Broker Regulation - Adapting to regulation

Two years on from the Financial Services Authority's statutory regulation and some brokers have yet to completely blend into their new environment, with some blaming the body's cumbersome rules. Marcus Alcock reports

Despite the fact that insurance brokers have had more than two years to get used to statutory regulation from the Financial Services Authority, it seems that many still have to come to terms with the new regulatory environment. According to the latest survey by accountancy firm Moore Stephens, entitled Managing risk in the insurance industry, the situation is such that some 93% of brokers who responded placed regulatory risk at the top of their immediate two-year agenda, ahead of strategic and financial risk.

In some senses, however, these findings are not too surprising, according to Simon Gallagher, the partner behind the Moore Stephens report. As he says, insurers have had to operate in an arena of statutory regulation for a long time now, so the approach to regulation is expected to be more embedded, whereas, for brokers, two years is not that long at all. Insurers have had to be fully audited and face individual capital assessments for years - areas of regulation that do not apply to intermediaries.

Despite such sentiments, Mr Gallagher still reserves some criticism of the way that some brokers, particularly smaller and medium-sized businesses, are responding to the advent of external supervision, especially when it comes to regulatory risk management. "The driver for risk management still comes from the FSA, which is disappointing," he says. "What should really be happening instead is to drive risk management from a commercial standpoint rather than simply adopting a 'tick-box' approach to regulation.

"Many organisations are missing the point, seeing the process as a 'must-do' and looking to get it out of the way with as little fuss as possible, and that's a shame. To get a risk management process embedded in an organisation takes time and resources, it's not going to happen overnight: we're talking about a three to five-year timeframe."

But haven't brokers already had this kind of time period to adjust their business to the new way of working that statutory regulation entails? "Well, we're somewhere along a curve," he replies. "Maybe the FSA has triggered an industry-wide improvement and we're not yet seeing the benefits within organisations, but there is evidence in the larger brokers that things are going well. It's smaller and medium-sized brokers that lack the resources; maybe they lack the commitment as well."

Unfairly blamed

Steve White, head of training and compliance at the British Insurance Brokers' Association, believes it is simply unfair to put the blame on brokers for failing to come to terms with the new regulatory landscape. In his argument, it is important to look at the nature of the regulator that brokers are faced with in this country. "We are well aware that what we have in the UK is disproportionate to the rest of Europe where regulation is concerned," he comments. "It's not so much the rules themselves as the style in which they have been implemented. We've been shoe-horned into a regime that isn't suitable for brokers. If you look elsewhere in Europe, you have regimes that are based on registration, but the whole style in the UK is so different."

Other senior industry figures are in wholehearted agreement with Biba on this issue. "It has already been admitted at the highest level that the Insurance Mediation Directive was not a very successfully implemented piece of legislation and, as many commentators have described, it has had a very negative effect in the market and is quite disproportionate to the benefits derived," says Tim Ablett, the former chief executive of First Assist and now a director at financial services consultancy Project Consulting Partners. "Even companies such as Norwich Union have been forthright in their criticism of the legislation and its effect on the cost base of the industry with a lack of benefit to the customer."

Yet, for the industry to focus its ire solely on the regulator would be wrong, he adds: "After all, they are not the legislators, they are the enforcers and policemen. Introduce a bad law and, ultimately, you get anarchy as the law falls into disrepute. In my view, there are aspects of the directive, as implemented into the UK legislative regime, which need revision. I do feel that the FSA has tried hard to become more user-friendly and to bring into play proportionality as far as legislation allows it to." Thus, he feels the move to principles-based regulation, "while not without its problems, is a good step in the right direction".

Shortcomings

The brokers themselves, unsurprisingly, are not so keen to let the FSA off the hook and are instead eager to point the finger at the shortcomings of the regulator. Grant Ellis, chief executive of The Broker Network, is adamant that the majority of insurance brokers in the UK are doing their utmost to come to terms with compliance and all that entails. However, the problem they face is that the regulator has not exactly taken the best approach as far as certain issues are concerned.

"Most brokers are adjusting, but I'm not a massive fan of the FSA," he explains. "Some of their rules are a little bit cumbersome, especially those concerning the handling of client money and risk transfer, where it is using a hammer to crack a walnut." But isn't the FSA doing its best to look again at some of these rules as part of a more pragmatic approach in the wake of the Davidson Review? Surely the move to a more principles-based regime must be welcome?

