When preparation meets opportunity - EY

When preparation meets opportunity Perspectives on the life, pensions and investments markets in the UK

In modern times, we more often hear this paraphrased as: “Luck is preparation meeting opportunity.” However, I think the fuller version speaks better to the environment that faces the UK life and pensions industry, particularly in light of changes in the last few weeks. It’s certainly true that Demetrius has something when he talks of specialising in one or two areas. At the start of this decade, the industry had already started to specialise, but there were still a few ‘waterfront’ players who aimed to master ‘all the tricks and twists’ of the market. Since then, the global financial crisis and the focus on customer outcomes driven by conduct risk and the Retail Distribution Review (RDR) have sharpened the industry’s focus. Today, even the remaining providers who compete in all the major product lines are focusing on specific niches within them. Capital requirements are becoming more stringent, competition tougher, access – especially to the mass market – harder to secure, and traditional business models are under significant pressure. For most products, it is no longer enough to just to be in the market. The removal of commission, the introduction of best execution rules and demands by shareholders to deploy capital effectively mean that, if you cannot be a market leader, it is often better not to play. One area where this does not apply is annuities, where customers still routinely accept the

default option. As we went to press, the industry was still digesting the impact of the Budget and the Financial Conduct Authority’s (FCA’s) 2014 Business Plan. The Chancellor’s sweeping changes to annuitisation rules will widen customers’ options in retirement and force annuity providers to innovate or risk irrelevance. The FCA’s newly declared focus on back books asks companies to look carefully at how they share costs and risks between open and closed books and whether what they offer to back book customers disadvantages them compared to new customers.

When preparation meets opportunity

According to Seneca’s On Benefits, Demetrius the Cynic had a clear prescription for success in wrestling: “The best wrestler,” he would say, “is not he who has learned thoroughly all the tricks and twists of the art, which are seldom met with in actual wrestling, but he who has well and carefully trained himself in one or two of them, and watches keenly for an opportunity of practising them.”

But what of opportunity? We firmly believe that the opportunities are out there. Although some traditional product models are under pressure, there is potential to create mutual value by engaging directly with end customers and forging deeper relationships based on genuinely helping them to achieve more with their money. Achieving this will mean answering some big questions, and it won’t be an easy or quick transition. But the current market presents the best opportunity to reconnect with customers for 30 years. We look at the FCA’s new direction, options for optimising the value of the back book, and emerging possibilities for networks, auto-enrolment and digital – and pull it all together with some views from leading executives about what success will look like in 2020. Future business models may look very different, and will definitely need some new and unfamiliar capabilities. Companies will need to try a range of approaches to find and build on the ones that work, and now is the time to start experimenting. Because if luck is preparation meeting opportunity, then as the golfer Gary Player once said, “The harder I practice, the luckier I get.”

Trevor Hatton

UK Life and Pensions Insurance Leader

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Is there a future for networks? Will you be fit for 2020? The benefit of hindsight: interview with Nick Sherry

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Inside It’s the end of the world as we know it (and I feel fine) Sea change ahead for the retirement market Calibrating the pendulum

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Wealth management: a client perspective An increasing focus on in-force performance The changing face of the Skilled Person Review

PERSPECTIVE | Malcom Kerr explores the future of networks

Is there a future for networks? It’s more than 30 years since Ken Davy and a number of other highly successful salesmen left Abbey Life to set up their own businesses and joined in a network to support each other. The scale of this network allowed them to negotiate higher commissions with life companies. by Malcolm Kerr

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The network — DBS — grew exponentially. And, as regulatory requirements increased, additional support services were developed to meet the needs of the members. As scale increased, so did additional commissions. In the end, these payments more than compensated for the fees payable for the service. Other firms with similar models followed. And the rest is history. Networks became the most powerful distribution channel for product providers. And, according to our analysis, in spite of higher commissions and significant marketing support, they also became the most profitable channel for providers. However, the RDR saw some clouds on the horizon and, whilst these have not all turned into thunderstorms, it is clear that there is now a question that needs to be asked. Is there a future for networks?

Let’s look at the downside first: ►► RDR bans commission on investment products. This punches a hole in the original network model – as does the FCA clamp down on inducements. And these payments were very important to some firms. Can they survive without them? ►► The regulatory bar is increasing all the time. Is it possible for networks to insulate themselves and their members from the conflicts of interest, business conduct risks, poor quality files, anti-money laundering, inappropriate incentives and the plethora of other past, present and future regulation? ►► Profitability remains difficult for some networks. And the future looks challenging. Total adviser numbers have reduced and are unlikely to recover in the short term. Costs, including professional indemnity (PI), remain high for many players, and some of the larger firms have struggled to realise economies of scale. To what extent can overheads be reduced?


►► Culture remains an issue within some firms. A significant number of network advisers continue to charge percentage based fees on a ‘no transaction, no fee’ basis – pretty much identical to commission. So the culture remains, to some extent, one of selling products rather than advice. Is this sustainable?

Of course, some firms have strong brands in a specific consumer segment or neighbourhood. But, even if we look at the £15b plus retirement market, there is no recognisable national advisory brand. Maybe a network could rise to the challenge and fill this gap – and maybe a franchise approach could be viable.

►► T  he ‘sunset clause’ which, in two years’ time, will require trail commissions and platform fees to be unbundled from existing mutual fund investments. What impact will this have on adviser profit and loss? Could we see a further reduction in numbers?

There are precedents. For example, Specsavers has transformed the ophthalmic market from a cottage industry of 2,000 firms into the most trusted brand in that space, comprising 1,700 stores, each part-owned and managed by directors who are shareholders in their business. Interestingly, their analysis, diagnosis and prescription models are very similar to that of a financial adviser.

However, there are opportunities: ►► A number of smaller networks have emerged with enviable, highly ethical, cultures and a clear focus on mitigating risk rather than increasing market share. Other common characteristics include an emphasis on financial planning and fee structures which are not contingent on transactions. ►► The profit margin of the smaller firms seems higher than that for the major players. This seems counterintuitive. But when one looks under the bonnet, it is clear that running a large network is a great deal more challenging than running a small one. So is the route to success to shrink the large businesses? Probably not. In fact, there are great opportunities for the large networks. But these will not be easy, or cheap to realise. If we ignore the wealth managers, where the focus still tends to be on investment, the advice market today is highly fragmented – almost a cottage industry.

What would be the characteristics of an intermediary franchise in the retirement space? ►► The first characteristic is that even though the firms would be individually owned, they would operate under the intermediary franchise brand. And they would help build that brand to be attractive to, and ultimately recognised by, the target market. ►► Second, the adviser would be required to swap a share of their firm in return for the franchise and shares in the franchise business. The result would be that both the firm and the franchise had a vested interest in the success of both parties. ►► Third, all firms would operate within the very strict franchise Rules with a capital R to ensure consistent client experiences and outcomes. Adherence to rules is critical. If you go to Body Shop, Starbucks or PizzaExpress anywhere in the UK, the experience is the same.

