Good conduct and market integrity

I want to argue that the lessons we’ve learnt over the last six years have the potential to create a business environment that’s significantly better post-great recession, than pre.

I want to start with a sincere thank you to the insurance industry for its positive engagement with the FCA over a year of significant change.

We remain, of course, locked into an enormously important period of our financial history – navigating make or break debates around the social utility of some of our biggest firms, as well as witnessing sweeping changes in technology, demographics, public attitudes, and so on and so forth.

So, in a very real sense, the decisions and directions we take today are likely to reverberate for many years to come.

And while this is clearly a pressure, I do want to make the case that, if handled correctly, it’s also an important opportunity to move things forward for the insurance industry.

In fact, I want to argue that the lessons we’ve learnt over the last six years have the potential to create a business environment that’s significantly better post-great recession, than pre.

And by this I do not just mean ‘better’ in terms of public credibility. So, building trust and confidence. But better in terms of creating greater long-run stability in our financial markets. Effectively, taking advantage of this period by rectifying past mistakes and learning from them.

And this is where the FCA’s post-crisis emphasis in the insurance industry on issues like conduct, ethics and prevention enter the picture.

So, as we all know and saw in the years building up to 2008, the official spotlight was very much on compliance. Using rules to de-risk. Indeed, between 2005 and 2008, FSA guidance grew by some 27%. A pattern repeated not just in the UK by the way but around the world as industry looked to adopt firm-friendly means of protecting consumers.

The great irony here of course was that a model designed to reduce uncertainty ended up achieving the exact opposite. So, we saw the strong bias for rules over ethics fanning the flames of the multiple conduct-induced crises that followed.

And what happened next, while not necessarily fair, nor reasonable, was perhaps inevitable. The reputational consequences of scandal were effectively mutualised across industry.

The best firms could of course point to others as the source of the problem. But the cumulative impact of misconduct was to poison the well from which all firms drank: as we saw in London’s fall down the Global Financial Centres Index earlier this year.

Wholesale conduct

there’s no room or reason for complacency here. Commercial insurance may not have quite the media ‘pizzazz’ of retail, if you like. Partly because it’s more complex. Partly because it’s harder to link its activities to people’s everyday experiences. But it’s clearly just as susceptible to conduct shocks.  

The FCA, as Clive Adamson has just outlined, has been charged with carving a more stable future out of this difficult context. Hence, the broad focus last year on business models, consumer outcomes, culture, prevention and so on.

And as we look ahead, to the next 12 months and beyond, the broad priorities will remain the same. Essentially using the current context as an opportunity to move conduct forward so we can, in turn, create greater market integrity over the long run.

The important question of course, is how we achieve this?

And there are a couple of major priorities I want to focus on today. First, oversight in the London market. Second, a broader look at the challenges in the retail insurance market.

Let me start with the former, so the London market, where it bears repeating that the UK has much to be proud of.

Even as the world around us has transformed in previously unimaginable ways - the advent of technology, big data, globalisation and so on – the City’s leading position in the global insurance market has, at times, appeared almost impregnable.

In other words, in terms of its relative position to other financial centres, you can make a credible case for saying not much has changed since the coffee houses. 

And in a way, this is no great surprise. Quite apart from the professional capability attracted to London, we know the City has persistently taken advantage of societal change and innovation to create a niche for itself in insurance.

But we’ve also seen a few close shaves along the way – perhaps the closest shave of all related to the insider trading scandals of the 1970s and 1980s that dominated the insurance industry up to, and beyond, publication of the Neill Report in 1987.

So, there’s no room or reason for complacency here. Commercial insurance may not have quite the media ‘pizzazz’ of retail, if you like. Partly because it’s more complex. Partly because it’s harder to link its activities to people’s everyday experiences. But it’s clearly just as susceptible to conduct shocks.  

And a specific risk I want to highlight in relation to the above, is the danger that oversight in the wholesale space has not yet extended far beyond capital and profitability.

