“Conduct risk” is a relative newcomer to the regulatory lexicon. What exactly does the FCA mean by this term, and how does it apply to insurers?
You won’t find “conduct risk” defined in the FCA Handbook Glossary, but the term has been in use by the UK regulators for some time. Looking back a few years, the FSA’s 2011 Retail Conduct Risk Outlook viewed “conduct risk” as being “the risk that firm behaviour will result in poor outcomes for customers”. At that time, the FSA viewed its retail conduct risk analysis work as a key aspect of its retail consumer protection strategy. For example, research that it commissioned into behavioural economics led to a concern that firms may be taking unfair advantage of consumers’ behavioural biases, such as their tendency to favour the status quo. This in turn led to supervisors questioning the use, for example, of initial free periods to sell insurance products to retail consumers.
However, since the division of the FSA’s regulatory responsibilities between the PRA and the FCA in 2013, the FCA’s remit with respect to “conduct risk” has quietly, but dramatically, widened. When the FCA speaks of “conduct risk” now, it does so in the context of its statutory objective to “secure an appropriate degree of protection for consumers”, with “consumers” now defined under FSMA 2000 to include any person who uses (or may use) regulated financial services, from consumers through to large corporate bodies; and its further objective of promoting market integrity. While retail customers remain important, the FCA is increasingly interested in the operation of the wholesale markets and the outcomes that commercial customers receive.
What then, under the new regime, is “conduct risk” in the insurance context?
It is clear from the schedule of planned work set out in the FCA’s 2014-2015 Business Plan that the FCA has its eye on a variety of conduct risks in the insurance markets, spanning both the retail and commercial sectors. For example, its planned thematic work for 2014-2015 includes a review of commercial claims handling (scheduled to have started by the final quarter of 2014), as well as finalising the work it had already begun in relation to the sale of premium finance to retail consumers alongside general insurance products. The announcement of this work plan was foreshadowed by Martin Wheatley, speaking to the General Insurance Conference in June 2014, when he said:
“Commercial insurance may not have quite the media ‘pizazz’ of retail… but it’s clearly just as susceptible to conduct shocks.”
The expansion of the FCA’s conduct risk focus to include commercial policyholders in part reflects its concerns about socalled “wholesale/retail contagion”, whereby retail consumers may be prejudiced by poor conduct in the wholesale markets as a result of complex distribution chains. As Tracey McDermott put it in a recent speech, the FCA had previously been “focussing on misconduct in the wholesale markets that disadvantages retail consumers”. The FCA now views poor conduct in the wholesale markets as a matter affecting the level of trust in those markets, which in turn brings into play another of its statutory objectives: to protect and enhance the integrity of the UK financial system. As the FCA explains in its current Business Plan, poor behaviour in relation to commercial claims handling “could have a wider impact on trust in the market, as well as leading to poor customer outcomes”. That is why conduct risk has become so important.
The FCA’s published policy in relation to examining conduct risk in the wholesale markets is borne out by our own experience of the regulator’s supervisory activity over the past year. We have seen the FCA taking a particular interest in the types of product that span the wholesale and retail divide: for example, providers and distributors of group policies where the end consumer may be a retail consumer, but the immediate consumer is a purely corporate entity. But we have also noticed the FCA showing a far keener interest than the FSA ever did in commercial, rather than retail, lines.
It is clear that identifying and managing conduct risk has become, in the regulator’s mind, a matter that is central to the re-building of trust in our financial institutions. Insurers will therefore increasingly be asked to demonstrate to their FCA supervisors that, to quote the FCA’s Business Plan, they have “adopted a holistic approach to identifying and mitigating the conduct risk arising from their activities”. This will include the need to have tangible evidence, at Board level, of the fact that the insurer’s policies are providing valuable and appropriate protection to policyholders in relevant target market(s). The following actions are likely:
First, a review and re-structuring of firms’ governance frameworks, for example to include a specialist conduct risk committee with delegated responsibility for proactively identifying and managing conduct risks within the business – spanning commercial lines as well as retail business;
Secondly, a review of firms’ risk management functions, to ensure that conduct risks are adequately measured within the overall risk management framework;
Thirdly, a sound internal process for assessing - on the basis of cogent evidence - whether the scope of cover provided by each of the insurer’s policies is appropriate for the target market and therefore providing valuable protection to those who are policyholders; and
Finally, implementation of new processes for the collection and reporting of conduct risk management information at a sufficient level of granularity to enable firms’ governing bodies to monitor and control each of them effectively.