Articles - The bridges between conduct and prudential regulation

As an insurance regulatory specialist I used to identify squarely with the prudential camp and I have to admit to being a bit dismissive of conduct matters - too many words and not enough numbers for my taste. But today, I would feel confident asking any chief actuary whether they are aware of the FCA’s risk of harm approach, if they know who their vulnerables customers are, how the use of ‘Big Data’ fits in to that picture and what their view is on price discrimination within underwriting and pricing.

 By Kareline Daguer, Director, PwC

 I believe all these questions form the bridges that tie conduct and prudential regulation together - and understanding those bridges helps insurers to thrive.

 To explain how, I’d like to start with Big Data as I believe it is the key element that brings all the others into sharp perspective. The volume and granularity of data available to insurers today would have been unimaginable just a decade ago. Data science can help insurers innovate in terms of the products they offer, how they are offered and how they are priced. The data, coupled with the science applied to it, can be a great source of power to insurers. But such power should be used responsibly.

 As an example, just a few days ago John Hancock (a significant player in the US life insurance market) announced that it will no longer offer life policies that do not include fitness tracking. What does this mean for policyholders? Will it price out those who are less active? Will it triumph where the state has failed in trying to create incentives for people to lead healthier lives? From an underwriting perspective, more data means more accurate risk assessment; from a consumer perspective it means some people will become uninsurable. Some might argue this is a question of public policy, but I would argue it’s a question that goes to the heart of what insurance is meant to be for. Do insurers currently have the ability and willingness to reflect on whether their use of Big Data and data science is right for consumers? If the ultimate purpose of insurers is to create long term value by providing a service or product of value to their customers, then exploiting behavioural biases to maximise today’s profit should be avoided.

 The FCA has clearly been reflecting on these issues for some time and in its July research note on Price discrimination in financial services it puts forward a framework to help them determine when intervention would be needed in the market and what type of interventions could be used. The FCA argues that price discrimination is not a bad thing per se, but in some circumstances it would definitely be undesirable. Although the paper describes how the regulator might think about price discrimination, the ideas are equally helpful for firms trying to navigate these treacherous waters.

 The need for a risk of harm framework
 The basis for assessing whether certain practices might be undesirable is the concept of risk of harm to consumers. A harm framework should allow an insurer to assess what products and channels present a higher risk of harm to consumers. Some of the factors insurers should consider include:

 ? who is harmed and whether they are likely to be ‘vulnerable’ consumers
 ? how many people would be affected and how significant the harm could be
 ? how essential the products involved are

 I have not seen many insurers developing such a framework, even though it’s likely they already have all the data needed to build it. There’s obviously a risk in using Big Data, creating innovative products and pricing models that factor in increasingly detailed consumer information without a clear understanding of how consumers could be harmed by these innovations. Insurers should be proactive in crossing the bridges that link prudential with conduct matters, and actuaries should understand what it means for consumers to use certain detailed information when pricing. I believe insurers need to allow for this type of dialogue to flourish in their organisations, rather than approaching the conduct aspects of regulation merely as a compliance exercise.

 There are a lot of opportunities for those crossing the bridges. Staying out of this debate is not an option if insurers are to thrive in the future.

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