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The Actuary The magazine of the Institute & Faculty of Actuaries

Treating customers fairly

Whether you are a life or nonlife
actuary, the ever-increasing
likelihood is that you
cannot afford to ignore the
FSA’s treating customers fairly (TCF) initiatives,
predominantly if you are an approved person.
It is likely that your colleagues in marketing,
sales, claims, and compliance have TCF high on
their agenda. TCF is definitely high on the FSA’s
A motivation behind the FSA pushing for TCF
to be implemented is
that, arguably, the
traditional focus on
rules has failed to
protect consumers.
In the Retail Financial
Services Forum
held in October
2005, the FSA
expressed a concern
that there were still
too many cases of
mis-selling and misrepresentation.
FSA indicated that it
expects senior management
to incorporate
its approach to
‘treating customers
fairly’ into the firm’s
corporate strategy.
What does the FSA mean by TCF?
TCF is a principle-based approach. Such an
approach should be familiar to actuaries working
on individual capital assessment (ICA). The
implication of a principle-based approach, as
opposed to a rules-based one, is that the onus
of interpretation is left to senior management.
Each company needs to determine what TCF
means for itself. For example, one general
insurer may determine that moving to pure
risk-based pricing is fair to its customers as each
customer is paying an amount based on the risk
he poses. Another general insurer may decide
that this is not fair, as some of their policyholders
would be priced out of the market.
To assist firms’ interpretation of TCF, the FSA
published a series of case studies and papers to
help the regulated community to understand its
view of TCF and to explore ways in which firms
might assess, monitor and demonstrate TCF.
Moreover, the actuarial profession has set up
Life and General Insurance TCF Working Parties
and both the GIRO and Life Conventions
included sessions to consider the implications
of TCF.
Further, it is worth highlighting that ‘treating
customers fairly’ is not to be confused with
‘treating customers well’. Take for example a
‘low-cost no-frills’ airline, which promises transport
from point A to point B. It can be said that
customers are treated fairly as they are provided
with what they have paid for and receive what
they had expected. However, as a few frequent
flyers on these airlines will tell you, it is questionable
if customers are treated ‘well’. On the
other hand, an insurer offering personal accident
compensation by quoting a standard compensation
package to all claimants without
investigation may be treating its customers well
but not necessarily fairly, since no account is
being taken of the details of the claim.
What does a TCF strategy entail?
It is evident from these examples that TCF
should be an integral part of the insurer’s corporate
and marketing strategy.
The first step in implementing a TCF strategy
would be for senior managers to ensure their
understanding of the implications of TCF for
their firm in terms of the products they sell, the
distribution channels they use, and the customers
they target. This will include defining
‘fairness’ for their firm. The firm will then need
to identify gaps where the firm is not complying
with TCF principles. An action plan to close
these gaps and embed the concept of TCF into
the firm’s strategy, operations, and culture
should be devised. One main focal point for the
action plan should be prioritising the tasks,
securing resources and accountabilities, training
staff where necessary, and clearly defining
the measures to be taken in the future.
This control-cycle approach, shown in figure
1, will also enable insurers to demonstrate
progress from one ARROW visit to the next
(ARROW Advanced Risk Responsive Operating
frameWork is the FSA’s risk-based regulation
framework). Given that TCF has become
an integral part of the FSA’s risk-assessment
process, firms will need to demonstrate that
their customers’ best interests are embedded in
firms’ business practices. The actuary, who may
be one of the approved persons in the organisation,
could expect to be interviewed during
the ARROW visit on the insurer’s TCF strategy
and be held accountable for it.
However, TCF is not just a compliance issue.
There are potential additional benefits for the
customer-focused firm. An insurance contract
is essentially a promise by the insurer to the
insured that the insurer will be there in the
policyholder’s time of need. Being perceived as
fair by the policyholders will assist the insurer
to maximise the value of that promise in their
eyes, thus achieving better customer loyalty and
maximising profits in the longer term.
Why should actuaries care about
The FSA’s view is that TCF should be business
as usual in the organisation. As a general rule,
TCF will have implications which cut across
diverse business areas such as internal governance,
IT systems, and staff training. TCF is as
much about staff behaviour and the culture of
a firm as about product design and marketing.
Given the scale of this task, the FSA has been
encouraging firms to think of TCF using the
product lifecycle framework, ie considering TCF
implications for product development, through
sales and distribution and right up to after-sales
service, claims management, and complaints
handling. Management information (MI) is
vital in order to demonstrate that firms are
meeting their TCF obligations.
