What Is Conduct Risk In Insurance?

Regulators have focused on the behavioral characteristics of organizations and their commercial activities in the aftermath of the financial crisis. The crisis highlighted that a compliance mindset of “checking the boxes” is insufficient. Firms must enhance the intangible variables that affect risk in addition to following the rules in order to avoid future problems. To put it another way, in order to reduce conduct risk, firm culture and activities must reflect a “should we” mindset rather than just evaluating whether business decisions satisfy the “can we” issue.

Regulators and businesses around the world are increasingly concerned about conduct risk; for example, the UK’s Financial Conduct Authority (FCA) has emphasized the need for businesses to handle conduct risk and provided recommendations on how to do so. Despite its relevance, conduct risk is difficult to define, and no single definition applies to every company. In essence, conduct risk is the possibility that a company’s unsuitable corporate culture or poor judgment in carrying out its business activities could harm its customers and clients.

Firms must assess their exposure to conduct risk and plan ahead of time how to respond to ethical challenges. Firms can avoid or limit the negative effects of conduct risk failures, such as financial, legal, and reputational damages to the company; poor results for consumers and clients; and harm to the financial system as a whole, by doing so. The Conduct Risk Suite of courses teaches employees on their personal responsibility to obey the firm’s policies, act ethically, and make the best decisions possible when conducting business.

What is an example of conduct risk?

Conduct risk is a type of business risk that refers to a regulated firm’s or individual’s potential wrongdoing, as well as any activity that has an undesirable influence on market stability. Improper trading or an employee and a third-party communicating material non-public information are examples of conduct risks (MNPI).

Regulated businesses must foster a culture of good behavior and make it clear to employees that misconduct will not be tolerated. It is the firm’s obligation to define conduct risk in their context and ensuring that all employees, management, and board members, as well as other entities, are aware of the concept.

What are types of conduct risk?

What kind of conduct risks does the company face? Insider trading, conflicts of interest, product design, and misselling through unsuitable incentive schemes are all examples of important dangers.

What is the official FCA definition of conduct risk?

The FCA continues to be concerned about conduct risk. Firms must comprehend what it means because it is not a term defined by the FCA. The FCA expects businesses to create their own conduct risk definitions and strategies, as well as a customized conduct risk framework to handle the specific risks they face.

In 2015, the FCA launched the 5 Conduct Questions initiative, and the top wholesale banking institutions in the UK responded with feedback papers in 2018 and 2019.

  • What proactive measures does the company take to identify and mitigate conduct hazards in its operations?
  • How does the company encourage employees in the front, middle, and back offices, as well as control and support areas, to take responsibility for controlling conduct?
  • What kind of support does the company provide to help its employees improve the way they execute their business or function?
  • How does the firm’s board of directors and executive committee keep track of the company’s behavior? And how do employees incorporate data into their conversations?
  • Has the company examined any business activity that may be jeopardizing its efforts to improve conduct?

The FCA’s 2019/20 Business Plan outlines the FCA’s general goal of improving the way financial markets work in terms of consumer protection, market integrity, and competition promotion. The 5 Conduct Questions initiative, for example, clearly helps their cross-sector work on corporate culture and governance.

The FCA’s three legislative objectives are reflected in conduct risk, which is widely defined as any action by a regulated firm or individual that harms customers or has a detrimental effect on market stability or effective competition.

  • Protect financial markets – the integrity of the UK financial system must be protected and enhanced.
  • Foster competition – in the best interests of consumers, promote effective competition.

Firms should strive for good behavior in all facets of their operations and cultivate a culture that makes it apparent that wrongdoing is not tolerated. Although treating customers fairly (TCF) has long been a cornerstone of the retail regulatory framework, conduct risk should not be overlooked. The frequent misunderstanding that conduct risk is only a problem for retail clients is linked to this.

Firms must assess what conduct risk entails and ensure that the term is defined and understood consistently at all levels of the organization, including overseas subsidiaries.

The firms’ structures and behaviors are conduct risk drivers, as they pose a risk of harm to customers or market integrity. Firms that understand the drivers of conduct risk can better assess whether their conduct risk frameworks are capable of mitigating the risk of harm resulting from their activities or individual behaviors. Firms must consider the following factors:

  • The company’s exposure to conduct risks. Insider dealing, conflicts of interest, product design, or mis-selling through unsuitable incentive and bonus schemes are examples of important risks.
  • The systems in place to continuously monitor and reduce these risks. How will it be guaranteed that these restrictions remain effective?
  • Changes that needed to be made within the organization in terms of culture and values, and how they could be tracked: and

Prior to implementing a conduct risk assessment, we propose conducting a gap analysis to determine any further controls that need to be implemented. This will guarantee that all risks are addressed. Other categories of risk, such as market and operational risk, must be managed separately from conduct concerns.

It is necessary to establish a clear link between conduct risk and corporate strategy. The FCA expects businesses to be able to show and prove how conduct risk influences company strategy and decision-making.

The major conclusions from the conduct risk assessment and the firm’s conduct risk plan should inform the overall risk appetite for conduct risk. We urge that risk appetite be linked to the FCA’s main goals of good customer outcomes and market integrity.

A company with insufficient governance arrangements will be unable to properly recognize and mitigate the risks of harm created by its operations. It may be difficult to ensure that hazards highlighted through reporting are properly addressed if a company has numerous layers of management and committees that receive comparable and overlapping Management Information (MI). Furthermore, effective oversight in terms of how issues are handled and by whom must be taken into account. Companies may choose to form a separate Conduct Risk Committee.

A study of the business models should be conducted, as well as an assessment of any potential conflicts of interest that may exist. The following are some possible areas to concentrate on:

A company with insufficient systems and controls will be unable to adequately identify risks of harm produced by its operations. MI is a critical sort of control that, if not properly designed, can result in hazards not being appropriately identified. The design of MI should be reviewed on a regular basis by senior management to ensure that it remains suitable for purpose in flagging risk areas. Training is another essential kind of control, and the FCA expects firms to develop training in order to integrate awareness of conduct risk at all levels of the organization, rather than just a tick box approach. The Senior Managers and Certification Regime strives to improve accountability and provides businesses with an excellent chance to implement new conduct risk training programs for all employees so that they fully grasp the risks associated with their individual jobs and how they should act.

For example, in the creation and delivery of products/services, a company’s business strategy can be a driver for conduct risk. In a low-interest-rate environment, for example, customers’ hunt for yield typically motivates firms to build more complex and hazardous products to suit this need. However, this may bring important behaviour hazards, such as consumers not fully comprehending the products, which are inherently unsuitable.

  • Senior management must follow the policies and procedures of the company.
  • Employee remuneration based only on financial targets should not be used to promote unethical behavior by senior management.
  • When things go wrong, a blame culture might deter people from speaking out and acknowledging they’ve made a mistake, preventing problems from being resolved.
  • