The Financial Markets Authority and Reserve Bank of New Zealand have released their Report on findings from their review of the conduct and culture of New Zealand life insurers (the Insurance Report).

As widely predicted, the Insurance Report is much more critical of the life insurance sector than the Regulators’ November 2018 Report on Banking Sector (the Banking Report). The Regulators state that, while they found relatively few instances of potential misconduct, they “saw serious weaknesses in the approach of insurers to identifying, managing and remediating conduct risk and issues”. They also expressed concern that some insurers who sell their products through intermediaries often do not consider they are responsible for the intermediary’s impact on customer outcomes, instead seeing the intermediary as their customer.

In line with the extent of the issues identified by the Regulators as a result of their review of 16 New Zealand life insurers, the Regulators are more prescriptive in their requirements of the sector, providing very clear direction in their Report on the matters that need to be addressed and by when (30 June 2019).

The Insurance Report also makes a number of recommendations to government for strengthening the regulatory framework governing conduct in the life  insurance sector (and by implication, the general insurance sector as well). The Government has announced today that it plans to fast-track consumer protection measures in the financial sector, including banning sales incentives in the insurance industry that are driving behaviour that is not in the best interest of consumers. The government plans to release a consultation paper on the changes by May and introduce legislation later this year.

Who needs to read it? Why?

Although the Insurance Report focuses on life insurers, all participants in the insurance industry need to read the Insurance Report. The Regulators note that non-life insurers are also expected to assess their conduct and culture frameworks against the findings in this Report and consider and act on all relevant recommendations made by the Regulators.

The Boards and senior management of life insurers will need to quickly digest the Report’s contents, so that its key messages can be disseminated appropriately and the any operational and cultural changes required to address the Regulators’ concerns are able to be put in place, and reported on by the deadline of 30 June 2019.

We also recommend other financial service providers read the report, as it provides a clear view of the standards to which the Regulators consider they should be held – and which may be relevant as the spotlight moves to other parts of the industry.

What does the Report cover?

The main topics covered are:

• What the Regulators reviewed
• What the Regulators’ found
• Recommendations for life insurers
• Regulatory gaps

The Report found:

• Life insurers have been complacent in addressing conduct risk, too slow to implement changes following FMA reviews, and insufficiently focussed on developing a culture to balance shareholder and customers’ interests. There is “extensive” weaknesses in life insurers’ systems and controls;
• There were instances of poor conduct, and potential misconduct (albeit these were relatively few). However, there is a serious risk of further conduct issues arising in the future. The RBNZ/FMA saw evidence of the insurers’ sales incentives structurers creating risks that sales would be prioritised over customer outcomes;
• The RBNZ/FMA saw limited evidence of products being designed (and sold) with good customer outcomes in mind, as well as a varied approach to ongoing contact to monitor the continued suitability of products. There were limited policies to deal with potentially vulnerable customers;
• Until the review, few life insurers had seriously considered conduct and culture issues. Boards and senior management were not setting a tone to manage these issues and prioritise good customer outcomes. The Report expressed some concern that the boards of insurers which were part of a bank or a foreign-owned insurer were not sufficiently independent;
• The RBNZ/FMA were also concerned that a lack of analysis of the systems, processes and controls in place against the matters highlighted by the Australian Royal Commission (ARC) meant that insurers risked misplaced confidence that similar issues would not occur here;
• In situations where sales and advice were provided through an intermediary, the RBNZ/FMA found a lack of oversight and responsibility for the sales, advice, and customer outcomes;
• Training on products, sales, and advice was generally under-resourced and under-prioritised. In particular, training for intermediaries was inadequate and there was little evidence of training on conduct expectations;
• Reporting on conduct risk was limited and often focussed on ‘lag’ indicators such as complaints. Conduct risk management was insufficient integrated and risk management functions were frequently resourced too thin. The process and systems for customer complaints and incident management were generally under-resourced and inconsistently used. The RBNZ/FMA observed it cannot be confident life insurers’ are aware of all current issues;
• While most insurers had a whistleblower policy, these did not always provide an anonymous, confidential and independent channel for raising concerns. The policies were not always well-known, and overall were infrequently used. However, staff across most insurers indicated they would be comfortable raising an issue;
• Remediation of conduct issues has been poor with insurers’ responses being slow or insufficient with insufficient systems to monitor and manage remediations. In some extreme cases there was complete disinterest in remediation at all;
• The RBNZ/FMA observed “consumer trust is paramount to the effective functioning of the life insurance industry in New Zealand. We are concerned that this trust could be eroded unless life insurers – led by boards and senior management – transform the way they approach conduct risks and issues, and achieve a customer-focused culture.”[1]. 