Product design
The first stage in the product lifecycle is product
design. Under TCF, a firm should be able to
show that its products have been designed to
meet the needs of its selected target market.
Consider, for example, a new unitised withprofits
contract designed to offer investors the
benefits of a smoothed return on a pool of
assets, to meet the savings needs of certain
policyholders. Suppose, in line with recent
trends, the new with-profits product does not
offer any significant guarantees and the investment
policy is biased towards higher risk assets
such as equities.
Life actuaries in the product-development
area, presumably having helped develop this
product, should be in the best position to ascertain
the risks inherent in the product structure
and help assess for which groups of customers
the product is most suited. ‘Stress testing’,
which involves modelling how the product performs
in different situations, is important for
developing this understanding and should ideally
form part of the product-development
process. For our example, the stress test may
indicate that the product is suitable for customers
who are willing to risk losing part of
their initial investment in the short term in
order to seek better returns in the longer term.
This is clearly an area which actuaries can make
a contribution.
The actuary may get involved in assessing
whether the policy conditions are unnecessarily
complex and hence difficult for consumers
to understand. Moreover, changes to the policy
design, such as the addition of a particular
exclusion, may change the target customer
base. Hence, there might be knock-on effects for
pricing assumptions such as average propensity
to claim, decline and fraud rates, and adverse
Marketing and sales literature
Firms should provide clear information, which
will instil consumers with the confidence to
make appropriate decisions and give them the
ability to question the information and advice
they receive. For example, the marketing material
used to promote the product will need to be
reviewed to ensure that risks are clearly stated.
Many policyholders and their advisers naturally
associate the word ‘with-profits’ with ‘guarantees’
so the low guarantees available on our
with-profits product example above should be
clearly highlighted by the actuaries to the marketing
and sales areas as well as in the product
On the general insurance side, payment protection
insurance (PPI) is one of a long line of
insurance-related issues in the media spotlight
recently, and it looks set to stay there. The FSA
conducted an investigation last summer following
concerns that PPI policies have been
sold to people who were neither eligible to
make claims nor suitable for the product. The
FSA raised concerns about the way PPI salespeople
are trained and the commission they
receive. However, this does not absolve the
actuary given his involvement in other parts of
the product lifecycle.
In most insurers, the main point of contact with
the policyholders after the sale is at the point of
claim. TCF in a claims department will entail
ensuring that genuine claims are paid and
handled promptly. It is important that the level
of evidence requested from the policyholder is
reasonable and not perceived to be putting off
claimants. Fraud detection approaches need to
balance fair treatment of customers, particularly
the elderly who may be caught out by more
aggressive questioning techniques. Where elements
of the process are outsourced, it is important
to ensure that any outsource providers
adhere to the same TCF standards as the insurer.
Changes to the claims process for the purpose
of TCF compliance will have an impact on actuaries’
work in reserving and pricing. The development
patterns and loss ratios may change
due to, for example, changes in the speed of
claims settlement or the proportion of claims
MI (management information)
Many of the key performance indicators (KPIs)
used to monitor TCF are in the actuarial department’s
domain. For example, appropriate MI
will be required to enable senior management
to gauge whether the product is being sold to
the appropriate target market and meets the
needs of the customer.
The actuary is in a good position to identify
the most appropriate MI for this purpose, for
example, on a life policy, the age of policyholders
at entry, duration-specific lapse rates,
and numbers of complaints. The distribution of
the age of the policyholders can be compared
with the target market identified during the
product-development process. Durationspecific
lapse rates will enable identification as
to whether the product met the needs of the
policyholders. Much of the relevant MI (such
as lapse rates) may already be available in a
company through the experience analyses performed
to determine assumptions for the statutory
A similar array of MI tools including retention
rates, loss ratios, claims decline rates, etc, is
available to the general insurance actuary. For
example, industry experts say that analysing
the PPI’s loss ratios and claims decline rates
could have given an early indication that the
product may have TCF-related issues.
What now?
TCF is a continuous learning process so feedback
on the organisation’s TCF performance
should be communicated across all parts of the
firm. This last step intuitively follows back
through to the first, making the whole process
a continuous feedback loop. The feedback will
include not only customer feedback but also the
analysis of the MI conducted by the actuary.
Therefore, in order for the insurer to fully comply
with TCF, the actuary must be part of the
implementation process. So, get talking find
out who is running the TCF project in your firm
and talk to them and your colleagues in other
departments about what TCF means to them
and how you can get involved.