UK: Insurance Market Update - The Deloitte View For Life Insurers

Welcome to this August edition of the Insurance Market Update, in which we focus on issues in the life insurance industry.

The impacts of the recession, such as increasing unemployment and the deflated housing market, mean that demand for many insurance products has fallen. Profits are down and there is pressure from shareholders on senior management to deliver better returns. As a result, many firms will be seeking to increase new business volumes and entice customers back through the door.

This focus on new business brings significant regulatory and customer risks and in this month's article, Chris Terry and Julia Fachon look at potential mis-selling risks. They look at the importance of providing quality advice on sales, responding to changes in customer needs and ensuring that risks are managed effectively within a firm's governance framework.

We hope you find this edition informative and, as always, your comments and suggestions for future themes or topics are welcome.

Managing the risks of mis-selling in a recession

Economic recession introduces a number of risks and challenges for manufacturers and distributors of investment products, the underlying themes of which will be very familiar: poor or increasingly volatile product performance, decreasing investor confidence and demand, together with increasing or changing customer expectations around product service and delivery. All of these inevitably increase the risk of unsuitable sales and/or mis-selling. These risks should also be considered against a regulatory backdrop that demands an increasingly tight grip on solvency as well as the need to be managing risks and delivering to the customer, consistently and right first time.

These risks and challenges pervade the entire product and customer experience lifecycle but also go right to the heart of strategy, governance and a firm's culture. In this article we explore some of the direct challenges firms may face in quantifying and mitigating the risks of mis-selling, looking across key elements of the product and customer lifecycle. We will look at:

• the provision and quality of sales and advice;
• customer insight and understanding;
• product design and performance; and
• finally, some very broad governance and strategic considerations.

Product sales and quality of advice

The current recession has already led to a drop in demand for some types of financial products. The recent ABI Savings and Protection survey¹ for Q2 09 indicates that the popularity of savings, stocks and shares continues to be low. Those unfortunate enough to lose jobs will find it difficult to maintain policy payments or investment contributions and many still in work will retrench their spending to essentials only. Many will be unwilling to invest more or, as ABI figures again suggest, turn their focus to non-mortgage debt repayment. When consumer demand is subdued, there is the potential risk that the standards of sales quality will drop as sales forces and intermediaries fight over a diminishing pool of available customers' money.

As the pressure on sales volumes increases, firms need to ensure that they maintain sales quality standards and consider potentially different and more advanced tools to do so. This might mean much greater, proactive and joined up use of wider business management information, identifying and using a broad range of sales quality indicators. Firms may well review new business from a quality/compliance perspective with quality checking integral to the sales process. They may also seek to gain more assurance from a customer perspective, choosing to undertake mystery shopping and post-sale client satisfaction surveys, whilst validating and challenging this against a host of other indicators, such as persistency and complaints data.

However, our experience shows that many firms still struggle to take either a holistic or proactive enough view of sales quality and fail to link up and respond to the breadth of sales "quality'' indicators, taking action as soon as is needed. Firms should also look at how all "quality" indicators can be used to drive behavioural change in their sellers. That might be through up front and ongoing investment in training, performance management and/or remuneration schemes that recognise and reward good performance but can address shortfalls in quality at an individual level. We are still aware of firms where "quality" indicators fail to make a significant, if any, effect on the income and bonuses of sales staff.

Firms must recognise that in a challenging market place, all business that is available must be won by firms fairly. If not done fairly, the eventual profit stream will be potentially diluted by future increased lapse rates or costs of redress.

Understanding your customer/customer understanding you

Recession brings concerns for customers in relation to job security, incomes and more general consumer confidence. Firms may also be slow to recognise how these changing circumstances will directly affect how customers make investment choices. Importantly, firms may not always be quick to re-focus their 'customer lens' by understanding changing customer needs and demands and so continue to sell the same types of products while expecting the same customer response.

For example, the historically low interest rates, the bruising experience of bank defaults and stock market volatility have created a situation paradoxical to accepted investment lore. Customers seeking growth on investments are now valuing security more and those seeking income may actually be considering more risk to maintain their income. Other assumptions are being challenged too. Funds that advertised themselves as 'balanced' now experience negative returns in the short term and sectors that were seen as potentially stable have lost their sheen (e.g. property funds may have been sold as a balanced/adventurous investment but are they not now definitely 'adventurous'?). Holding money in cash was always considered the cautious route, but for a few months in 2008 the security of large cash deposits with several key banks was at risk or, in the worst case, subject to actual losses.

Some of the direct consequences of failing to respond to these shifts are obvious and include: increased complaints, redress & compensation, poor quality sales with low persistency rates.

We have seen several firms that are now re-assessing their product profiles in response to changing customer needs and investment performance. As a result some firms are also amending how and what they communicate about their products through associated sales guides, used by in-house advisors or third party distributors/ intermediaries.

Irrespective of whether a product or its literature needs to be changed, it is clear that firms need to be consistently and continually considering and responding to the changing landscape of product returns and customer needs and demands.

Product design and performance

Firms need to consider, and keep considering, their portfolio of both current and past products and whether these remain appropriate to changing customer needs. Much of this will be done through the ongoing formal product governance processes.

There are a wide range of impacts on product design, performance and appropriateness that need to be considered. These include investment performance against objectives, actual against planned customer targets, sales and persistency data and complaints information. However, some of the factors that are often missed include:

• market change – investment returns, cost of guarantees and sector wide issues. We have already cited property as an example, particularly commercial portfolios;
• tax change – for example the impact of capital gains tax changes on the attractiveness of Bonds;
• actuarial change – for example changing morbidity/mortality rates; and
• regulatory change – a key example being Treating Customers Fairly and consideration and management of customer risks.

Firms should be more proactive in spotting changes across a wide number of areas before they crystallise into potential consumer loss. This also means considering the extent of these changes when identifying risks and prioritising and scheduling their ongoing product governance programmes.

One less savoury area in the field of performance is the acknowledged increase in complaints. Broadly speaking, complaints solely on investment performance can be refuted if these investment risks were made clear at the sale. But in a time when many customers may want to access funds quickly or feel aggrieved by the market volatility, there are increased "opportunity" complaints. Some are just clients trying their luck to gain back market losses, some will be more sinister in that they come close to being fraudulent. Firms will want to keep a tight rein on such claims.

Risk management, governance, strategy & culture

Product governance leads us to our final point, that a firm's overall governance framework is the arena for all its risks to be managed, in line with its strategy and business objectives. As we said from the outset, firms are often not good at steering through the risks and issues we have covered with the breadth of focus required. Risk management turns into full blown crisis management as the risks and issues outlined above have already crystallised. These are then dealt with in isolation where risks to meeting business targets and strategy are mitigated without consideration for the wider customer or reputational risks of potential mis-selling.

Senior management should proactively deal with this by accepting the need to properly manage the impact of a recession on customers and products, not just capital and the bottom line and recognise the real need to maintain a viable, risk managed business.

Footnotes

1 Q2 2009 ABI Savings and Protection Survey

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.