Key conduct issues that all insurers should consider

The Financial Markets Authority (FMA) expects the insurance industry to prioritise and improve its conduct and culture ahead of the new conduct regime brought in by the Financial Markets (Conduct of Institutions) Amendment Bill (CoFI Bill).  The Insurance conduct and culture: Fire and general insurers update (Review), which was released in July 2021, makes clear that the insurance industry is not meeting the FMA’s conduct expectations.  This review echoes the findings in the joint review of Life Insurer Conduct and Culture with the Reserve Bank of New Zealand (RBNZ) in 2019 (Life Insurer Review).

The Review found that, overall, the responses showed poor understanding of and commitment to good conduct and culture practice across the sector.  Just two of the 42 insurers met the FMA’s expectations. Around 95% of insurers’ responses were unsatisfactory for the FMA.

While current laws do not provide specific conduct requirements for insurers, the FMA is clear that now is the time for the industry to take meaningful steps to improve its conduct or risk facing regulatory action when the new conduct regime comes into force.  This article explores the key findings and recommendations from the Review and what will be required of insurers under the new conduct regime.

Governance

The Life Insurer Review included a directive for all insurers to actively consider conduct risk within their business.  Fire and general insurers were asked to complete specific tasks, including a requirement to develop an action plan to address any issues in their business arising from the recommendations in the Life Insurer Review (which included weaknesses in governance and accountability for conduct and culture).  The FMA’s Review provided that responses were well below their expectations.

The FMA found that Board engagement was mixed across the industry.  Only one board amended its charter to reflect their governance of conduct and culture, while others used audit and risk committees to discuss conduct and culture issues.  However, others were not sufficiently engaged: eight insurers’ audit and risk committees overlooked and excluded conduct and culture risks in their risk management frameworks, and in several cases, it was unclear how conduct and culture risk identification and management was integrated and embedded across the business.

The CoFI Bill includes a requirement for a fair conduct programme to clearly define the roles, responsibilities and accountabilities for managing risks associated with conduct that fails to comply with the fair conduct principle (new section 446M FMCA).  Therefore, insurers should further develop their conduct plan with the future CoFI requirements in mind.  Each plan should clearly outline the governance arrangements, including the roles of the Board and senior management in managing conduct and culture.

The FMA expects Boards to prioritise conduct risk.  Boards should ensure they have a clear mandate over conduct.  In particular, foreign-owned insurers should ensure they have the independence and control to identify and manage conduct and culture risks in relation to their New Zealand practice.  While there is no one-size-fits-all approach, conduct governance should occur at both a Board and sub-committee level, with effective two-way communication channels within the business.

Boards and senior management need to set the tone for managing conduct risk and prioritising good customer outcomes.  The Review encouraged each Board to further articulate their expectations for managing conduct risk in the business.  Boards then need to ensure that they have sufficient information from the business to satisfy themselves and to hold management accountable for meeting their expectations.

Controls and processes

The FMA found that majority of insurers are not yet prepared for the new conduct regime.  The Review shows that insurers need to prioritise investment in improving internal systems, processes and controls in order to effectively manage conduct risk.

Insurers now have a directive to consider conduct risk within their business.  Each insurer should ensure that it has set an appropriate risk appetite, which acknowledges conduct risk as a material risk.  Insurers should also ensure that conduct risk is embedded in its risk management policies.  Policies should set out roles and responsibilities, outline systems and processes to monitor and control material risks and be subject to regular review.

The CoFI Bill will require insurers to apply a principles-based approach to ensure good customer outcomes.  This represents a shift from compliance-led regulation to conduct-led regulation, which requires insurers to consider the fair conduct principle throughout its business and act beyond minimum requirements.  The new regime will require insurers to conduct a deeper examination of their existing culture, governance, policies, processes and procedures.

Insurers should review their existing policies and frameworks, applying a conduct risk lens.  In particular, insurers should ensure that they have sufficient controls in place to manage conduct risk (focusing on key policies such as vulnerable customer and whistle blowing policies) and that each control effectively manages conduct risk.  In particular, insurers should review their code of conduct to ensure a focus on good customer outcomes.  New or amended policies should be communicated to, and implemented by, staff ahead of the new regime.

Product review

22 out of 42 insurers conducted the systematic review of products and policy-holder portfolios requested by the FMA.  Of those, all but four identified “major issues”.  Most issues related to weaknesses in systems and processes, poor value, legacy products, and insufficient ongoing monitoring of product suitability.  Positively, six insurers withdrew poor value or legacy products from sale.

Product review will become an essential part of an insurer’s fair conduct programme when the new conduct regime comes into force.  In order to treat consumers fairly, insurers will be required (among other things) to ensure that their services and associated products are likely to meet the requirements and objectives of likely customers (new section 446B(2)(d) of the Financial Markets Conduct Act 2013 (FMCA)).  This obligation applies when the product is designed, offered to a consumer and provided to the consumer.

We suggest that insurers:

  • Clearly articulate intended outcomes for products (including new products) to consumers.
  • Review products regularly to ensure they remain fit for purpose and relevant to those intended outcomes.
  • Review existing products to assess whether they remain relevant, suitable and fit for purpose.  Insurers should also review the product review process to ensure that design and suitability is appropriately assessed.  Where issues are identified, root cause analysis should be conducted.

