Welcome to Part 4 of Insurance After Hayne, a six part series on our Insurance Law Tomorrow blog focusing on the implications for insurers following the release of the final report of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services industry.

In this week’s article, we explore Commissioner Hayne’s recommendations on governance, culture and remuneration, and particular his focus on the people in control:

“There can be no doubt that the primary responsibility for misconduct in the financial services industry lies with the entities concerned and those who managed and controlled those entities: their boards and senior management”  – The Commissioner, the Hon Kenneth Hayne, AC QC

Conduct is now a prudential issue

Hayne recognises that a central driver of behaviour is remuneration. The failures of remuneration practices were catapulted into the public arena following the Global Financial Crisis, resulting in APRA releasing Prudential Practice Guide PPG 511 in 2009. Prudential Standard CPS 510 was amended in 2010 to include formal governance requirements regarding remuneration. CPS 510 currently applies to general and life insurers.

From 1 July 2019, CPS 510 will also apply to private health insurers. CPS 510 specifies requirements in relation to board size and composition, board procedures, and establishment of various committees including remuneration, audit and risk committees.

However, Commissioner Hayne has indicated that APRA’s work has not gone far enough. He has directed APRA to revise its prudential standards and guidance about remuneration so that they do not just encourage sound management and financial stability, but also reduce incidences of misconduct, compliance and other non-financial risks. This will require the board of directors to make regular assessments of the effectiveness of the remuneration system, to set limits on the use of financial metrics in connection with variable remuneration, and to introduce claw-back provisions for remuneration in certain circumstances.  Further relevant changes will follow with the extension of BEAR to the insurance sector.

In the APRA response to the Final Report, APRA says that it intends to release proposed revisions to CPS 510 by mid-2019 to address the recommendations. APRA says that the revised CPS 510 will incorporate not only the Royal Commission’s recommendations, but also the CBA Prudential Inquiry and international guidance. APRA also wants to collect more information to better assess how remuneration frameworks operate in practice.  An updated standard is to be determined in 2020.

It would be prudent for insurers to start looking at these issues now and be proactive in addressing them. By improving governance practices, insurers will be well placed when the new prudential standards are released.

Rewarding sales…made properly

The Final Report’s case studies with respect to front line remuneration focus heavily on bank staff, however, the recommendation is wide reaching and covers all financial services entities, including insurers.

The recommendation is to ensure remuneration systems for front line staff consider not only what staff do, but how they do it. While the 2017 Sedgwick Report focused on commissions and product based payments in retail banking in Australia, its recommendations were endorsed by Commissioner Hayne.

However, caps are not the only solution. The Commissioner expects insurers to put into place remuneration structures that reward staff for not only what staff do, but how they do it. This will require consideration of what best practice sales looks like, and how best to reward this. A focus on consumer outcomes and appropriate non-financial metrics is of increasing importance in remuneration structures.

Who is supervising culture?

“Although culture cannot be prescribed or legislated, it can be assessed.”

The Commissioner has recommended that APRA revise its approach in relation to supervising culture.

The Commissioner identified that in recent times, APRA had not continued its further work in undertaking risk culture reviews. Instead of continuing to make independent assessments of culture, APRA had decided to assess the way boards formed a view of the risk culture in their own organisation. This is, however, not desirable according to Commissioner Hayne. He has recommended APRA to adopt the steps and recommendations proposed by the Financial Stability Board (FSB) in its April 2018 “Strengthening Governance Frameworks to Mitigate Misconduct Risks: A Toolkit for Firms and Supervisors” report and the November 2018 “Recommendations for National Supervisors: Reporting on the Use of Compensation Tools to Address Potential Misconduct Risk”.

As an international standard-setting body, the FSB’s April 2018 report provides some principle based tools that can help inform insurers’ approach to culture. These tools are broadly categorised as follows:

a)    Mitigating cultural drivers of misconduct;

b)    Strengthening individual responsibility and accountability; and

c)     Addressing the ‘rolling bad apples’ phenomenon.

In its response to the Final Report, APRA has said that it has already increased its supervisory oversight of governance, culture and remuneration and is working with government on a multi-year program to implement the recommendations, albeit having conceded that it had not until recently had the appropriate skills to perform this function.

In the meantime, Commissioner Hayne expects all financial services entities, including insurers, to take proper steps as often as reasonably practicable to:

a)    Assess entity culture and its governance;

b)    Identify problems with culture and governance;

c)     Deal with those problems; and

d)    Determine whether the changes have been effective.

While documented policies and procedures are important, it is also important that these policies and procedures are followed in practice. Accordingly, insurers should take a multi-faceted approach when undertaking their assessments of culture and governance.  Central to the process is the need to continually collect information, assess, review and repeat. The ability to provide good governance in a large organisation is dependent on the ability to collect and use reliable information and data.

Stay tuned for Part 5 of Insurance After Hayne which will be released next week.

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