►► The rules would define everything from the typeface used on communications, the advice processes, the propositions and the fee model to the common technology platform and the look and feel of the reception area. Clearly this won’t appeal to everybody. But it may resonate positively with a sufficient number of advisers to create an attractive business model and, ultimately, a strong consumer brand. ►► The culture and values of this new model would be focused on mitigating conduct risk and driving superior client outcomes. Needless to say, these would be reinforced with robust systems and controls. Development would not be easy. For firms and advisers moving from an entirely independent model, where the network is to some extent at arm’s length, to a much more intimate relationship where equity, values and culture are shared, would be a huge step. As would be the acceptance of central control — albeit balanced with local incentives for business owners to make it stick. For networks, it would require a significant investment in terms of the service proposition. Having said that, some larger firms are already evolving their business models in this direction — albeit without the ‘franchise’ factor. So: is there a future for networks? In my view, yes, but the evolution of the model will need to accelerate, and advisers may have to decide whether to seek direct authorisation, or become part of an organisation that looks less like a network and more like a national firm.

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RESEARCH | The future of UK life insurance by Trevor Hatton

Will you be fit for 2020? by Trevor Hatton

Just as many elite athletes are already starting to plan for the Tokyo Olympics in 2020, life insurers need to start building the skills that they will need to survive in 2020 and beyond. The challenge faced by many insurers is monumental – comparable to transforming themselves from a heavy weightlifter to a lean runner athlete >>>

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In Beyond 2020, our recent research with the Chartered Insurance Institute (CII), we spoke to a number of insurance CEOs and other industry commentators, combining their views with EY research to clarify what skills will be required for future success in UK life, pensions and health insurance. Some of our findings will be familiar. But they are salutary: to be successful 5 to 10 years from now, insurers need not only to reinforce their existing capabilities, but also to build strength in new skills that have traditionally been the domain of marketingintensive businesses.

What will be the key capabilities for success in 2020? The (end) customer will be king The days of treating customers as little more than policy numbers are already over. However, as the mass market for investment and protection advice shrinks, and the remaining ‘pockets of wealth’ become increasingly diverse, insurers will need to make a quantum increase in the depth of their consumer insight. They will also need to rebuild consumer confidence in their (damaged) brands and engage with customers in the way customers want, in relationships that may last several decades and involve many changes and interventions.

“The reputation of the financial services industry has been so greatly damaged that it won’t recover. The public are very sceptical but trust has been irrecoverably lost.” Phil Loney, Group Chief Executive, Royal London Group.

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RESEARCH | The future of UK life insurance by Trevor Hatton

Key interventions through customer journey

Pre-maturity contact

Proactive servicing contact

Depth of relationship

Statement — ‘keep you informed’

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Newsletters — ‘reinforce benefits’

Pre-acquisition

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6 Lapse event

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Follow-up contact

Welcome pack

Maturity/ reinvestment

Routine servicing contact

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Customer journey

“The customer experience needs to be ‘digitised’ as much as possible, but some personal contact will still be vital.” David Barral, CEO, Aviva UK and Ireland Life

Digital technology has been adopted by consumers far faster than the insurance sector has been able to respond. People already expect to access insurance and investment products through the channel of their own choice. If insurers don’t respond effectively, new entrants will take their place. Face-to-face advice, although still a preference for many, will soon only be cost-effective for those customers either with significant assets to invest, or at a handful of key life milestones, such as bereavement or retirement. Insurers need to invest in rebuilding their customer interactions to improve engagement, at the same time as reducing cost substantially. Clearly this is a major challenge, even when leveraging technology. Insurers once led the world in their ability to generate commercial advantage by crunching huge data sets. However, this advantage has been eclipsed as banks and supermarkets have mined proprietary, as well as external, data to develop personalised insights into consumer behaviour. Insurers need to be enabled, not swamped, by the proliferation of new data that continues to grow exponentially.

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Retirement is the future The tax advantages of life and pension products continue to be eroded, taking away a substantial part of the industry’s ‘raison d’être’. However, those insurers with foresight recognise the huge opportunity presented by retirement as millions of people seek help with the financial uncertainty that retirement presents. Retirement market transformation will be a continuing focus over the coming years. Successful insurers will work closely with the UK Government to develop practical and cost-efficient retirement solutions, including the unlocking of housing equity and the provision of ‘semi-private’ health.

“Our present challenge with big data is gathering and deploying useful insight from it. This will shift to needing to gain more data and then using it to interact intuitively with our customers.” Mike Kellard, CEO, AXA Wealth


Retirement phases

Income needs in retirement

Transition

Active

Stable

Secure

1 “Third way” investment products (with guarantee) 2 Tax-free cash 3 Income drawndown and/or fixed-term annuity

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4 Enhanced and/or impaired annuity 5 Equity release and/or immediateneeds annuity

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Only do what you can be best at Focusing on core competencies has never been more important as industry margins come under relentless pressure. Insurers will have to quickly assemble skills which have not been strengths in the past – such as digital innovation, marketing and analytics, and non-core product provision.

“As margins get tighter, firms will need to move to much lower and more flexible costs bases.” Paul Matthews, CEO UK and Europe, Standard Life

Conversely, there are some skills which are at the traditional core of life insurance, that should be further refined and refocused. In capital management, non-UK insurers may avoid investing in the UK’s tough market, leaving UK incumbents as the primary source of capital in a post Solvency II world. Similarly in underwriting, as insurers recapture control of their customer data, they may choose to reinsure risk more selectively. To do this, insurers will need to nurture and develop these core skills through focused industry learning and development programmes.

“Predictive underwriting has got to be a key change going forward – why not use this to find out when people may want a product and allow them to buy it with one question?” Russell Higginbotham, CEO, Swiss Re UK & Ireland

The constant theme that runs through Beyond 2020 is the acceptance that the future looks more challenging than the past. In today’s environment, the forces of regulation, technology, media and consumer demand all drive towards a scenario where customers have greater control relating to their financial products. This has been less so in the past and provided a foundation for volumes of static customers. Insurers will need to take more control of customer relationships if they wish to remain relevant to consumers.

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INTERVIEW | Dan Mahony talks to Nick Sherry

Former Australian Senator and EY Senior Advisor, Nick Sherry

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In the UK, auto-enrolment is well under way, with over two million new employees now contributing and only around 10% opting-out. However, the real challenges lie ahead. And a particular concern is the potential capacity crunch as small businesses reach their staging dates. Australia has operated a compulsory pensions saving framework for many years, which requires individuals to contribute a portion of income into superannuation, from the point they enter the workforce to when they retire. Total assets in this framework are currently A$1.75t (£0.97t) and forecast to be A$3.5t (£1.91t) in 2025 and A$6-7t (£3.3-3.8t) by 2035.† At EY, we are fortunate to have as a Senior Adviser former Senator Nick Sherry, previously a member of the Australian Senate, Assistant Treasurer and the first Minister for Superannuation and Corporate Law. Nick has spent a good deal of time in the UK over the past couple of years and, in an interview with Dan Mahony, we asked him to reflect on the Australian experience and provide some insights for the UK market. DM: Has compulsion worked well in Australia? NS: It is important to recognise that there is a difference in perception which has grown with the system. Initially, compulsory individual pensions were viewed as a supplement to the existing modest state pension. Over time, as pots and contribution rates grew, the individual pension increasingly became viewed as the core retirement savings vehicle by higherincome earners who receive little or no state pension, due to means testing, and a major supplementary benefit by most lower- and middle-income earners who receive a full or part state pension.

