Insurance conduct and culture – a new regulatory focus

Australian Royal Commission and New Zealand review

Insurers and insurance intermediaries in New Zealand are under intense scrutiny by regulators, the media and customers as the Australian Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry unfolds.

The Financial Markets Authority and the Reserve Bank of New Zealand are undertaking their own review of the banking, insurance, superannuation and financial adviser sectors to determine whether the systemic failures that have been identified in Australia exist in New Zealand.  The focus is upon business processes, conduct and culture.

The insurance sector review is on-going, with a report expected later this year.  This will follow the FMA’s report on its review of the banking and superannuation sectors, which is due in October.

Context – the FMA’s earlier QFE investigation

The FMA was already focussing upon conduct and culture in the insurance sector before the present review, primarily in the sale of life insurance – particularly replacement life insurance.  In its July 2018 report on QFE insurance providers’ business practices in relation to replacement insurance, the FMA reported that it had reviewed the processes of eleven QFE life insurers and explored whether their processes were designed with good customer outcomes in mind. The FMA found that fewer than half advised customers of the risks of replacing existing life policies with new policies, and three of them may have breached their legal obligations.

The FMA focussed upon replacement insurance policies as a particularly high-risk transaction for customers, because of the risk of claims being declined in the future and original policy benefits being lost.  Even where the impacts on policyholders are neutral, the FMA was concerned that replacement of policies benefits the QFE rather than the customer.

The FMA was particularly concerned that the vertically integrated product sales model that many QFE insurance providers employ creates an inherent conflict of interest.  The FMA considered that this sets QFE advisers up to fail in complying with their obligations, even if they do not receive commission based remuneration. The FMA said that it will continue to use its regulatory tools to monitor conduct, sales and advice practices and commissions structures in QFE insurance providers.

The key findings in the report were the following:

  • Most firms had processes to identify when a customer was being advised to replace life insurance.  However, these seemed oriented towards reducing the provider’s legal risk, rather than risks for customers.
  • Fewer than half of the firms reviewed advised customers that replacing their life insurance could lead to worse cover or the potential loss of benefits.
  • Although firms use specific “replacement business forms”, these were used mainly as a risk management tool for insurers at the end of the advice process, not to help customers’ decision-making.
  • Only one of the insurance providers reviewed had an independent process to distinguish between new and replacement business.

Australian Royal Commission’s Interim Report

At the time of writing, the Australian Royal Commission has just released an Interim Report following the first four rounds of public hearings held between March and July this year, focussing on misconduct in the banking and financial adviser sectors.  The FMA and RBNZ have been awaiting the Interim Report before they report on their review on New Zealand Banking Conduct and Culture, which is expected towards the end of October.

Although the Australian Royal Commission’s Interim Report does not cover the insurance round of hearings that have been held more recently, it will nonetheless be used by all financial institutions, including insurers, to continue to further guide the improvements in their own practices and procedures that have already begun.

The Interim Report is lengthy, comprising three volumes.  Its findings make sobering reading.  In answer to the question – “Why did this misconduct happen?” the Commission suggests that the answer is: “Too often, the answer seems to be greed – the pursuit of short term profit at the expense of basic standards of honesty.”In answer to the question “How did it happen?” the report says that:

Banks and all financial services entities recognised that they sold services and products. Selling became their focus of attention. Too often it became the sole focus of attention. ..From the executive suite to the front line, staff were measured and rewarded by reference to profit and sales.

Where misconduct was revealed, it either went unpunished or the consequences did not meet the seriousness of what had been done. The conduct regulator, ASIC, rarely went to court to seek public denunciation of and punishment for misconduct. The prudential regulator, APRA, never went to court…”

We anticipate that the Australian regulators will become much more proactive in taking enforcement action for misconduct in future.

FMA review

In New Zealand, Rob Everett, the CEO of the FMA, recently stated (in his speech to the September 2018 Conference of the Financial Services Council and Workplace Savings NZ) that:

We are still learning on the job and we appreciate that the industry is too. We have however signalled that while we are proud of the efforts we have made to engage with and set out our expectations for the industry, we are also frustrated in places with the slow pace of change.  That frustration will manifest itself over time as we become less understanding and less tolerant of firms that talk a good game but don’t put the hard yards in to make sure it happens.”

It can be safely assumed that financial services providers that do not take heed of the regulators’ warnings and make changes to meet expected standards of conduct will run the risk of attracting the FMA’s critical scrutiny and potentially regulatory action.

What insurers should be doing

Insurers are taking heed of these warnings.  They are using the FMA’s findings, as well as the misconduct identified during the Australian Royal Commission hearings, to guide improvements in their own practices and procedures.  The need to change historical sales driven business models to more customer-centric models is becoming widely accepted. The financial adviser regime reforms soon to be introduced with the passing of the Financial Services Legislation Amendment Bill will also assist to drive cultural changes within the financial services industry, including in the insurance sector.

It is imperative that insurers and intermediaries ensure that their business processes and culture are fully aligned to the FMA’s view of good conduct, as set out in its updated Guide to the FMA’s View of Conduct in February 2017. The five “building blocks” of these good conduct principles are:

  • Communication: Listen to customers and help them understand your products and services
  • Capability: have the skills and experiences to provide the right products and services. Meet professional standards of care. Seek continuous improvement through training.
  • Conflict: Serve business and customer interests. Disclose and discuss conflicts. Explain related party arrangements.
  • Control: maintain systems to support good conduct. Seek out continuous improvement. Effectively manage complaints.
  • Culture: Act in the interests of customers. Treat customers honestly and fairly. Conduct expectations communicated clearly by leaders and understood by staff. Address poor conduct and recognise and reward good conduct.

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