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The Actuary The magazine of the Institute & Faculty of Actuaries

Your customers’ interests

The fair treatment of customers is a key part of the Financial Service Authority’s (FSA) regulatory regime. In the words of a recent FSA publication (‘Treating customers fairly: progress report’), ‘the principle for firms to treat their customers fairly will continue to underpin the whole of the FSA’s approach to fulfilling its statutory objectives’.
The importance of this concept to actuaries, not least because of its close relationship to policyholders’ reasonable expectations (PRE), led the Research Committee of the Life Board to establish a working party on the subject of customers’ interests. This working party expected to prepare a report for the 2000 Life Insurance Conference. However, when Equitable Life closed to new business in 2000, a number of enquiries relevant to the fair treatment of policyholders were triggered. The report in 2000 was therefore of an interim nature, and was followed by further presentations in 2001 and the final report in 2002. This article summarises the final report, the full version of which may be found in the profession’s website (www.actuaries

High-minded principles
The concept of customers’ interests was first introduced into financial services regulation as one of the FSA’s high-level principles of a business. Principle 6 states that a firm must pay due regard to the interests of its customers and treat them fairly.
This is described as being ‘the foundation for the substantive materials within the handbook of the insurance concept of policyholders’ reasonable expectations’.
Like many principles, this is difficult to argue against. The problem lies in ensuring consistent interpretation for different businesses, in varying circumstances, over time.

PRE versus customers’ interests
What is the relationship between the traditional concept of PRE and the new idea of customers’ interests? There are a number of key differences. There was no positive obligation on companies or their directors to satisfy PRE, whereas the requirement to have regard to the interests of customers is a positive obligation, the breach of which could lead to disciplinary action. Also, the principle applies to all regulated businesses, not just businesses writing long-term insurance. In practice, there seems to be little purpose in erudite debate about similarities and differences between the two concepts. The new regulatory regime requires the fair treatment of customers, and it is clear that responsibility for this rests with the board and senior management of regulated firms.
All’s fair that ends fair?
What does treating customers fairly mean? The FSA’s discussion paper ‘Treating customers fairly after the point of sale’ attempts to define fairness in this context. This is a rather discursive ramble around the subject of fairness; it seeks to define what treating customers fairly means, to identify examples of unfairness in financial services, and to set out the FSA’s plans to address these. Unfortunately, anyone seeking a simple definition of fairness will be disappointed; in the words of the paper:
We conclude that fairness is not a definitive concept. Instead it represents a series of values, which help us to decide how to behave and treat others.
The paper lists a number of examples of fairness, but concludes that there cannot be an exclusive checklist since ‘fairness is a flexible, dynamic, and time-sensitive concept’. It is recognised that it is often easier to judge in hindsight what is fair and unfair, and there is a risk of applying standards retrospectively. The FSA’s feedback on this paper includes some helpful statements on the standards to be used to judge complaints. ‘A firm’s conduct should always fall to be judged against the standards prevailing at the time when the matter of complaint arose. Any need for consumer redress should flow from and be consistent with this.’ So, do not throw away those old rulebooks!

Unfair contract terms
Further guidance on treating customers fairly is given in the Unfair Terms in Consumer Contracts Regulations (UCT) 1999. There was discussion of these within the profession when the relevant European Union (EU) directive was first implemented about ten years ago, but they seem to have received little attention from actuaries since then. This may well change: the FSA is now a qualifying body under the regulations, and can challenge the fairness of specific policy terms, request companies to remove those considered unfair, and can, if necessary, seek a court injunction to compel such action.
The regulations apply a general test to assess whether a standard contract term is unfair, based on whether, contrary to good faith, it would give a significant advantage to the firm that could cause detriment to the consumer. The regulations do not apply to terms setting the price of the service or product, or describing what is being provided, unless these are written in such a way as to make them hard to understand.

Discretion in with-profits policies
The FSA has published draft guidance, to be included in the Enforcement Manual, on its general approach to UCT. While this imposes no new obligations on firms, which are already required to comply with the regulations, it significantly raises the profile of the regulations and the possibility of a challenge to contract terms. It remains to be seen whether policy conditions will always pass the test, especially those concerned with the exercise of discretion in with-profits policies.
The FSA’s project on with-profits business has picked up a number of ideas from ‘Treating customers fairly’ in considering fairness in with-profits business, in particular in the areas where insurers typically reserve discretion. It concludes that treating customers fairly means being far more explicit about the circumstances in which firms seek to exercise such discretion.
Being able to show that discretion will operate, and has operated, predictably, according to objective criteria, can be expected to help consumers and understanding of what has happened to their policies.
This leads to the conclusion that a strengthened governance framework for with-profits funds is required and the FSA has set out detailed proposals for this.
Some of these ideas have been picked up in the Sandler Review, which proposes the development of a new structure for with-profits business, together with increased disclosure for both new and existing business. Whether anything recognisable as with-profits business can be offered under this new model is a matter for debate! At the minimum, it is likely to require low levels of smoothing, more frequent changes to market value adjustments, and few, if any, guarantees. This all needs explaining in clear English to policyholders. Furthermore, there is also the requirement to set up procedures ensuring any remaining discretions are operated in accordance with defined principles and practices.

What should actuaries do?
Responsibility for treating customers fairly, satisfying UCT, and making appropriate provision for any resulting liabilities rests entirely with the directors. The days of the appointed actuary providing his or her ‘interpretation’ of PRE, and the director sheltering behind this, are coming to an end. Directors will need to take full responsibility for matters concerning the fair treatment of customers and will no doubt wish to take appropriate advice. It is not obvious that most of this advice will necessarily be from actuaries; the concepts seem likely to be increasingly rule-based, which points to more legal advice. Actuaries remain well placed to contribute significantly, but will need to do so within the new legal framework, recognising for example the effect of unfair contract terms legislation and the powers of the FSA. Continuity will be important in moving from the old to the new regime, and the continued involvement of actuaries will help to achieve this.
If the FSA’s proposals in consultative paper 167 are implemented, the current role of appointed actuary will be replaced by a head of the actuarial function and, for companies which transact with-profits business, a with-profits actuary.
The with-profits actuary will be responsible for advising on the use of discretion by the company; this will presumably draw upon many of the current practices in advising on and managing PRE. The main role of the head of actuarial will be to advise on the calculation of liabilities to policyholders including ‘any liability or obligation arising from the requirement to treat policyholders fairly under principle 6 including with respect to policyholders’ reasonable expectations’. This will require an agreed understanding of these expectations, reflecting, where relevant, the advice of the with-profits actuary. It seems there will be a need to define clearly the expectations of policyholders, and the extent to which these expectations could constrain future actions. It could be argued that splitting the responsibilities for advising on the exercise of discretion and for quantifying the financial implications of the decisions made is unlikely to improve the governance of companies particularly as the FSA is placing increasing emphasis on the realistic financial position of life insurance companies.

Actuaries’ reasonable expectations
The concepts of customers’ interests and fair treatment of customers seem likely to be at least as important in the management of life insurance business in the future as PRE has been in the past. Actuaries can continue to have a key role, but need to recognise the changes in the framework within which business must be managed.