The key positives are: ►► While a mandatory contribution exists (currently 9.25%, increasing to 12% by 2020) the average additional voluntary contribution is between 3% and 3.5%. ►► Australia is the fourth-largest and fastest-growing pension system in the world – it adds to the sustainability of overall retirement incomes and has a key role in investment to support economic growth. ►► It includes 92% of employees, thanks to the low cut in point on earnings. ►► The sector is overseen by independent non-legal disputes resolution and features full compensation in the event of theft and fraud – except the self-managed sector (similar to Self Invested Personal Pensions) – along with arms-length trustee governance and investment based on UK common “trust” law, requiring diversification in the best interests of members. Aspects that require improvement: ►► The system is very complex and contains many “electable” decisions, such as insurance coverage, estate requirements, splitting contributions and a range of contribution options overhauled by tax treatments. ►► Taxation is carried out partly at the point of contribution and partly on earnings (nil on withdrawal after retirement age). ►► There are far too many investment options – hundreds in some cases – adding to the complexity facing the customer.

►► The complexity mentioned above drives advisers and sellers, leading to costly administration. Simplification is believed to have a positive impact on cost and has led to the recent ‘MySuper’ directive, requiring defaults to be low-cost solutions. ►► There is an abundance of multiple accounts as a result of workers changing employer. ►► Members can take a lump sum at age 60; there is no annuitisation requirement or yearly cap on drawdown, presenting a risk that large withdrawals might unbalance the system. DM: What are your reflections on the UK pension situation? NS: The existing system is complex and increasingly demanding on the government. It is good to see it being simplified. As in Australia, there has been a large scale exit from defined benefit in the last decade, and it has virtually disappeared for new employees in the private sector. It’s hard to see how it can survive in the public sector on equity and sustainability grounds. In Australia, most defined benefit schemes closed to new employees 10 or more years ago. The auto-enrolment regime will have a major positive impact and is very important – it’s a second best to compulsion, but far better than a voluntary opt-in proposal. And, we’ve seen in Australia, it will take a long time for account balances to grow to a meaningful level.

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INTERVIEW | Dan Mahony talks to Nick Sherry

DM: You mentioned multiple accounts as an issue. Is there a way to address this? NS: Compulsory contributions in a multiple-fund provider system such as that in Australia led to 30 million accounts in total, with approximately 6.1m ‘lost super’ accounts, holding assets of A$11.9b (£6.5b) never to be claimed by members. This is unconscionable.† The same would have happened in the UK if it hadn’t been thought through at this early opportunity. In such systems, the majority of customers reside in default options, so you can’t expect them to proactively merge accounts. Government policy must deliver an effective solution. Having the pot follow the member via government tracking is an example. Australia uses tax file numbers to track pots and has provided a central resource to identify multiple pots and consolidate through the ATO. Fortunately, Pensions Minister Steve Webb and the Department for Work and Pensions (DWP) have acted early in the life of autoenrolment to minimise the problem – unlike in Australia, where it has taken 20 years to tackle effectively.

DM: With auto-enrolment being a new initiative, is the insurance sector likely to have an appetite for small balances or small employers? NS: The insurance sector benefits from auto-enrolment, so the system should be designed to deliver effective pricing and returns for all, not just large employers with full-time employees on middle to higher incomes. Whilst some price or return differential is inevitable, it should be minimal. NEST (National Employment Savings Trust) is useful in this regard. DM: What are your views on NEST? NS: NEST is important – both to provide effective price/fee tension with the market and to ensure there is coverage for a smaller balance or a lower-income employee. But in the long term, it should not be funded by the general taxpayer. DM: How much will increasing compulsory contribution from 9.25% to 12% (by 2020) address the savings gap? NS: It will have a major impact, but over time, and we have seen this at each phase; the phase in – 3% in 1987, 3% to 9% from 1992 to 2002, and 9% to 12% from 2013 to 2020 – and time in system is important. Individual outcomes are also complex due to interaction with the means-tested state pension. The replacement rate after 40 years of working life is telling: lowerincome earners 100% plus, lower to middle 60%–70%, middle 50%–60%, and higher incomes 30%–50%.

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DM: Should the rate be higher than 12%? NS: No – unless higher contributions are temporary to assist those who are not in the system for long enough due to phasein. It is effectively a diversion of wages that therefore impacts on consumption. And governments can only do so much. Other policy approaches to maintaining a reasonable outcome, such as increased retirement and access age to track longevity, need to be used. DM: Should mandating savings for retirement be introduced in the UK? How can customer engagement be driven up? NS: There needs to be a combination of mandatory and voluntary topup. But government can (fiscally and philosophically) only go so far. Engagement may be useful, but how many can be ‘educated’ or independently advised. It is costly. In the pensions world, I am sceptical. † Exchange rate of AUD$1.83 to £1 used, February 2014

It’s the end of the world as we know it (and I feel fine)

Jason Whyte examines the implications of the 2014 Budget for the UK Life & Pensions sector >>

PERSPECTIVE | Jason Whyte examines the implications of the 2014 Budget

The Budget Statement If the Life & Pensions industry collectively breathed a sigh of relief at the FCA’s decision to take no immediate action from its thematic review of annuities, George Osborne’s Budget statement on 19th March will have triggered a sharp intake of breath. Mandatory annuitisation was first introduced by the Finance Act of 1921, but low interest rates and increasing longevity have meant that today’s annuitants are often locking into a permanently low income. Successive governments have tried to offer alternatives but have been concerned that pensioners might spend their accumulated savings too quickly and thereafter rely on the State. After the initial introduction of Income Drawdown in 1995, the overall tone has been one of small adjustments at the margins. No longer. Osborne has chosen to wield the sword of Alexander and cut the Gordian Knot: “We will legislate to remove all remaining tax restrictions on how pensioners have access to their pension pots. Pensioners will have complete freedom to draw down as much or as little of their pension pot as they want, anytime they want. No caps. No drawdown limits. Let me be clear. No one will have to buy an annuity.” Specifically, from 27 March 2014 pensioners’ options for drawdown and small pots were significantly widened: ►► The minimum income requirement for flexible drawdown will be reduced from £20,000 to £12,000 and the capped drawdown limit rises from 120% to 150% of GAD annuity rates ►► Total pension wealth of up to £30,000 can be taken as a lump sum (up from £18,000) ►► Up to 3 small pots of up to £10,000 can be taken as lump sums regardless of total wealth (up from 2 pots of £2,000)

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These are only the initial steps. The more significant changes require new legislation, and so will take effect from April 2015: ►► Retirees will be allowed to access any or all of their retirement funds subject to their marginal tax rate rather than the current 55% charge for full withdrawals ►► Early retirement age for private pensions to rise from 55 to 57 in 2028, in line with State Pension age ►►“The government will guarantee that everyone with a defined contribution pension will be offered free and impartial face-to-face guidance on their financial choices in retirement when they retire. The government will deliver a new duty on pension providers and trust-based pension schemes to deliver this ‘guidance guarantee’.” (HM Treasury, Freedom and Choice in Pensions, March 2014). To support the guidance guarantee, the Chancellor committed to provide “£20m over the next two years to work with consumer groups and industry to develop this new right to advice.” Insurance shares fell heavily on the news, especially those with limited international diversity. But is this just a reflexive market response to sudden news, or the beginning of a more permanent correction?