So, as important as capital buffers, aggregate management and the like are (and they are) – it is equally critical for firms to have regard to market integrity, to have a good handle on conduct, particularly in areas like financial crime risk.

An immediate question here, or so it seems to me, is to ask whether boards are confident that the product or service they’re supplying offers value to the end-customer. Particularly where product development and product distribution span different parts of the market.

How do we know cover holders and agents are delivering expectations of fair customer treatment? 

And if they’re not, who then does reap the reward? Are we facing a situation where the benefit is mostly felt by those in the supply chain – so distributors up to insurers and shareholders? And, if so, what do we do about it?

A priority question here for regulators relates to integration. So, effectively what we’ve witnessed over the years is a blurring of the lines between what were traditionally wholesale markets on the one hand, retail markets on the other.

Products are now being developed in different parts of the industry, with multiple routes to consumers. And each of these layers, in effect, is performing a different role, with distribution chains often spanning across both wholesale and retail. 

Adding to the sophistication here, we know management of complaints and claims are dealt with across a complex web of structures in many parts of the market. 

And this is where it becomes less certain whether these structures are delivering good outcomes for consumers, or indeed having an impact on the effective functioning of the market.

For those looking in from the outside, this all looks very much the classic ‘black box’ of finance that Michael Lewis so famously talked about. And, as is often the case in markets of this nature, complexity tends to invite more questions than it answers.

So, as we delve deeper, a few immediate challenges seem to present themselves. How do we, for example, manage the collective challenge of customer-facing distributers that are unregulated, such as mobile phone distributors?

Is conduct oversight at board-level sufficient? Are commercial insurers confident they’re treating smaller businesses fairly? And, importantly, are products meeting the needs of less financially sophisticated customers?

When the FCA published its thematic review into conflicts of interest recently, it was interesting to see the confusion among SMEs over the differing roles of intermediaries. Not simply the varied jobs they perform, but also what they’re remunerated for – so we shouldn’t assume a business background equates to a sweeping expertise of industry.

And for me, this is a cautionary warning for the insurance industry as it considers its own relationship with smaller businesses. It’s also, as we shall see, an issue that the FCA will be probing over the coming year.

Retail

retail insurers make an enormous economic contribution. And, just as importantly, they make an enormous contribution to people’s day-to-day lives. The ability to understand risk and protect ourselves against it.

The second area I want to focus on this morning – retail insurance – has attracted more attention over the last year – for all the reasons that commercial/wholesale insurance sometimes falls under the radar.

And for this reason, I do think it’s important to bring perspective here.

So, for some the insurance industry has been psychologically bundled into the bracket of generally untrustworthy financial services. For others, it stands far apart. Neither responsible for systemic crisis, nor a contributor to any of the conduct crises that followed.

It seems to me that both sides risk being on the wrong side of this argument.

So, yes, retail insurers make an enormous economic contribution. And, just as importantly, they make an enormous contribution to people’s day-to-day lives. The ability to understand risk and protect ourselves against it.

Flood Re is the obvious example here - but so actually was the industry’s response to this winter’s flooding, where the vast majority of claims appear to have been settled by firms with minimum fuss or bother.

Balanced against this of course, there is legitimate concern over the way general insurance complaints have waxed and waned over the last few years – at times significantly. And the mood music has not been helped by large redress schemes.

As we look to move conduct forward from this point, it is clearly important for regulators and firms alike to maintain perspective on strengths as well as risks. 

It’s also clearly a difficult fact that the insurance world is today dominated by tricky market conditions for many firms. Rates are continuing to soften across a number of business lines. While for leaders, there is the added day-to-day pressure to meet returns on capital and maintain margins.  

A good question in this context then is how do we create greater certainty and integrity?

Now, prevention by the regulator is undoubtedly one factor. Effective regulation – by which I mean regulation that anticipates conduct crisis – is much better than a low value, disruptive clean-up operation after the event.