The Report identifies a number of areas for life insurers to make substantial improvement in order to identify, manage, remediate and report on conduct and risk issues and to deliver consistently good customer outcomes, including:

The role of boards

• Boards need to take responsibility for setting the tone from the top, with a focus on good customer outcomes, by having a clear plan for change that sets targets, assigns responsibility, includes milestones and ensures information flows to all parts of the organisations.

Oversight of intermediaries

• Insurers need greater oversight of how intermediaries are selling and managing their products. Both insurers and intermediaries need to be responsible for ensuring good customer outcomes, but the insurer remains ultimately responsible for this.

Product design, training and support

• New products should be designed to provide good customer outcomes and target markets and intended outcomes for products need to be clearly identified.
• Staff need to receive ongoing comprehensive training on the products they sell and support.
• Insurers need to proactively and regularly communicate with their customers and encourage customers to consider whether their needs have changed and whether the product remains suitable for them.

Policies and processes

• Risk management processes need to be appropriate and incorporate all material risks, including the monitoring and management of conduct risk, and the review of advice provided at point of sale and over time.
• Insurers must have a relevant code of conduct, educate staff on good conduct, and have clear policies, processes and training for identifying and dealing with vulnerable customers
• Insurers need to have an accessible, confidential and independent whistleblower process.

Identification and remediation of issues

• Insurers need appropriate and sufficiently resourced systems and processes to record and resolve customer complaints and incidents and to proactively identify and resolve issues.

Incentives

• Insurers are expected to remove or substantially revise incentives linked to sales for sales staff and all layers of management no later than the first performance year after 31 December 2019, and, if not to be removed, to be able to explain to the Regulators, by 30 June 2019, how control systems will be strengthened to mitigate conflicts of interest and risk to customers.
• Insurers are also expected to review commission structures for intermediaries, and change their qualifying criteria for soft commissions, to ensure they are incentivising the delivery of good customer outcomes.

Regulatory gaps

• The Insurance Report notes that the RBNZ, the FMA and the Commerce Commission each regulate parts of the wider insurance industry, but no regulator has oversight of insurers’ and intermediaries’ conduct over the entire insurance policy lifecycle.
• The review has not identified any notable regulatory gaps from a prudential perspective, but there would be benefit in progressing some of the enhancements being considered under the IPSA review.
• Some of the IMF’s recommendations in its Financial Sector Assessment Program (the FSAP) included a number of recommendations for the RBNZ and FMA which have implications for conduct regulations, which are being considered as part of MBIEs’ review of insurance contract law.
• Given the similarities in the nature of the regulatory gaps identified as part of the Banking Report, and the benefits of having a consistent framework across regulated industries, the Regulators suggest that the government consider establishing similar regulatory duties to apply to life insurers.
• Most notably, since the Insurance Report was released today, Commerce Minister Kris Faafoi has advised that Government would fast-track consumer protection measures in the financial sector, and would ban sales incentives in the insurance industry that are driving behaviour that is not in the best interest of consumers. Government plans to release a consultation paper on the changes by May and introduce legislation later this year. The consultation on these new measures would run alongside work already under way to update insurance contract law.