EY’s perspective: change and opportunity At EY, we see as much opportunity as threat in Osborne’s proposed changes (which, it should be stressed, are still subject to consultation). The first thing to note is that while the industry has been surprised by the announcement (and by the apparent lack of pre-briefing for such a large change), the moves themselves are not entirely unexpected. Industry commentators have argued for some time that annuitisation needs to be reformed and that consumers need support for the complex and often irreversible choices they have to make around retirement. The proposed reforms offer both these things.

Furthermore, the impact on the annuity market itself may be less dramatic than might at first seem. Bulk annuities should be largely unchanged. Individual annuities are not outlawed and consumers still value many of the features that they can offer – security of income, protection from longevity and inflation risk, spouse’s pensions. However, we expect the reforms to drive a step-change in competition in the retirement income market. In the past, annuities have often not even had to compete against one another. In the future, they will compete with a wide range of other options – and will need to improve or risk becoming irrelevant. Annuities remain at one end of a spectrum, offering a permanent defined income, but far more customers will now be able to draw income from their pension while their assets remain invested. This offers the potential for a bigger income and ongoing growth, and allows customers to hold assets back to fund healthcare later in retirement or for inheritance. But it can also be a high risk option. A few years of bad investment performance early in drawdown could seriously deplete the pot for the long term. We expect many customers to look for a balance of security, income and flexibility. A combination of drawdown and partial annuitisation might be the right option for some customers, but the reforms are also likely to drive innovation between the two extremes. In investment terms, customers may look for investment portfolios that balance yield, capital growth and low downside risk. Advisers will look to take a significant share of this business, but life and pensions providers may be able to deploy their existing skills in liability-driven portfolios directly for customers. There may even be a role for with profits-like solutions. We also expect to see disaggregation of some aspects of today’s annuities, with distinct solutions to partially mitigate longevity, inflation or falls in portfolio value. These could be structured products, but insurers could opt to use their balance sheets directly to underwrite them.


►►Proposed changes to pensions regime make pension saving more attractive for consumers and providers will significantly increase competition and innovation in the retirement income space — “At Retirement” will become “In Retirement” ►►Much greater flexibility around use of pension pots, including saving for later health care or inheritance ►►Investment platforms and corporate pensions expected to be early winners as customers consolidate funds in one place to manage their retirement options ►►Competition to offer high-yield investment portfolios as an alternative to annuities – including insurers deploying their expertise in liability driven investment and with profits ►►Potential for innovation around standalone guarantees ►►Annuities must become more flexible and competitively priced to remain relevant, and guard against the danger of adverse selection — improved risk selection will be needed ►►“Guidance guarantee” still to be defined but financial advice in retirement expected to grow significantly ►►Changes may drive more vertical integration of advice and distribution.

Annuities will need to adapt to compete with these new options. They will need to offer better value, and greater flexibility – perhaps through fixed terms or options to switch rates should conditions improve. We may finally see the breakthrough of USstyle variable annuities in the UK, although a shift in regulatory support might be needed. Risk selection and pricing will become more important. Enhanced and impaired life annuities will be threatened if customers judge that they can live better on drawdown over their expected lifespan. It is possible that annuities will become most attractive to those who expect to live for a long time, and insurers will need to guard against adverse selection while remaining competitive – and this may be done by routes other than traditional underwriting. One thing seems clear: customers will value the flexibility to manage their options in one place, so investment platforms that can offer access to the full range options will benefit. The converse is also true: solutions must be platformfriendly to succeed. The same may also be true of corporate pensions, which are now potentially more attractive for both customers and providers. However, providers will need to ensure that their

corporate pension platforms have the right functionality to be an effective “In Retirement” tool. A note of caution is still required: much depends on the “guidance guarantee”, and this is the least well defined element of the reforms. It is notable that the Treasury paper opts to use the word “guidance” and not “advice”, and there is no detail yet on how detailed and personalised the guidance will be, whether it will go so far as to recommend specific solutions, or whether the guidance will be one-off or ongoing. The industry still talks of “At Retirement” as a market, but now it may be better to think of “In Retirement”. Customers increasingly see retirement not as an event but as a process that can last decades and requires multiple complex decisions. It is not clear whether the guidance guarantee will cover all of this process, or just the first step. The latter seems more likely, but even so there is a question mark over the industry’s capacity to support it. Although adviser numbers have crept up since the RDR came into effect, they are still down around 30% from their peak, and the fallout has been felt most strongly in the mass market. It will be interesting to see if the government has clear ideas about where the guidance workforce will be found.

One possibility is that the government will build on the good work done by the Pensions Advisory Service. Another is that advice businesses will look at the guarantee as an entry point for an ongoing advice relationship. Provided they can serve “guidance only” customers costeffectively, the initial retirement planning conversation is an excellent opportunity to qualify customers with more complex needs who will need support over a long period. This will result in a further shift of value to distribution – and possibly further vertical integration as providers look to gain access to that value. The world isn’t ending for annuity providers, but it is changing dramatically. The transition will not be painless and there is a real risk of individual providers or even the whole industry ceding ground to advisers, asset managers or specialist players if they are too slow to react. But the picture that emerges is of an end game where consumers potentially have both a far better range of tools with which to manage their income over a lengthy retirement and the support to make good use of them. If that potential can be realised, it can only be a good thing.

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PERSPECTIVE | Dan Mahony looks at the UK retirement market

Even before the Chancellor’s Budget bombshell, there was a growing sense of urgency in the UK retirement market. After years of sluggish and reluctant change, most pension providers had woken up to the need to improve propositions or build partnerships to address gaps. by Dan Mahony

Sea change the retirem Even though the FCA’s recent thematic review stopped short of demanding immediate change, after years of variable customer outcomes and a dysfunctional market, the tide had started to turn.