But I’d also argue that the industry itself has a role to play here. In other words, rather than waiting for official intervention, spot and mitigate future risks internally ahead of time.

What, for example, is the right balance between the treatment of new and existing customers? Does the inertia we typically associate with back-book consumers create its own challenges?

And another important issue, where will the electrifying pace of technological change take us?

All sort of questions here spring to mind: how does innovation affect purchase? How do consumers interact with these new technologies, especially as the techy-desire to simplify and improve usability rubs up against the complexity of financial products?

And, finally, a challenge that’s been circled by lawyers, compliance departments and regulators for longer than I care to remember – disclosure.

The key question here: how do we support consumers more effectively than we have in the past – particularly in insurance, where we see so many product features and exclusions?

A major challenge, it seems to me, is that we know the pre-crisis reliance by regulators on disclosure has largely failed. Or at least, we know that consumers don’t engage with it, even if it has been embraced by our legal community.

Why are we in this space? Because faced with a breakdown of price efficiency or rationality, the standard industry response (encouraged by regulators) was effectively to provide more information and provide it more quickly.

So, if someone didn’t appreciate the risk of a product, we extended the description; if it looked too risky, we pushed people to the risk profile that allowed a sale.

People were required to tick the boxes – that they had high-risk appetites; that they had read and understood the terms and conditions; and, that the decision was their own, that it was a non-advised sale.

What followed, of course, should have been predicted. The complexity of financial products led to the ever-increasing length of terms and conditions associated with financial products, at least one bank (which I won’t name) offers a basic current account with T&Cs longer than Hamlet.

And a challenge here for all of us here is that the majority of people do not read these documents. Or, if they do, comprehension is often an issue. We know, for example, that some 20% of financial service customers do not understand whether a higher or lower APR represents a better deal.

The FCA has done work here in areas such as behavioural economics, which is helping firms deliver better communications to consumers.

But I suspect a sizeable chunk of future progress will be industry-led, as new technology and attitudes to transparency create different models of customer service.

And, as an aside, can I say how welcome it is to see some of our insurance firms already looking at the possibility of two-page T&Cs.

It is important, I think, for the FCA to support this more ‘open source’ approach, if you like. And that’s one of the reasons why we last week announced an agreement to grant waivers to product disclosures that don’t follow FCA guidance to the letter – if firms can work with us to prove they are better for customers.

Later this year, all this work will be pulled together into a single paper, alongside a consultation on potential Handbook changes.

I’d encourage firms here to engage – either direct or through the roundtables we’re running next month.

Conclusion 

I do appreciate, of course, that there’s a considerable challenge here in terms of applying lessons learnt. I also appreciate the significant strides our insurance industry has already taken. For all the challenges we face, it is almost impossible not to see the importance our insurance firms attach to consumers and clients.

Managing reform and societal shift of this magnitude is never straightforward for leaders – whether in business, politics or indeed regulation.

But for me, the far greater risk would have been to find ourselves on the wrong side of global momentum.

All around the world, reform of conduct is dominating industry – to the point that we’re seeing financial centres actively competing on issues like market integrity and cleanliness.

So, in Hong Kong, new requirements on product disclosure; in India, the banning of front-end fees; in Singapore, the introduction of testing for investors…

…in Australia, the best interests duty; and in the US, the implementation of Dodd-Frank, as well as the setting up of the Consumer Financial Protection Bureau. The list goes on.

In this context, it is very difficult, frankly, to see how you could ignore the importance of the link between conduct and commercial value.

And a key issue for me in all of the above, and one I’ve repeated many times over the year, is that effective regulation is not a zero sum game: the equivalent of a cricket or tennis match, where for one side to win, the other has to lose.

Improved conduct, stability, better consumer outcomes, trust, confidence: I’d argue these are strong indicators of a non-zero sum game, where all participants are victorious – like a good marriage or partnership. 

It is also, it seems to me, the key to creating opportunity out of recent challenges.