Well, not entirely, in Mr Ellis's opinion. "Instead of trying to fine-tune regulation and make it better, they are actually making things more cumbersome," he declares, giving as an example the current proposed changes to the Insurance Conduct of Business Rules, which are likely to see the introduction of a two-tier approach, with the strong possibility of weaker disclosure requirements for insurers offering products in the personal lines arena.

Perhaps, though, brokers themselves do not need to worry? Maybe there is an argument to be made that many brokers have been right to only pay lip service to regulatory risk until a principles-based regime is introduced, doing the minimum necessary to ensure that they do not face a fine? Not in the opinion of Mr Gallagher, who, ultimately, comes down on the side of the regulator. "If you look at it, the FSA has been quite hard on brokers because a number of enforcement actions have found inadequate systems and controls," he explains. "And the FSA has talked about its principles coherently and consistently. So it has done its bit - it has educated and enforced. It's now down to the industry to have a little bit more appetite for this because, if they don't, the FSA will tighten the screws."

It's clear from a closer examination of the Moore Stephens' survey that attitudes do need to change. Asked whether risk management processes inform strategic management, only 74% of intermediaries said they agreed, while only 58% said that risk management processes informed quality management.

Increased pressures

Mr Gallagher says these figures are alarming, because they demonstrate that attitudes towards regulatory risk really are not penetrating businesses to the degree that they should be. Perhaps, then, as has been argued before, although the majority of brokers are aware of the challenge posed by the FSA when it comes to regulatory risk, for many it does not matter. They can see the increased pressures being placed on the broker distribution channel by the growth of alternative methods of distribution, and the encroachment made into formerly secure areas, such as small-to-medium-sized enterprises' commercial packages by the insurers themselves.

Given this context, the pressures they envisage as a result of regulation are simply too much on top of the existing competitive pressures. Therefore, would it not be better for some struggling smaller brokers to simply throw in the towel? Mr Ablett is unconvinced. "I believe that a very good business case remains for the insurance broker channel and those businesses that are well run, have good governance and efficient and effective processes should not fear the regulatory regime," he says. "If they were making profits before the implementation of the directive then they should be just as capable of running a profitable and growing business encompassing the regime."

It is important not to over-generalise as far as the FSA is concerned, he adds: "Each business needs to consider its own strengths and its weaknesses, its risks and its opportunities. Regulatory risk is only one of these, but is probably one that is focused on by most brokers because they are fearful of the consequences of not complying. However, if you don't understand, for example, the credit risk of slow paying clients, that is a far surer and quicker way of going out of business."

Although there are undoubtedly serious concerns among insurance brokers about the pressures brought upon them by the FSA, the fact that 93% of brokers see regulatory risk as their biggest challenge can be viewed positively. The industry is well aware of the importance of regulatory compliance and is taking steps to address it. The only downside to all this, as far as Mr Gallagher is concerned, is that fear rather than a certainty of business improvement is driving the approach to regulation.

"To get to an improved state in terms of regulatory risk management you have to go through a structured process and that involves getting the right people on board and them setting the right strategy," he says. "You have to really change the way things are done and engineer your business decisions around this. It's not an option, it's a requirement and, in terms of business benefit, there's an evolving trend for businesses to properly take on board risk management. There's an upside as well as a downside, and it should be used in a positive way to manage your business."

As an example of how this works in practice, he says brokers should look to how the global insurers manage risk - an approach that affects "every single decision they make".

Active addressing

Besides, it seems that even though regulatory risk is seen as a challenge, there is no doubt that much good work has already been carried out. Research undertaken by Lloyd's, in conjunction with Biba, last summer revealed that 90% of those questioned said they were actively addressing increased regulation, for example, while brokers felt that they have adequately addressed the key issues of client money, contract certainty, and conflict management, although as the report noted, "they feel more work needs to be done".

The final message, according to Mr Ablett, is for brokers not to panic about the challenge of regulatory risk, but take a measured approach. "It is becoming more user-friendly and in many ways is less onerous than it was, but it still needs to be taken seriously," he comments, "but with good controls in place and well-trained staff focused on the customer, the insurance broker channel will endure and will, in my view grow." Brokers take heart.

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