As is often the case in our industry, it was a slow process. When the Pensions Minister, Steve Webb, recently raised the idea of transferrable annuities, the reaction from the industry was dominated by howls of derision and predictions of impending doom. And, of course, this suggestion would be challenging to implement. However, with very few exceptions, the products currently available in the retirement income market do not accommodate the shapes of retirement income that reflect customer’s actual needs, e.g., an ‘inverted bell curve’ where income requirements are higher in the early ‘lifestyle’ years of retirement, fall away during more sedentary years and increase in later life as care needs arise. Following the Budget changes we are heading rapidly towards a market in which annuities must compete directly with alternative options for generating retirement income. Annuities will need to rapidly evolve to stay relevant. Most providers were heading steadily in broadly the same way, with strategy focused around three areas, each of which now needs to accelerate and change:

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1. Helping customers access advice to improve their retirement outcomes

Pension providers have recognised the potential in leveraging their customer relationships to introduce them to intermediary firms (in return for a lead fee), particularly where the provider has little or no appetite for longevity risk. Advisers will increasingly see a chance to develop a long-term relationship helping customers to manage their resources throughout retirement. With the trend towards advisory firms providing their own investment and platform solutions, there is a risk that providers could see a much reduced portion of this value chain. 2. Improving the ‘customer journey’ for internal vesting customers New conduct guidelines and the threat of regulation had already increased pressure on providers to ensure the ‘pre-retirement journey’ is as simple, straightforward and rich an experience as possible for customers. The Budget changes take this a stage further: “retirement” is no longer a single event but an ongoing process that could last decades 3. Improving underwriting capability and longevity risk expertise The rapid growth of the ‘enhanced’ annuity specialists in recent years,


e ahead for ment market allied to a more general trend for granular and personalised underwriting, had already made developing this capability a necessity. However, with rates at historical lows, annuities will look poor value to many customers compared with simply living off accumulated pension savings. A rethink will be required to be competitive

Hang on though, say some, let’s face the facts: 1. The majority of pension pots in the UK are modest. 2. Income drawdown is probably only viable for pension pots over £100,000, so for most an annuity is still an appropriate option. 3. Many people with larger pots are already advised and will be offered a broader range of options. In reality, we think this way because most sales processes today are designed only to promote lifetime annuities — partly a function of the difficulties in the economics of advice for the mass market. Mr. Osborne’s changes will force a fundamental rethink of the shape of the market. An annuity should not, and probably will not, be seen as a ‘default safe haven’ — the risks (e.g., around rate, inflation, death benefits) are significant

and, for many customers, other options should be considered. The industry needs to focus on customer need when developing the next generation of decumulation products.

So, what might the retirement product of the future look like? To answer this, we need to consider some of the following: ►► Most people will face a retirement with less income than they may have hoped, having failed to accumulate sufficient retirement savings. As a result, more will need to stay economically productive for longer. ►► Many will hold significant unmortgaged housing equity. And the social attitudes and expectations around financial legacy are evolving. ►► There is an increasing realisation that we will have to take a more active role in funding for any future long-term care need. ►► From a distribution perspective, advisers recognise that they need to keep engaged with their clients into later life, when many of the more complex planning needs (and fee-generating opportunities) arise. Increasingly, they are recognising that there is value for them in helping customers to manage the assets that will fund their needs.

All of this means that today’s retirees do not have one product requirement. The winners in this market will be those firms that recognise this and can build solutions that combine the right mix of products and advice over time. Fundamental to delivering this sea change will be for the regulator to reappraise its attitude to sales processes for unsecured pensions. Historically, very few drawdown products have been written without regulated advice, which is unrealistic for smaller pots. For the new regime to be successful, there will need to be a tangible change to this approach. This is not to say that annuities and guaranteed products do not have a role to play in the market, research has shown that customers value certainty and are willing to pay a premium. However, as previously discussed in our paper The decumulation agenda, we believe that there are opportunities for asset managers and insurers to build partnerships to leverage their relative expertise and experience to build more holistic retirement propositions. The eventual market leaders of the future will be those that continue to innovate and look beyond the current landscape; we were already witnessing the greatest shift in demographics and retirement in history and now it’s been accompanied by the biggest legislative shift. It’s about time we caught up. 15

PERSPECTIVE | Sheila Nicoll looks at the new regulation environment

Calibrating the pendulum We can all monitor the thinking of the regulator through its public pronouncements but, in seeking to understand what it is looking for, it is also important to understand some of what is going on ‘behind the scenes.’ What lies behind some of those pronouncements? What is driving them? Where does it see its challenges?

16

g m


by Sheila Nicoll, Senior Adviser to EY and former Director of Conduct Policy at the Financial Services Authority. We use the analogy of a pendulum when we talk about financial services regulation. The pendulum swings, for example, between prudential and conduct regulation, or between ‘light touch’ and interventionist regulation. One of the most important challenges for the FCA, since it came into independent existence in April 2013, has been to calibrate that pendulum. And there are signs that it is still calibrating in areas such as the tone it takes, its attitude to politicians, its approach to Europe, and the publicity it gives to enforcement activity.

Tone The FCA continues to work through how much it wants to be seen to be cooperating with regulated firms as opposed to confronting them. Martin Wheatley’s widely reported “shooting first and asking questions later” comment from late 2012 raised concerns, but now seems somewhat misaligned with the current emphasis on engagement and ‘conversation.’

The political climate The FCA has been set up very deliberately to be independent of government, but politicians are ultimately in charge of legislation. If politicians determine that the FCA must take responsibility for consumer credit in 2014, or must decide on the policy for capping interest rates on payday loans, the FCA must do it, however daunting, difficult and distracting that task may be. Politically driven changes in the FCA’s mandate are a significant drain on resources for it, meaning that prioritisation across both old and new responsibilities will be an ongoing theme.

the Consumer Protection and Markets Authority was going to be the ‘consumer champion.’ But that phrase has now disappeared and the FCA is instead under considerable political pressure to prioritise use of its new competition powers. The idea now is to let market forces, rather than regulation, drive fairness and value for the consumer, but the FCA still needs to work out exactly how to make that happen. Consumers are still important, but that pendulum seems to be swinging towards giving them more responsibility for their actions. We can expect more debate around that in the weeks and months to come.

Public enforcement

Europe

►► The FCA wants to be forward-looking and, as Martin Wheatley says, “not driving along looking in the rear view mirror”. That said, it will not offer an amnesty for the sins of the past.

Another balancing act arises around the FCA’s relationship with Europe. If it finds a UK market problem that may need a rule change, does it act unilaterally or does it work to persuade the rest of Europe to do the same? The FCA works extensively behind the scenes to influence the European agenda although there are a number of European measures it would prefer not to have to deal with. Recent pronouncements from European authorities around product governance, for example, have clearly been heavily influenced by FCA thinking. But the European tanker takes a long time to turn, and it will not always go your way. There is always a balancing act: should the FCA support firms that work on a cross-border basis and lobby for consistency across all jurisdictions, or do they move on their own to address issues in the UK market – where they can – more quickly?

The regulator’s approach to enforcement has recently made a definite shift towards a harder line. In October last year, it announced its intent to issue warning notices publicising enforcement investigations at a much earlier stage. So far it has only issued one and how frequently it intends to use these new powers remains to be seen.

Clear messages So our new regulator is grappling with plenty of challenges, but some clear messages are already emerging, including some unfamiliar ones:

►► It has shifted focus away from compliance and onto risk and the culture of firms. ►► It wants proof that senior management and boards are closely involved in oversight of what goes on in the firm. ►► Above all, it wants clear evidence of business models that put the consumer at the heart of the business.

