UK: Insurance and Conflict Management

(This article was prepared with the assistance of Laura Cooke, Associate, Financial Services Regulatory team) This article was first published on Complinet on 7 April 2006.

The management of conflicts has become a key issue throughout the insurance industry, particularly for brokers and general insurers. At the same time, many in the industry have yet to realise the extent to which the issue may give rise to concerns beyond the general insurance and retail sectors.

The FSA has stated its intention to focus on management of conflicts within the insurance industry in 2006/2007. We consider the key areas where conflict management is required and explore how the challenges set by the FSA can be met.

Just before the FSA began to regulate general insurance intermediaries in January 2005, John Tiner outlined in a speech the key issues the FSA had identified as requiring attention in the general insurance market. The management of conflicts of interest was specifically identified as an early priority. At this time, the FSA’s concerns about conflicts of interest were heightened by Eliot Spitzer’s attack on commission practices in the US insurance industry, and the implications for the UK market. As a result, the majority of the FSA’s work on conflict management in 2005 focused on commission and profit sharing arrangements.

Yet the issue is a broader one; conflict management is certainly not confined to commission arrangements alone. To this end, the FSA has stated in its recently published Business Plan for 2006/2007 that it will be focusing on the adequacy of internal systems and controls within the insurance industry for the identification, management, mitigation and disclosure of conflicts, in light of feedback to the recent Dear CEO letter. These issues will be of relevance to the wider insurance market, including insurers, but more so for intermediaries due to the complexities of agency arrangements.

The FSA’s general Principles provide a framework for considering this issue. FSA Principle for Business 8 requires a regulated firm to manage conflicts of interest fairly, both between itself and its customers, and between the firm’s customers. Conflict management is also inextricably linked to Principle 6 which requires regulated firms to pay due regard to the interests of their customers and treat them fairly. The disclosure of conflicts is relevant to Principle 7 which provides that regulated firms must pay due regard to the information needs of their clients, and communicate information to them in a way which is clear, fair and not misleading.

In November 2005, the FSA published a "Dear CEO" letter which set out the FSA’s concerns about the effective management of conflicts by insurers and intermediaries within the general insurance market.

The comments contained within this Dear CEO letter were partly based on the results of a review carried out by the FSA of 38 firms earlier in 2005 to investigate the identification and management of conflicts of interest, particularly in the area of commission arrangements. The FSA’s conclusions were:

• currently, the process for identifying and mitigating conflicts of interest is not sufficiently developed in most firms;

• conflicts of interest are often perceived in too narrow a manner, and are sometimes viewed purely in terms of commission and other remuneration arrangements; and

• in addition to being alive to conflicts which may arise from agency arrangements, intermediaries should consider how these conflicts may affect the fair treatment of customers.

The findings of this study were summarised further in an FSA factsheet published in January 2006 which included the identification of a number of other areas of possible conflict for general insurance:

• close links – customers’ interests are potentially compromised, particularly in the retail insurance sector, by close relationships between the broker and insurer which may lead to a lack of impartiality;

• claims handling authorities – the FSA is concerned that intermediaries who have the authority to bind insurers under a delegated underwriting authority may be handling claims to the detriment of policyholders where there is an equivalent claims handling authority;

• personal conflicts – it is important for intermediary firms to have a formal policy for trading by employees in the shares of clients or insurers which could lead to personal conflicts of interest; and

• inducements – remuneration conflicts are not just limited to commission and profit sharing arrangements. Conflicts can also arise in respect of binding authorities (where the binding authority operates with a profit commission, the intermediary may direct business with good claims history to the binding authority, and business with poor claims history going elsewhere), premium finance (directing policyholders to preferred finance suppliers) and soft loans and cash gifts.

Possible conflicts arising in claims handling are particularly pertinent to the concept of Treating Customers Fairly (TCF), and ICOB 7 makes particular provisions for the appropriate disclosure and management of conflicts in this area. The FSA has recently emphasised the importance which it attaches to firms embedding TCF into their culture, and that TCF must feature at all stages of the product life cycle.

It would be dangerous to regard these findings as having no, or limited, applicability to the wholesale sector. The principles and issues apply beyond the general insurance sector and consumer facing businesses. It goes without saying that each firm’s business model will give rise to differing potential conflicts of interest, depending on its size, client base and insurance speciality. No insurance business is immune to potential conflicts.

Much of what the FSA is trying to achieve in the context of conflict management is linked to senior management responsibilities, another of the FSA’s key thematic concerns. The FSA has been vocal of late in emphasising the importance of senior management responsibilities generally and, particularly, for systems and controls in their business. The rise in the number of fines made against CEOs and other senior management personnel of regulated firms over the last few years is indicative of how seriously the FSA views these responsibilities.

The FSA continues to stress that the ultimate responsibility for putting in place effective conflict management procedures sits with senior management. One way of achieving this is to view conflict management as another arm of business or operational risk management and monitor, identify and manage it in a similar fashion through audit and compliance checks. Separation of roles and Chinese Walls can also be implemented to reduce the risk of one employee being responsible for conflicting decision making. Transparency through disclosure is another tool which the FSA favours when dealing with conflicts. The FSA has been urged to require brokers to provide mandatory disclosure of commission to commercial customers, but has not (so far) made this compulsory. Some have elected to do this voluntarily.

The key to satisfying the FSA’s concerns is to ensure that businesses identify and consider the issue at the highest level and actively consider how it may arise in that business. This involves considering all the regulated activities both holistically and individually. After that, the key is not just a matter of identifying and managing actual conflicts, but also identifying possible conflicts and issues which could be perceived by customers as being in conflict with their own interests. Then, as always, retain a record of how this issue has been considered, addressed, resolved and monitored.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.