Our previous article addressed the interaction between competitiveness and conduct risk in the ToR and subsequent regulatory publications. This article addresses themes and initiatives that are likely to inform the FCA's response to the Market Study's findings.
The subject of the Market Study is: "… risk business, from overseas and the UK, placed by brokers with Lloyd's syndicates and insurance companies operating in … London … [for] cover purchased by large corporate clients … and … portfolios [of SME risks] pooled together and placed in blocks …"
Two of the Market Study's main topics are:
- conflicts of interest – especially as to the selection of products and risk-carriers for insureds; and
- conduct that could be adverse to insureds' best interests.
Conflicts and conduct are key features of the FCA's recent Business Plan 2018/19 and its discussion paper: Transforming Culture in Financial Services (the discussion paper).
The Business Plan specifically refers to the Market Study and also indicates links to the FCA's wider work in the insurance and other financial services sectors. The Discussion Paper provides evidence of thinking that the FCA could apply in addressing cause and effect between conduct, conflicts and culture.
The Business Plan spells out the importance of the Market Study for the FCA, describing the wholesale insurance market as "underpinning" the wider general insurance market that "has a central role in enabling activity in industries such as construction, agriculture, manufacturing, leisure and professional services … [Therefore it] is vital [the wholesale market] works well and keeps adapting to meet new needs and changing circumstances."
The Business Plan makes wider references to wholesale markets, which implicitly include the London Market: "The firms we regulate and their senior managers are responsible for ensuring that they act in accordance with our principles and rules … To do this, we take a forward-looking and strategic approach. This includes looking … at how … wholesale markets are evolving. To supervise effectively, we need a thorough understanding of … business models, strategies and cultures … This allows us to recognise more effectively the risks of harm that a firm, or group of firms, pose.
"… Our work is concentrated on … drivers of harm in wholesale markets [including where] … market participants [fail] to deal with each other appropriately … [such as] through … Conflicts of interest and a lack of clarity … about the capacity [in which participants] are acting … [These factors can result] in … participants overpaying for services or products, [or] purchasing poorly performing products [or] products or services that do not meet their needs."
In managing its compliance risk, it is important for the London Market to understand that the FCA sees it as part of a bigger piece, and
not an exception. For instance:
- the ToR emphasise the Market Study's focus on "distribution chains" and the ramifications of the "client … not necessarily [being]
aware of the length of the chain of firms involved in placing the risk"; and
- the Business Plan highlights "the first phase of … diagnostic work on value in the distribution chain [for] tradesman insurance, travel insurance and motor ancillary insurances …"
Some might see such consumer products as remote from London Market business. However, not only does the ToR explicitly cover "portfolios [of SME risks] pooled together and placed in blocks", the Business Plan explains that the FCA's distribution chain analysis "follows [previous FCA] thematic reviews of delegated authority and appointed representatives". Evidence from regulatory, media and market representative studies shows that distribution through delegation is a vital feature of the London Market.
As highlighted in the ToR, studies show rising acquisition costs are potentially associated with increasingly extended distribution chains. More importantly for regulatory purposes the FCA regards its own reviews as showing "that the value of insurance products and related services could be eroded through the distribution chain."
The discussion paper contains a handful of references to insurance, with most being less than flattering, such as: "The increased use of digital comparison tools to buy general insurance has led to a 'hollowing out' of policies, higher excesses and increased administrative costs. People's understanding of what their policy covers differs considerably from the reality … This is hardly surprising when terms and conditions can run to hundreds of pages, and use incomprehensible jargon.
The FCA says that firms should not exploit behavioural biases … Yet that is exactly what they do. Long-standing home insurance customers pay on average 70 percent more for their annual premium than a new customer would …
Financial Ombudsman Service … Uphold rates are above 40 percent for … insurance … suggesting that many firms are treating customers unfairly and not taking responsibility for doing so."
Again, some might dismiss the discussion paper because of its emphasis on retail insurance. Yet it does indicate approaches to diagnosis and remedy that the FCA could take if the Market Study were to result in findings that:
- certain practices that engender competitive efficiency in the London Market give rise to conduct that is detrimental or
disadvantageous to insureds, and therefore
- the continuation or proliferation of these practices reflects or drives a culture that does not have the best interests of customers at its
Included in the discussion paper's wide-ranging content is "… the metaphor of an iceberg as a means of describing the difference between [certain] overt and objective elements of an organisation ([e.g.] systems, structures, stated strategies, financial control and reporting mechanisms, information technologies, procedures … etc.) which [are] definable, measurable, open to inspection and even controllable, and … more covert aspects.
"These latter properties, inherent in each and every organisation, consist of the perceptions, emotions, attitudes, value systems, interpersonal dynamics, conflicts and even power agendas imported into the organisation by the human beings that inhabit it. And these are, by definition, below the water level of the iceberg, submerged, subjective, irrational, unpredictable, … unmeasurable. But they have a massive impact on an organisation and often subvert the rational, above-the-water level agenda, sometimes fundamentally."
This last point is highlighted in a reference to the advisory work of the Financial Stability Board in global financial markets and "its stocktake of measures against misconduct, [which] concluded that 'the culture of an institution can defeat its formal governance.'"
The above propositions suggest that the UK authorities' work on insurance market governance in the form of the Senior Manager & Certification Regime will not — possibly even cannot — be sufficient to prevent conduct and conflicts of interest in the London Market that are contrary to customers' best interests.
If so, the authorities would need to look at alternative solutions. These could include explicit and detailed rules on restricting or
removing the mechanisms and structures that are salient features of the current operating environment for the London Market, such as:
- full transparency as to each entity involved in the distribution chain, and what its role and remuneration is;
- limitations on the circumstances in which broker facilities can be used; and/or
- bans on the involvement by certain market entities in MGAs.