The political climate has clearly changed since the early days of establishing the two separate regulators. As proposed,

17

PERSPECTIVE | Sheila Nicoll looks at the new regulation environment

New approaches With consumer credit in its mandate, the FCA is necessarily focusing more on lowvalue, high-volume business. This is a long way from the original Financial Services Authority regulating relatively high-value, low-volume investment business. Other new areas of focus include whether financial services and products are offering value to consumers, especially in the context of how consumers behave. There is considerable interest among regulators, not just in the UK, around behavioral economics. We can expect the FCA to be interested not only in how firms use their understanding of consumers to know how best to sell products and services, but how they use this to ensure, for example, that those products and services are suitable. One interesting example of this is recognition of the limitations of disclosure. It is necessary, but not sufficient and not the answer to everything. We are also seeing individuals in the FCA looking with fresh eyes at issues or sectors in which they don’t have a long history. As a result, it is challenging traditional approaches and views: asking “why?” and not accepting “it has always been like that” as an answer. One good example is the relationship between asset managers and brokers, where the FCA is challenging the traditional approach to sharing brokerage commission.

The impact on insurers So what is all this going to mean for firms and their relationship with the new regulator? Dual regulation If a firm is regulated by both the FCA and its sister regulator, the Prudential Regulation Authority (PRA), it may well be asked similar questions by both organisations – but they will be coming from different directions. When asking about the business model, the PRA will be thinking about the resilience of firms and potential impacts on the overall stability of the system, while the FCA will be looking at consumer protection and the 18

integrity of the market. This is a deliberate consequence of the new system and while they will coordinate where they can, they are making no promises that they will always do so. Thematic reviews The FCA is taking a three-pronged approach to supervision: firms, events and themes. For larger firms, it will analyse their business models individually, while for smaller ones it will do this on a sectoral basis, with the smallest firms having a ‘touch point’ with the regulator at least once every four years.’ There will be more thematic reviews – involving relevant firms of all sizes – which will lead to the publication of good and bad practice guidance. One challenge around thematic work will be whether the FCA is probing just to better understand what is going on, or whether it has taken a view that there are problems which need to be sorted out. Senior management attestation Senior managers of firms will increasingly be required to attest or self-certify compliance with the FCA’s requirements, and the FCA can be expected to follow up on this. It is noticeable that recent disciplinary notices have referred to such attestations by senior management. This is a quite deliberate policy to ensure that senior management sits up and takes notice. Skilled persons reviews Section 166s are already being used more as a probing supervisory tool, intended to be constructive rather than critical or enforcement focused.

Specific areas of focus Product Product quality is a major theme across Europe and not particular to the UK. Recently, the three European supervisory authorities, covering all financial services sectors, published a paper in which they agreed on a range of principles about how they will approach financial services products. These include requirements around establishing, implementing and

reviewing, on an ongoing basis, product oversight and governance processes. Their focus is on: ►► Identification of the target market and ensuring that the product meets the objectives and interests of that market ►► Stress testing the product and ensuring charges and features are transparent ►► Selecting appropriate distribution channels ►► Monitoring the product to ensure it continues to meet the objectives of the target market ►► Taking action where detriment to consumers has materialised or can reasonably be anticipated. This thinking appears to have been heavily influenced by the FCA, and so offers a very good indication of where they will probe in the weeks and months ahead. One significant theme, and a potential change to the traditional approach, is around the relative responsibilities of the product provider and the distributor. We expect a challenge to the view that, in an intermediated market, a provider has little responsibility beyond the development of the product. We also expect an emphasis on showing how products are developed with the end customer in mind. Just coming up with a good idea that will sell is unlikely to be enough. Post-RDR compliance The FCA has already published two reviews into compliance with the RDR. The initial approach of the regulator has generally been to try to help, but over time, less tolerance will be given to non-compliance. The main message will be the need to use creativity to work out how to comply with the new regime, rather than to find ways of getting around it. The regulator has always said that the RDR was a journey which did not stop on 1 January 2013. The next stage in the journey is clearly the implementation of the new rules around platforms. But the FCA has also said that it will keep the position of non-advised sales under review, and that it will consider


further whether to extend the rules for platforms to other distribution channels such as execution-only brokers and life companies. The FCA is engaging positively with a number of propositions that use technology to provide advice. The question has traditionally been around whether advice is being given or not, but a more fruitful approach is likely to be around how suitability is ensured. Other important thematic reviews are around annuities, unit-linked business, incentives and the asset management value chain.

So what does this mean for regulated firms? So, even though some things are still settling, the overall message and the direction of the FCA’s thinking is very clear. There is much that regulated firms can do now to anticipate what the regulator will be expecting. We are seeing firms reviewing their culture and governance and their product development processes; asking questions around how they can demonstrate their focus on the end customers, and how they understand those customers; and whether products are reaching their target market. Senior management of regulated firms are going to have to be honest with themselves, and with their regulator(s), about the risks in their business. The FCA will be expecting firms to give evidence of senior management scrutiny, at board and executive committee level, of those risks and of customer outcomes and needs. Expect a particular focus on product governance and development. Also expect some broad questions – as fundamental as how the business model leads to good customer outcomes, for example.

The FCA wants to engage. That will be a challenge, and the engagement may be different from before, particularly since there will be fewer firms with a designated relationship manager. The regulator will need to find new ways of communicating and talking to firms. And firms need to hold the regulator to its word and take up whatever opportunities it offers, whether through traditional means such as direct contact, through trade associations, through industry events and workshops, or through social media, including Twitter.

19

RESEARCH | Sara McLeish reports on new EY and ComPeer research

Wealth management:

The past five years have seen an unprecedented degree of upheaval across the wealth management industry. Market volatility, poor investment returns, historically low interest rates and an erosion of trust in financial services, together with a raft of regulatory change, have proved a challenging combination. by Sara McLeish

The implications of these developments for wealth management organisations have been explored in some detail, but what has been the impact on the end client? To understand the consumer perspective in the changing wealth management landscape, EY, in association with ComPeer, undertook a comprehensive research project at the end of 2013 to gain insight at a time of unprecedented change. The research was undertaken by surveying c.1,000 UK-based residents from across the wealth landscape, spanning the spectrum of services from discretionary through to execution only. We surveyed:

The findings

►► 200 ► high net worth clients (HNW) (£1m+ of investable assets)

►► Nearly ► half of all respondents reported that their attitude to risk has become more cautious over the past five years, with the results demonstrating a direct correlation between appetite for risk and level of wealth.

►► 400 ► affluent investor clients (£250k–£1m) ►► 400 ► mass affluent investor clients (£50k–£250k)

Many of the findings will come as little surprise to those who have been following developments in this space: ►► As ► ever, investment performance stands head and shoulders above other factors such as brand, fees and product range in the choice of wealth manager and the decision to stay with a wealth manager. ►► Investors ► trust their own wealth manager more than they trust the wealth management industry as a whole.

However, some of the other findings may raise an eyebrow or two.

