Thursday, 9 June 2016

Thoughts on the FCA's TR16/2: Fair treatment of long-standing customers in the life insurance sector

I recently submitted a response to the FCA's Thematic Review on the Fair treatment of long-standing customers in the life insurance sector (TR16/2).

As is the nature of Thematic Reviews, it raises, both directly and indirectly, some interesting questions of strategic interest for the UK life and pensions industry.

Customer Engagement

Providers' challenges in maintaining contact with customers is inversely proportionate to customers' own levels of engagement. Customers fail to read and/or understand documentation properly, fail to advise providers of changes of address, fail to return post intended for a previous resident at their current address (which would allow a gone-away to be flagged), and forget to claim benefits when they are due. Where industry consolidation and rebranding has happened, customers are frequently unaware of the name of the entity which now services their policies, further increasing the likelihood that they will ignore communications.

Intermediation, where the customer may be more engaged with the adviser / distributor than with the provider, adds an additional layer of complexity.

Customers become gone-away through lack of engagement. Customer engagement remain the fundamental problem to be solved.

Providers' incentives

In the annuities market, providers are incentivised to proactively identify deceased customers (through 'certificates of existence' and other means) so that they can stop payments. In the pensions (accumulation) and life insurance markets, no such incentive exists. In fact (notwithstanding over-riding common sense and fairness), it rather suits providers to take a more passive stance, as this allows them to reflect higher customer, policy and fund values than might truly be the case.

Especially in the case of life insurance, unrecognised deaths allow providers to simply release reserves for the benefits of other customers, management and/or shareholders (depending on the product arrangement). Where it goes to other customers, this might be considered a good enough outcome, but it is certainly not as good as if the claim had been paid to its rightful beneficiary.

Mortality mismatches and the Tontine effect

It would be interesting, at an industry wide level, to compare the mortality experience against the mortality expectation for different types of business and across different providers. Mismatches between mortality experience and expectations will arise where policyholders simply fail to submit a claim, usually through lack of engagement. This has a number of consequences, most notably for the calculation of bonuses on with profits policies, and for the Tontine effect - if your mortality experience data is suspect, how can you possibly determine who the 'last man standing' is, either at all, or within a useful timeframe. (This has knock-on impacts which might reduce the benefits which have ever been or ever will be paid to any other member of the fund.)

In the case of legacy business, an historical over-reliance on postal communications (almost exclusively) combined with inadequate computerisation of paper based records and integration of legacy systems leaves providers particularly exposed. In many instances, I suspect it is hard to come up with reliable data to understand the problem let alone to effectively manage any solutions.

Tracing can alleviate but not solve

Whilst the FCA's proposals note the availability of a number of options for tracing and re-engaging customers, as well as for maintaining better contact in the first place, these are of course imperfect. 

That is, with the best intentions in the world, there will always be some customers who become gone-away, and some of those will never be traced. The costs of tracing are also not insignificant, and particularly for policies with smaller values or greater data challenges (see above), and a commercial assessment of how much effort a provider should reasonably be expected to make is required in order to sure the long-term profitability and therefore sustainability of the industry and its ability to continue to serve customers. To what extent do we want prices for those customers who do actively engage with their providers to have to pay for the costs of tracing other customers who are less diligent?

Further, given the propensity of many people to not return mail sent to the previous inhabitants of their current address, it is likely that many 'gone-aways' are never recognised as such by the providers. Tracing and re-engagement can never resolve these. Gone-aways is an inadequate approximation of the underlying problem.

Whilst the FCA's recommendations will certainly help to alleviate some of the current problems in the industry, they cannot completely solve them. More fundamental progress towards true customer engagement is required.

Sharing the costs?

Perhaps part of the solution is to share the costs of disengagement with both parties to the transaction. That is, to allow providers to charge some or all of the costs of tracing and re-engagement directly against the affected policies.

This would almost certainly not have been contemplated in many products or fund schedules, and so would require some level of creative latitude in this regard. However, this might be considered as a quid pro quo for the (perfectly reasonable) assertion the FCA makes that providers should not hide behind contract terms in order to avoid things they might otherwise reasonably be expected to do.

The Dormant Asset Commission

I think it is important that future regulatory proposals are harmonised with any recommendations/implementations from the Dormant Asset Commission. It is my perception, for example, that the scheme which operates in the Republic of Ireland disincentivises providers from trying too hard to maintain contact with policyholders, as where contact is lost the provider can simply transfer its obligations to the treasury fund. (The treasury fund acts as a scapegoat in this regard.) This could perpetuate the somewhat passive approach that providers have taken to date, and might not really help to ensure that more customers received the benefits for which they had paid.

No 'one size fits all' solution

It is tempting, but not always helpful, to judge business written 25 years ago by the norms and standards in place today. We now live in a hyper-connective world, where engagement is relatively cheap (as well as transient). Historic practices of, for example, sending only annual statement and only while premiums were being paid, seem laughably inept by today's standards, but were most likely perfectly appropriate at the time.

In considering the most likely best outcomes for all customers, a balance needs to be struck between the effort expended on rectifying long-standing relationships created in a different environment, versus that expended on ensuring future new relationships are commenced on a better footing.

That is, we should aim to set the benchmark for new relationships at a much higher level than benchmark we will almost certainly have to settle for given the practical constraints of long-standing relationships. And we certainly don't want any recommendations put in place for legacy contracts to be considered to have set an acceptable benchmark for new contracts going forward.
I look forward to seeing the broader industry response to the TR. In the meantime, if you wish to discuss any of the thoughts above, please feel free to drop me a line.