By Rebecca Sellers*
The financial services industry is changing fast. Regulatory structures designed to respond to risks from the 1990s may no longer be appropriate. The revelations of the Australian Royal Commission may damage consumer confidence. However, the Australian market is well-established, with superannuation savings worth more than $2 trillion. The damage may be justified if the process ensures that Australian financial markets are fair, efficient and transparent.
Can we learn from what is going on, without the pain and cost of a similar spectacle? Our politicians are questioning the regulators and the regulators have turned to the financial services industry for answers – firstly from the banks and now from the life insurers.
The broader question of insurers’ conduct forms part of the Review of insurance contract law.1 The Minister of Commerce and Consumer Affairs, Kris Faafoi appeared on Fair Go last week, to encourage consumers to tell their experiences. The impetus to fix technical aspects of insurance law will come from a focus to do right by the consumer. Conduct will provide a unifying theme for the Review.
Why should governments intervene?
Governments can’t bear the cost of meeting citizen’s welfare expectations. Citizens must rely on products provided by financial institutions. For example, KiwiSaver should ensure the dignity of our older citizens; life insurance should prevent the bereaved begging on the streets; house insurance should prevent people losing their homes. Insurance and other financial products should stop us turning to our politicians and saying, “something must be done”.
It has been argued that government delegation of welfare provision to financial institutions must be balanced by oversight, to ensure that institutions treat customers fairly.2 When the news from across the ditch suggests that all is not well, there is rational motivation to consider the scope, structure and powers of the regulators.
International findings are that unfair or abusive business practices can give rise to systemic risks: “Not only does poor conduct affect individual customers, it can impact the reputation of individual insurers, whole markets, or consumer confidence in the sector as a whole”.3
What is conduct of business risk?
Insurance conduct of business risk can arise from three sources. Firstly, risk arises from factors inherent in the nature of insurance business. Insurance products can be complex and intangible. Distribution of insurance is supply driven. That means has has to be actively sold, as although people are aware that they need insurance, products deal with negative situations that people would rather not think about.
Insurance distribution is usually by an intermediary and commission payments can exacerbate conflicts of interest. The Review describes complaints from New Zealand consumers about pressure sales tactics, suitability of product and insurance churn and it seeks further evidence to assess any issues with insurer conduct.
The second source of risk factors arise where aspects of the insurer’s or intermediary’s own governance models or business processes can contribute to risk. International best practice requires insurers to treat customers fairly when designing products, incentivising distribution, underwriting risk and handling claims and complaints. Although New Zealand insurers are subject to certain statutory fair dealing requirements, there is no overarching obligation to treat customers fairly. This gap is not unique to insurers – aspects of bank conduct is similarly unfettered.
The third group of risk factors arise from market-wide economic and environmental factors. As recently identified by the Reserve Bank Governor, Adrian Orr, examples in the New Zealand context include levels of competition in the general insurance market and levels of sales incentives offered by life insurers.4
How do other jurisdictions regulate insurer conduct?
New Zealand has no industry supervisor or regulator with a remit to oversee and enforce that insurers treat customers fairly, although the Financial Markets Authority has general powers that touch on aspects of insurance business.
Some jurisdictions, have supervisory models with a remit focused on insurance. For example, Hong Kong’s new regulator, the Insurance Authority, is tasked to regulate and supervise for the promotion of the general stability of the insurance industry and for the protection of existing and potential policy holders. The Insurance Authority already has responsibility for insurers and soon will directly supervise insurance intermediaries. New Zealand and Hong Kong share a common law tradition and relatively small populations. New Zealand could benefit from assessing the effectiveness of the new Hong Kong regime.
From 1998 until 2013 the UK had an integrated regulator for conduct and prudential supervision (the FSA) with responsibility for the entire financial services industry, including insurance. The effectiveness of the FSA’s Treating Customers Fairly initiative (TCF) should be considered in the New Zealand context. TCF was developed from 2001, requiring that customers were treated fairly at every stage of the product life cycle. However, the mis-selling of personal protection insurance continued under TCF, costing the UK industry more than $30 billion in compensation payments (and significantly more when fines and legal costs are taken into consideration).
Identifying the costs and benefits of TCF may assist in considering how New Zealand should regulate insurer conduct. In 2009 the Turner Review of the Global Banking Crisis identified that the wide spread of the FSA’s responsibilities increased the danger that in periods when economic and financial stability conditions appeared to be benign, prudential issues would be accorded low priority. This failure to prioritise prudential risks, led the UK to move to an objectives model where supervisory responsibilities are distributed between two regulators: one with responsibility for prudential supervision, the other with responsibility for conduct of business objectives.
This “twin-peaks” model, is the one currently in use in New Zealand and in Australia, where ASIC supervises conduct of business issues and APRA is the prudential supervisor. Research suggests that what is most important, is not the particular supervisory model chosen, but having “dedicated, high-quality supervisory personnel and sensible working practices and arrangement for cooperation”. 5
Effectively managing insurer conduct
Prescriptive rules did not protect the Australian consumers whose stories have been heard by the Royal Commission, nor those UK citizens who were sold payment protection insurance. As Julia Black noted, “Regulators face a number of challenges. They have to govern at a distance in time and space, managing behaviour, risks and phenomena which possess almost endless variety and are constantly changing”. 6 Bank strategy towards insurance is changing, as illustrated by the recent announcements of the sale of Sovereign and of Onepath. Disruption of financial services is set to continue, and regulators must have flexibility to respond to change.
The size and depth of New Zealand economy means that regulation needs to be cost effective. The FMA Good Conduct Guide states that “Conduct is particular to each business or person and
to their circumstances. A regulator cannot, and should not, prescribe how that happens”. 7
Accordingly, industry self-regulation should be properly evaluated when considering managing insurer conduct. It is important that all New Zealand businesses and consumers have a voice in the Review.
Submissions on the issues can be made until 13 July 2018.
*Rebecca Sellers is a director of Melior Law & Regulation. She is a contributing editor to Colinvaux’s Law of Insurance in New Zealand and Convenor of the Commercial and Business Law Committee of the New Zealand Law Society.
2 “The Consumer Interest & the Financial Markets” Dimity Kingsford Smith and Olivia Dixon, The Oxford Handbook of Financial Regulation (2015)
3 “Issues Paper on Conduct of Business Risk and its Management” (November 2015), International Association of Insurance Supervisors.
5 “Institutional Design: The Choice for National Systems” Eilis Ferran, The Oxford Handbook of Financial Regulation (2015)
6 “Regulatory Styles and Supervisory Strategies” Julia Black, The Oxford Handbook of Financial Regulation (2015)