Proportion of respondents who agree or disagree with risking losses for potentially greater long-term gains Mass affluent Affluent HNW 20

38%

62%

47%

53% 58%

42%


A client perspective Awareness and engagement

The rise of self-directed investors

Charging structures

Client engagement levels remain low, and client awareness of major regulatory changes, such as the RDR, is even lower:

The ‘advice gap’ and the corollary rise of the self-directed investor are often cited as unintended by-products of RDR and the introduction of fee-based advice. Whilst the research confirms that self-directed investment is on the rise, it is not clear whether this is due to an advice gap:

The most common charging structure amongst respondents was the percentage of investment model. However:

►► Nearly ► one year into the post-RDR world, only a quarter of the investors surveyed had heard of RDR or were aware of its likely consequences. ►► Even ► amongst those clients who had heard of RDR, confusion appeared widespread – over half either believed that they were still paying traditional commissions for advice or did not actually know what they were paying. ►► As ► 2013 drew to a close, more than half of the respondents had yet to meet with their advisers, in spite of an apparent client appetite to meet more regularly.

►► The ► segment most likely to selfserve was, in fact, the high net worth investors. ►► Over ► 50% of high net worth clients consider themselves likely or very likely to invest without advice.

One out of two HNW individuals is likely to invest without advice

Have you been approached by your wealth manager or advisor to discuss your old portfolio post 1 January 2013? Yes

No

Advisory

46%

54%

Discretionary

45%

55%

►► Whilst ► only 11% of respondents were charged fees based on an hourly rate or a fixed fee, more than double that percentage of respondents expressed a preference for this approach. ►► Interestingly, ► the preference for hourly rate or fixed fee charges was more marked amongst the wealthier respondents, presumably where a percentage of investment charge can begin to feel very expensive in absolute terms.

So, what’s to be done? There is a clear opportunity for wealth managers to develop execution-only propositions for their clients. This will enable convenient transactions and generate commissions. It looks as though a significant number of wealth managers need to lift their game in terms of faceto-face contact and other communication channels. Wealth management is becoming increasingly competitive. There are challenges around acquiring and retaining clients and, equally, around recruiting, developing, incentivising and retaining high-performing advisers. Technology has a significant role to play in improving both the client and adviser experience.

21

PERSPECTIVE | Stuart Welsman & Katharine Williams look at back book management

The in-force book represents the most significant business asset for the typical life company; for most it is responsible for the majority of profit generated. EY research suggests that some life companies could expect to lose 25% of in-force business over the next 5 years.

A number of factors are combining that make managing in-force business today much more challenging. A prolonged low interest rate environment, high volumes of maturing policies and regulatory changes are all having an impact. Some companies are appointing ‘inforce’ or ‘back book’ managers to focus specifically on realising and enhancing the value of the in-force book. Increasingly we expect to see a greater degree of segmentation and / or separation between different parts of the new and in-force businesses. This will typically mean a move away from single portfolio solutions to more tailored forward thinking programmes of activity differentiated by segments of the in-force business.

by Stuart Welsman & Katharine Williams

Of course any activity needs to be closely aligned to a set of agreed metrics. In our experience this can be the first major challenge, but it is vital that all stakeholders agree to a common set of metrics and key performance indicators to enable consistent assessment of the attractiveness of options, particularly where there are ‘trade-offs’ between different measures.

Once agreed, the focus can then turn to the four fundamental business dimensions that are likely to have the greatest impact on value. These areas can be considered across the entire in-force book or, more likely, focused to address specific problem areas or enhance value within particular segments: 1. Financial: Focusing on the full set of financial levers, ranging from the most basic assessment of the margins in the business (either intentional or not) through to fundamental restructuring of the organisation, entities and the risks carried. This can include external transactions, hedging and internal optimisation. 2. Operational: New product and platform margins are already lower than the majority of the in-force book creating pressure on operational costs as more profitable policies ‘run off’. A focus on creating efficient operational processes suited to this new environment is critical. The FCA is likely to look dimly on any cases where in-force business is found to be subsidising uneconomic new business.

Profitability

£

Capital requirements

In-force policy volumes

Direct variable costs Direct fixed costs

22

Time


3. Technology: Investment is required to consolidate the legacy estate, to reduce overall costs and enable development of a broader range of digital services. This is often an area assigned to the ‘too difficult box’, however without addressing this, fundamental improvements to the in-force business will be difficult to achieve. 4. Customer: A customer-centric approach that focuses on the customer experience and customer retention is vital. A full understanding of the make-up of the in-force book enables better management and tailoring of services to customers, for example how to predict where to focus retention and upselling activity. This is a key enabler for ensuring fair outcomes and ongoing customer engagement. Against each of these four dimensions is a range of opportunities to create value. For some organisations, the focus may be on more tactical initiatives aimed at ‘making the most of what you have,’ while others are focused on strategic interventions, such as wholesale product and system consolidation, that change the dynamics of their business. From a financial perspective, fundamental opportunities include reviewing excess reserves for un-modelled business or the ability to identify where poor data quality is resulting in excessive reserve levels. Greater focus is also being placed on legal entity structures, internal reinsurance, external risk transfer, better asset liability management and aligning product strategy, all taking into account the £ new rules, such as Solvency II. These opportunities can both increase value and reduce the capital required to be locked into the insurance entities.

In terms of Operations, the primary focus remains one of expense. Following years of more traditional expense saving projects, a more sophisticated set of optimisation initiatives are now required to deliver a step-change in operational performance. We work with clients to look more closely at the core drivers of operational demand, considering opportunities to better fit their service offering to the real needs of customer and broker segments, and increasing levels of rules-based automation. Systematic reviews of product features and performance are yielding opportunities to rationalise servicing and other processes, e.g. by managing legacy features in simpler ways that achieve the same customer outcome. With a clearer line of sight into product performance and in-force costs, insurers are now able to make more informed decisions regarding the shape of their business mix. Outsourcing of small, legacy books of business to specialist providers who can better support the features is becoming more common, as are in-house migrations. As the volume of in-force business declines, the IT costs per policy become proportionately more expensive. The challenges from an IT perspective are

Profitability

twofold: the first challenge is to reduce infrastructure costs through consolidation and rationalisation; the second challenge is to move to an infrastructure that meets future demands, such as responding more quickly to new market entrants or market and product opportunities. A constant theme in all decisions is the customer. Too often, existing customers are forgotten in the constant drive to acquire new customers. Customer initiatives continue to grow in sophistication. Historically, these have tended to be more tactical call centre initiatives. More often now, we are involved in developing sophisticated propensity models and making better use of customer analytics to help identify where insurers can improve retention and identify real opportunities to better engage with the customer and provide relevant products and services that address genuine customer needs. Significant commercial benefits can be realised in these four key focus areas. Viewing these together to deliver a more holistic programme of activity provides the business with the best opportunity to improve ongoing profits while delivering better value to customers.

Fully utilizing these four focus areas in collaboration can help sustain or increase the profit margin of in-force business

In-force policy volumes Capital requirements Direct variable costs Direct fixed costs Time 23

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The changing face of the Skilled Person Review Once seen as the first step on the route to enforcement, the Skilled Person Review (SPR) should now be viewed as part of the FCA’s supervisory toolkit. by David Nancarrow

The SPR is now more forward-looking and used predominantly in the following circumstances: 1. Where the regulator needs external expertise to provide validation of an issue or to carry out a more in-depth investigation 2. Where commissioning a review is a more efficient use of limited regulatory resources 3. Where validation of previously completed supervisory actions is needed

This article provides some background on recent developments and gives additional information on the process for those of you who have not yet been subject to an SPR.

