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The Actuary The magazine of the Institute & Faculty of Actuaries

Risk management: Chain reaction

Never before in the history of insurance has the immediacy of change been so visible to the business, regulator and customer. The simple decision to change a rule in a medical questionnaire can fundamentally change the uptake of policies, the spread of liability risk and the capital requirements of a company.

So when everything impacts on risk, this places a whole different set of burdens and responsibilities on an insurance business, particularly when more underwriting organisations now report directly to the risk function. The measurement, monitoring and management of all risk classes is the concern of the whole business, not just the designated risk function.

But the world of risk now goes beyond that of ’simple’ capital and numbers. It moves into the murky world of the customer.

An early indication of the FSA’s direction and focus was seen at the beginning of this year when it published the Retail Conduct Risk Outlook 2011, which summarises the agenda of the FSA and its forthcoming replacement, the Financial Conduct Authority (FCA).

In short, the FCA expects to be able to directly intervene at any stage of the product lifecycle, from initial inception of the idea to ultimate sun-setting of a product withdrawal. The overriding purpose of this intervention, including the Retail Distribution Review (RDR), Treating Customers Fairly (TCF), Know Your Customer (KYC) and Solvency II, is consumer protection. This customer is now directly and visibly linked to the risk capital and regulatory requirements of any insurer.

At the heart of the financial consumer protection regulations anticipated over the next few years is the drive to better protect consumer rights by adopting a more intrusive approach, which will work in two ways.

First, it will intervene more directly with individual providers to ensure processes are clear, straightforward and, most important of all, that they avoid ‘detrimental outcomes’ — in other words, that the consumer gets the result that they were expecting at the time of the transaction.

Second, the traditional view that the product lifecycle essentially starts at the point where the customer took the decision to purchase has been swept away, replaced by an approach that goes back to the original inception of the product idea. Again, this changes the way risk is assessed for a product, making marketing part of the risk family.

This means that the regulator will in future consider all aspects of the product lifecycle, from initial concept development, through marketing, sales and support to ultimate product withdrawal — a time span of up to 10-15 years and more in some cases. It will demand transparency of processes throughout a product’s development and management, together with a broad range of support activities such as customer advice, responsiveness and commissions.

Here are just some examples of the breadth of planned new regulations:

• Retail Distribution Review: in restructuring consumer charges, the focus switches completely from the frequently opaque commissions paid by the supplier to the adviser to reflect more directly the service being provided to the customer. This is having a fundamental effect on process, as the need arises to rewrite the rules embedded within existing systems set up to manage commission payments, ‚Ä®for example.

• Treating Customers Fairly: in seeking to demonstrate compliance with the demands of TCF — with its emphasis on customer outcomes — this is driving the need for improved real-time performance reporting, business event monitoring and exception management as part of a broader programme of product lifecycle management.

• Product Intervention: under this new approach, the FSA will undertake ‘mystery shopper’ and other direct initiatives designed to put the provider’s design and governance processes and resulting products under the closest scrutiny and assessment. This will check for due diligence, effective testing and full documentary support to evidence fairness and clarity throughout.

By increasing product testing requirements prior to launch, the FSA is looking to prevent the introduction of potentially damaging financial products.

The problem facing retail financial institutions is equally clear cut: how to gain and maintain compliance in a fast-paced regulatory environment, while continuing to attract and retain clients and driving down operational spend.

This is a tough challenge demanding a new response. As regulatory requirements are changing the demands for customer service and blurring the hard definitions of risk, the traditional approach of ‘just enough, just in time’ will no longer work. Businesses need to adopt a new risk strategy that incorporates consumer product risk management and adjust their reserves accordingly to meet the increasing compliance demands and customer expectations.


Bart PatrickBart Patrick is director of European Insurance at Pegasystems