Will the ‘best interests of the customer’ sink some sector business models?

‘Acting in the best interests of each client’. It’s a phrase that should be familiar to the many insurance executives who have talked in recent years about making the sector more customer centric. Yet at the same time, it’s a phrase that shouts out from the pages of the UK regulator’s thematic review on general insurance distribution chains, published in April 2019. Unfortunately, that ‘shout out’ uses phrases like ‘extremely disappointing’ and ‘significant harm’. How has this gulf between expectations for customers and their delivery opened up?

‘Acting in the best interests of each client’ is no stranger to insurance. It’s a commitment that many insurance professionals signed up to when they became members of the Chartered Insurance Institute (CII). It’s one of the five core duties in the CII’s code of ethics. And at a corporate level, firms who have been awarded the CII’s corporate Chartered title have shared that same commitment across their operations.

Since October 2018, all regulated firms have been held to a similar standard, in rule ICOBS 2.5-1R. Under the somewhat pithy title “The customer’s best interests rule”, the obligation is clear: “A firm must act honestly, fairly and professionally in accordance with the best interests of its customer”.

Signs that firms are struggling

So what has the FCA been saying in its recent review? It found problems for customers in both product design and delivery, and in services like claims too. These stemmed from two key causes. Firstly, a lack of focus on customer outcomes in business models and strategies. And secondly, poor governance and oversight, certainly in distribution chains but in their own firms as well. As a result customers have been paying higher prices and receiving poor services.

So what exactly does ‘acting in the best interests of each client’ amount to?

Let’s break it down. Firstly, note the active verb ‘act’. Nice conference speeches about customer centricity are fine, but it’s the follow on actions and the leadership support to ensure outcomes are delivered that matter.

Secondly, it’s about the ‘best interests’ of each client. Not just something positive, but the best you can do. And those best interests have to been judged from the client’s perspective, not the insurer’s perspective. Of course those two perspectives can overlap, but it is the client’s one that takes precedence.

The importance of the singular

And thirdly, there’s that hugely important word ‘each’, or its equivalent in the FCA handbook, the very singular ‘customer’.

It’s often omitted from references to the commitment, which is strange, given its centrality. ‘Each’ and ‘customer’ brings an individuality to how client interests are framed. They’re not added up and averaged, but treated on an individual client by individual client basis.

So, for example, a firm can’t say that an initiative is in a customer’s best interests because it benefits customers in the round. It needs to be applied ‘in the best interests of each client’.

That could of course be a bit of a challenge at times. Clients can be both very similar and very different. Yet those that are different need to be treated as such, not crow barred into something that isn’t right for them.

Hard lessons for charities

The reality of ‘acting in the best interests of each client’ was driven home to insurance distributors in the charity sector a few years. Across a huge personal lines portfolio, a charity’s supporters may get a good deal, but within that portfolio, there were clear pockets where the deal was less than it was made out to be.

That event caused several charities to fundamentally review their insurance offering. The problem was that they were having to do so in hindsight, rather than through design at the outset or oversight during growth.

The danger is that the sector, having developed its great raft of distribution channels, may just find it very difficult to actually see, and get its head round, acting in the best interests of each client. The business models that many firms use just don’t fit well with it.

Another challenge that acting in the best interests of each client creates is in relation to conflicts of interest. One could find oneself acting as the agent for two clients whose best interests are in conflict. The loss adjuster and two parties to a loss, or the broken and two clients in competition, are two common examples.

Surely then, isn’t acting in the best interests of each client impossible in such circumstances? Is the bar being set unrealistically high? Not at all, for two reasons. Firstly, the loss adjuster and the broker can act in the best interests of each client by not acting for one of them, and being open about why they’ve taken that decision. Again, this is about seeing the situation from the clients’ perspective, not that of the insurance firm.

And secondly, remember the perspective of time. That lost client may have to find a new agent to work with, and that can be a pain for them. However, in the longer term, it’s in their interests to do so. Those interests need to be weighed up both in ‘here and now’ terms, and over the longer term.

What this points to is that a regulated firm’s capacity to act in the best interests of each client is in part defined by how it good it is at managing conflicts of interests. The two stand together.

Is personalisation the answer?

One argument I’ve heard in relation to ‘acting in the best interests of each client’ is centred around a key digital trend in insurance, which is personalisation. There’s a view prevalent amongst insurance people that personalising the premium and cover is acting in the best interests of each client, because of that sharp focus upon the ‘each’. In effect, each person pays the best premium for their own risk.

It’s a flawed argument because it prioritises that individuality over the best interests. So while it is in the best interests of a policyholder who never claims to pay a premium based on their own propensity to claim, life happens, and claims can result. My house has been hit by lightening, my car whilst parked. The policyholder’s best interests are much more likely to be better served by the insurance firm seeing a client’s interests over both the longer and the shorter term.

So personalisation is just as likely to be acting in the best interests of some clients, as it is to be acting against the best interests of other clients. It all depends on whose interests are give primacy, and what timeframe is adopted. The problem is that some insurance firms have a bad habit of viewing their clients’ interests through their own, short term lens.

Business models will struggle

What does all this add up to then? The nature of many insurance distribution strategies means that they will struggle to fulfil that ‘acting in the best interests of each client’ standard. This will make ‘customer centricity’ a perennial challenge for most firms in the sector. Those strategies have steered the sector too far off the customer course. Yet ICOBS 2.5 1R and the Senior Managers and Certification Regime (SMCR) exist here and now, sending a strong signal that the ‘best interests’ standard cannot be ignored.

I would recommend that insurance firms start by working out where they currently stand in relation to that ‘best interests’ standard. And they should include in that some analysis of the direction in which their business model is taking them. Are they heading more off course, or less? What ‘ICOBS 2.5 1R’ does is show insurers where they need to get to, and SMCR and the TR19/2 review shows them how urgently they need to get there. For some firms, the change of course could be dramatic.