What to expect – the process First, you will be notified that an SPR is to be commissioned. This is followed by the issue of a draft requirements notice, which is sent to the board or CEO of your firm. This notice may also go to the individual that holds the compliance oversight role in your organisation. It will be a draft notice, asking the firm to select a skilled person and submit their proposal for approval.

25

TECHNICAL | David Nancarrow examines the Skilled Person Review

NEW! Mandated appointment Draft notice issued

Firm’s appointment

Tri-partite meeting FCA approval

Appointing the skilled person

Firm’s appointment

There are now two options open to regulators:

The traditional model remains whereby, following the issue of the requirements notice, the firm is asked to submit its choice of skilled person. The requirements notice will state which lot(s) the review covers, enabling the firm to confirm that the skilled person is approved to work on the lot(s). (This is not mandatory, but firms are encouraged to seek a firm that is approved for the lot in question.) The regulator will normally expect firms to invite at least two or three firms to tender for the review.

Mandated appointment This allows the regulator to appoint the skilled person from a panel of firms known as (lots), and individuals within those firms. This approach is adopted primarily for issues of such sensitivity that the regulator requires direct control, or where speed is of the essence. The relevant lots are: ►► Lot  3: Client assets ►► Lot  4: Governance, controls and risk management frameworks ►► Lot  5: Conduct of business ►► Lot  6: Data and IT infrastructure ►► Lot  7: Financial crime ►► Lot  8: Prudential – deposit takers and recognised clearing houses ►► Lot  9: Prudential – insurance ►► Lot  10: Prudential – investment firms, intermediaries and recognised investment exchanges The list of firms on each panel is available on the FCA website. The regulator does not expect to follow this approach very often.

26

The skilled person can be chosen from a selection of up to three people, with the firm indicating their preferred choice. The regulator will then approve, or reject, the skilled person. When selecting a skilled person, there are a number of factors that you must take into account. These include: ►► Is  the skilled person included on the regulator’s panel? ►► Is  the skilled person sufficiently independent of the firm and the issue? ►► Does  the skilled person demonstrate a deep knowledge of the issue under review? ►► Does  the skilled person have a tried and tested methodology for conducting the review?

The key issue is to ensure that you are confident the skilled person will provide an independent view of any issue. The regulator will also have to satisfy itself that the skilled person is not conflicted and may reject a candidate if they have concerns. (The regulator has approved EY for all of the lots discussed.)

Post-appointment Once a skilled person has been selected, they will be invited to a tripartite meeting with the firm and the regulator. There may also be an additional meeting between the skilled person and the regulator. The detailed scope will be discussed at both. A final requirements notice will then be issued. It will include the final scope and the timescales for the delivery of the draft report and, where appropriate, any interim reports or updates. The regulator will expect to have an open and honest relationship with the skilled person. They may, at any point in the process, ask for feedback from the skilled person on the firm under review.

The review The skilled person will normally form their views through a mix of documentary reviews and interviews. They will supply a list of documents and individuals that the firm needs to make available, and it will then be the responsibility of the firm to gather those documents together and ensure time is made available for interviews.


Reporting Perform review Final notice issued

►► Interviews ►► Document reviews ►► Other analysis

Any firm subject to an SPR should ensure that it appoints a project manager to oversee the production of the documents and the booking of interviews. SPRs are frequently carried out within challenging time frames, and it is important that both sides have adequate resources. It is a requirement in any SPR that all draft reports are sent to both the regulator and the firm at the same time. Any amendments to the draft report should be tracked to enable the regulator to analyse the changes made. Before issue of the final report, there are normally bilateral (regulator and skilled person) and trilateral meetings with the regulator where the report is discussed. When the content is agreed, the final report is issued. As the report progresses, the firm will need to complete an action plan to ensure that any recommendations are implemented in a timely manner. This action plan can then be shared with the regulator as a way of demonstrating the firm’s commitment to ensuring all of the actions are addressed. There has been an increase in the number of SPRs, as well as revisions made to the appointment process. In addition, there have been changes in the reasons for commissioning SPRs. SPRs now form a substantive part of the regulator’s supervisory toolkit. A requirement notice can now follow any form of supervisory visit. However, an SPR should not be seen as a precursor to enforcement, although that may follow.

First draft

Tracked changes drafts

Final drafts

Final

Once the review has been completed, the issue of the draft and final reports follow a particular process: Report

Purpose

Role of the firm

First draft

Issued to allow the firm to comment and suggest amendments where necessary

Provide feedback and comment on recommendations

Track-changed version

Tracks the changes made to the first draft and gives the regulator visibility of all amendments

None

Final draft

A final version of the track-changed version

Approval of the report to be given by the appropriate governance forum

Final report

Issued following agreement to the final draft from the regulator

Begin implementation of recommendations

Forward-looking reviews SPRs are increasingly forward-looking. Requirements notices are now issued that ask the skilled person to design frameworks for firms to work within, or carry out ongoing oversight roles as processes are embedded. Such reviews can offer opportunities to firms, as they enable them to address issues in a timely manner, whilst keeping the regulator fully informed so that they can agree the final outcome. They can also be useful in resetting the regulatory relationship by demonstrating that the firm is engaged in the need to change, or that new processes are working as designed.

‘Traditional’ reviews The ‘traditional’ review, where the skilled person is asked to assess past processes and their effectiveness, is still in use. As with the forward-looking reviews, it should not be assumed that enforcement will result. Where firms are unsure about the general direction a review is heading in, or the range of possible outcomes, it is our experience that the regulator is normally willing to discuss this. The SPR has been with us for some time, and its use has evolved over this period. However, the fact that firms are not viewing such reviews as a tool of enforcement is, without doubt, a positive factor. Regulators have confirmed that they have no intention of increasing the number of reviews they commission, and we expect to see a continued decline in the numbers issued since the 2010 peak. However, firms should be aware of the process, should they face a review and, importantly, the importance of selecting the right skilled person.

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To discuss the issues within our new magazine, please feel free to contact our contributors: Trevor Hatton Partner and UK Life & Pensions leader +44 20 7951 8418 [email protected] Malcolm Kerr Senior Adviser to EY [email protected] Sheila Nicoll Senior Adviser to EY [email protected] Jason Whyte Director +44 20 7951 1070 [email protected]

Sara McLeish Senior Manager +44 20 7951 4254 [email protected] David Nancarrow Senior Manager +44 20 7951 7377 [email protected] Stuart Welsman Senior Manager +44 113 298 2479 [email protected] Dan Mahony Manager +44 20 7951 8485 [email protected]

Katharine Williams Director +44 113 298 2474 [email protected]

If you have any comments or would like a colleague to be added to the distribution list, please contact: Wayne D'Aranjo Manager +44 20 7951 6720 [email protected]

In the complex world of financial services, no two businesses are alike. Which is why our high performance teams tailor their global insights to support your specific growth agenda. Find out exactly how at ey.com.

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