Remediation of issues

Remediation activity to address issues identified from the FMA review is already underway by several insurers, with thousands of customers set to receive refunds as a result.  The FMA considered that many insurers did not meet the “basic requirement that premiums are accurate, transparent, administered correctly and with value communicated to the customer”.  The FMA expects compensation to be paid in a timely manner, and for the root cause of issues to be adequately addressed.

Under the new regime, insurers must treat consumers fairly when providing a relevant service (for example, when acting as an insurer, providing a financial advice service or acting as an intermediary for those services), which includes any dealings or interactions with a consumer in relation to their insurance policy (section 446C(c) and (d) FMCA).  Among other things, we expect regulators to have heightened attention on insurers’ conduct during claims and complaints handling.

Insurers need to review their remediation practices to ensure that they have formal remediation frameworks, policies and processes which centre around treating customers fairly.  In particular, insurers should consider how their remediation process ensures that they:

  • Pay due regard to consumers’ interests;
  • Act ethically, transparently and in good faith;
  • Assist consumers to make informed decisions; and
  • Not subject consumers to unfair pressure or undue influence.

Incentives

While many insurers were addressing staff incentives (including removing volume-based sales incentives), there was less proactivity in relation to commissions paid to intermediaries.  The FMA expects insurers to have better oversight on commissions and incentives, including to intermediaries, which should be “fair and reasonable to customers, and understood by customers”.

The Government has signalled its intention to take action in relation to sales incentives with the introduction of the new conduct regime.  The CoFI Bill contains a regulation-making power which allows for the prohibition or regulation of any practice or conduct related to offering or giving incentives.  The Bill also includes an obligation on insurers (and other financial institutions) to put in place policies, processes, systems, and controls for designing and managing incentives to mitigate or avoid the actual or potential adverse effects of incentives on the interests of customers (new section 446M(1)(b) FMCA).

In the consultation paper (issued 24 May 2021) on regulations to support the new regime, the Ministry of Business, Innovation and Employment (MBIE) indicated their preferred option was to prohibit sales incentives based on volume or value targets. MBIE considers that such a prohibition would prevent the inherent conflict of interest with consumer interests that is created by the incentive.

Insurers should consider how their existing remunerations structures would comply with the incoming conduct regime.  In particular, insurers should consider the inherent conduct risk attributed to sales incentives, and whether they should be removed from remuneration structures ahead of the new regime.  Insurers should also consider how to incentivise good conduct, such as through remuneration based on customer satisfaction, compliance with policies or through demonstrating good conduct culture.

Oversight of intermediaries

Intermediary oversight by insurers was identified as a key issue in the FMA’s Review.  The FMA considers that fire and general insurers, like life insurers (per the joint review of Life Insurer Conduct and Culture 2019), should take ultimate responsibility for customer outcomes regardless of how products are sold.  However, in its consultation paper (issued 24 May 2021) on the treatment of intermediaries under the new conduct regime, MBIE indicated that it would pare back the obligation to have oversight of intermediaries.

The Finance and Expenditure Committee amended the CoFI Bill at Select Committee stage to remove the requirement for intermediaries to have a fair conduct programme, and for financial institutions to ensure the intermediaries’ compliance with its fair conduct programme.  It is likely, following MBIE’s consultation, that the application of the CoFI Bill to intermediaries will be further limited.  In its consultation, MBIE proposed to limit the CoFI Bill’s application to intermediaries involved in the sale and distribution of the financial institution’s products or services and narrow the financial institution’s oversight obligations.

While intermediaries are no longer directly subject to the obligations in the CoFI Bill, financial institutions are required to have oversight of intermediaries to ensure they are supporting a financial institution’s compliance with the fair conduct principle including by (new section 446M FMCA):

  • conducting competence and fit and proper checks;
  • setting clear conduct expectations;
  • establishing procedures to address an intermediary’s misconduct; and
  • monitoring whether intermediaries are treating consumers consistently with the fair conduct principle.

It is unclear how extensive the requirements for oversight of intermediaries in the CoFI Bill will ultimately be.  However, insurers should note the obligations under the new financial advice regime and the need to ensure that they and their intermediaries comply with the duties under the regime and the Code of Professional Conduct for Financial Advice Services (which includes, for example, the duty to always treat clients fairly when giving financial advice).

Insurers should therefore be proactive in managing the relationship with the intermediaries it engages, particularly with those involved in sales and distribution.  Insurers should ensure that the contractual arrangements with an intermediary set clear conduct expectations and include robust procedures for monitoring and enforcing those expectations.

Next steps

The Review provides a useful guide as to those matters the FMA expects fire and general insurers to consider as they prepare for the introduction of the new conduct licensing regime set out in the CoFI Bill (which is expected to be in force in early 2023).  Re-assessing their conduct and culture governance frameworks, and considering and acting on the relevant recommendations in the Review, will be essential to insurers demonstrating readiness for the new regime.

Co-authored by Maria Collett-Bevan and Sarah Jones.

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