line business management is product design. 'Good' here involves understanding the needs of particular customer groups, working through what a fair outcome means for a particular product, stress testing how the product performs in different scenarios, whether it constitutes good value to the customer, how it will be sold, whether consumers' behavioural biases are being exploited in the sales process and how post-sales service over the product lifespan will be designed.
The final aspect of what 'good' looks like is governance. As I said earlier, we are pleased that the conduct agenda is now more firmly at the board level. Our expectations though are high – although we are not expecting the board to approve every product as that would be both unrealistic and confuse their role with that of executive management, we do think that boards should understand how and where the firm makes money, what the conduct implications of that are, how customer outcomes are tracked across the product life-cycle as well as the more traditional oversight over control functions.
What we have done?
Returning now to the work we have done so far. I hear from many of you that you think we are doing too much! Well, we need to listen to that and make sure that our work is properly focused, joined up across the FCA and carried out as efficiently as possible. I would say though that the whole industry has probably had less regulatory oversight from a conduct perspective than others so to some degree we are catching up.
In our first year our thematic work focused predominantly, but not exclusively, on the experience of retail consumers. This is for two reasons: firstly, we were concerned that products and services were falling short of consumers’ expectations; and secondly, most retail consumers are not sophisticated buyers of insurance and are less likely to engage with detailed product information.
So we have shone a light on different aspects of the consumer journey through all stages of the product life cycle: how products are designed; how they are sold – including how conflicts are managed; how claims are handled; and in the event things go wrong, how complaints are dealt with. We also undertook our first market study in general insurance and where it has been most relevant, we have supported our work with consumer research to understand consumers’ experiences and expectations. But as you know, the FCA’s focus is not just on retail consumers, so we have recently looked at the provision of products and services to SME customers, and I will come back to our work in relation to other types of consumers and areas of the market we plan to focus on over the next period.
What does the work we have done so far tell us?
Our strategy for the general insurance sector is to work towards consistent consumer outcomes by raising conduct standards.
I would say five things:
- Firstly, many firms do broadly work in the interests of their customers.
- Secondly, and this is the ‘but’ after the first statement, retail consumer outcomes vary markedly, which is dependent to some degree on the business model of the firm and the extent to which a customer-focused culture is embedded in the way it carries out its business. For example, our recent work on claims handling for household and travel showed that across all of the policyholders we surveyed, 64% were either ‘satisfied’ or ‘very satisfied’ with their experience, which we see as broadly positive, and we uncovered no evidence of systematic attempts by firms to deny valid claims, squeeze settlement costs or deliberately slow claims down. We did, however, identify a number of areas where improvements will further increase customer satisfaction
- Thirdly, the industry has responded constructively when challenged – following our motor legal expenses thematic review, firms did respond to our findings and we are now moving forward with the outputs of the GI add-ons market study to ensure that those standards are consistent across the market
- Fourthly, conflicts of interest are a problem - our recently announced results on the work we have carried out in the broker market suggest that more needs to be done to effectively manage conflicts
- Fifthly, there are also market structures and practices that work less well in the interests of consumers and Chris Woolard will talk later this morning about the work we are doing in relation to the GI add-ons market study. Our day-to-day supervision still tells us there is a gap between consumers’ expectations and firms’ ability to service their needs
Overall then, I would summarise our view of where the industry is at; it is generally heading in the right direction, there is a good understanding of where we would like it to be, it is responsive to challenges but more could be done to completely embrace the conduct agenda. Consistent with that, our strategy for the general insurance sector is to work towards consistent consumer outcomes by raising conduct standards. For the retail market this means maintaining the momentum and embedding the progress made over the last year and, for wholesale markets, it means increasing our focus on board engagement in consumer outcomes, on distribution chains including coverholders, and on the connectivity between commercial and retail markets.
Of course, regulatory initiatives are not the only way to make progress. In some areas, the industry has also taken steps in proactively to develop its own initiatives - not just addressing issues we have highlighted - but raising the bar on conduct more generally. Most notable are initiatives such as the Chartered Institute of Insurance’s (CII’s) Aldemanbury declaration, which has reached critical mass, and the work of the Society and Corporation of Lloyd’s on conduct standards, and the industry response to the public policy issue on access to flood cover and we welcome these steps.
We set out in the Business Plan that we published on April 1 our intention to carry through the changes we see as necessary stemming from the GI add-ons market study and some of you have already signalled your intention to be involved in the industry working groups on the proposed remedies we set out in March. Later this year, we intend to publish our new rules on client assets, as the protection of clients’ money continues to be important and our supervision work suggests that firms’ controls in this area need improvement. We also intend to establish whether areas where we have already shone a light are indeed starting to deliver better outcomes for consumers.
We have spent less time so far focusing on wholesale and commercial markets in our thematic work. However, we set out in the Business Plan our intention to undertake two further pieces of thematic work focused on some of the more complex structures in relation to distribution chains in firms that operate in wholesale markets, but also looking through to the impact on retail and small commercial customers. We propose to look into the key risks in complex distribution chains and the mixed responsibilities in them, including the cultural risks relating to product design, sales and post-sales handling. In this respect, good consumer outcomes are reliant on all links in the chain. We will also look to build on findings from our recent retail claims and conflicts of interest work, and look at whether commercial customers’ expectations are met in the claims process, where poor behaviour could have a wider impact on trust in the market, as well as leading to poor customer outcomes.
In addition, we have dedicated a significant part of our supervisory resource engaging with Lloyd’s and London market firms and in particular improving our understanding of the conduct risk profile of the Lloyd’s market, what types of customers firms in this market serve and the different levels of their sophistication. We are keen to continue our dialogue with Lloyd’s on the degree of oversight they can give in respect of managing agents’ conduct obligations and this will be a key area in the coming year.
But it’s not all about role the market has to play in working towards greater consistency of consumer outcome. We also have to reflect on how our regulatory framework supports this objective. And we recognised this in our cross-FCA work in relation to complaints handling where our Handbook does not support firms’ ability to deliver good outcomes and we are working to change that. And there may well be other areas where we might need to change and adapt as markets don’t stand still.
It has been clear to me that having constructive and pro-active engagement with the industry, working together and sharing good practice, has enabled us to get to better outcomes more quickly than we would otherwise have done. We intend to continue this approach where we can to maintain momentum.
I would like to make a few concluding points to draw the threads in this talk together.
Firstly, it has been clear to me that having constructive and pro-active engagement with the industry, working together and sharing good practice, has enabled us to get to better outcomes more quickly than we would otherwise have done. We intend to continue this approach where we can to maintain momentum.
Secondly, I recognise that the significant changes in regulatory architecture and approach, both in the UK and globally, present challenges for the industry and individual firms. We will endeavour to take this into account as we carry out our work.
Thirdly, we have seen the industry react positively to the conduct agenda and I both welcome that and encourage you to keep at it.
Lastly, I am optimistic about what we can collectively achieve with will on both sides. I believe that effective regulation and sustainable businesses go hand in hand. The style of regulation that I have emphasised here that is predictable and measured with an approach that is judgement-based, pre-emptive and pro-competitive will, if we succeed in carrying it out with the quality and professionalism we aspire to, help achieve the fair treatment of customers that lie at the heart of truly sustainable and successful businesses.
Once again, many thanks for giving me your time this morning and I hope you enjoy the rest of the conference.