Our view

The regulation of the insurance sector (both life and health, and general) has been under intense scrutiny over the past two years, since the IMF/World Bank released the 2017 regulatory assessment of New Zealand’s financial system, which identified a number of gaps in our regulatory framework, including a lack of conduct regulation of the insurance industry.

Previous criticism of conduct

In addition, through several thematic reviews and discussion documents, the FMA has been openly critical of the heavy reliance by some life and health insurers on commission-based sales structures, and the potential harm that such structures can cause to customers. FMA considered that the conflict of interest inherent in such commission-based sales structures creates an increased risk of customers being mis-sold insurance products that do not ensure good customer outcomes. The FMA has therefore signalled the need for the sector to make significant changes to the way in which insurance products are marketed and sold, through to the way in which claims are managed, requiring a more customer-centric approach than exists currently.

What is already being done

However, many insurers are already moving to address some of these concerns. A number of life insurers last year voluntarily abolished the use of soft commissions following the findings of the FMA in its May 2018 report on conflicted remuneration in the life insurance industry. The new code of conduct developed by the Financial Services Council (FSC) for its members (whose members include 95% of the life insurance market in New Zealand) launched on 1 January this year. The code covers ethical, communication and consumer outcomes which designed to complement existing regulation and laws. Breach of the code can result in fines of up to $100,000 or termination of membership. On its website the FSC says “we are clear that we need to take the lead in lifting standards to deliver better outcomes for New Zealanders. We know that we don’t always get it right and we know that we cannot be complacent….We believe that this [the Code] is just the beginning, and by working with Government and Regulators on initiatives such as the Financial Services Legislation Amendment Bill, together we can deliver great consumer outcomes.”

However, despite these initiatives, the Regulators have continued to be vocal in their concern about their findings of conflicted conduct in the life insurance sector and inadequate attention paid to customer needs already identified in the various thematic reviews. It therefore must come as no surprise that the Insurers’ Report is critical that more and faster change in the sector has not yet occurred, and that the requirements for change in the sector are more prescriptive than those in the Banking Report.

Regulatory gaps

The themes emerging from the Insurance Report are likely to be reflected in important policy decisions in connection with the review of insurance contract law and conduct currently being undertaken by the Ministry of Business, Innovation and Employment (MBIE), and the review of the Insurance (Prudential Supervision) Act being undertaken by RBNZ.

Indeed, this has already been confirmed by the announcement today that government will fast-track legislation to address the issues identified in the Insurance Report (and the Banking Report that preceded it), including a ban on conflicted sales incentives. This demonstrates the importance placed by government on ensuring consumer interests are adequately protected by regulation both in the wider insurance and banking sectors.

In the meantime, the imminent changes to financial advice regulation to be introduced by the Financial Services Legislation Amendment Bill will go some way to address the Regulators’ concerns around the mis-selling of insurance products and insurance churn, but will not be sufficient to address the deeper concerns expressed around insurer responsibility for good customer outcomes.

The Regulators’ hard deadline of 30 June for life insurers to put in place changes to their systems and controls to remediate the poor conduct they have observed during their review, and the promise of government led regulation to enforce changes to the incentives-based sales structure of the insurance industry will serve as an immediate incentive to insurers to make those changes ahead of the regulatory imperative to do so.

What next

The ARC Report is due to be released in the next few days. More will be known then about the findings of the Australian Royal Commission in relation to insurance misconduct in Australia (an aspect not covered in the previous ARC Interim Report).

New Zealand insurers and brokers will need to take heed of those findings, and life insurers are also required to undertake a gap analysis of those findings against their own business structures and processes as part of the Regulators’ requirements imposed on life insurers under the Insurers’ Report.

The FSLAB remains before the Committee of the Whole House, with the indicative timeframe for passing into law unchanged as by 31 March 2019.

If you have any questions in relation to the Insurance Report or what this might mean for your business, please contact one of our experts.

Footnote

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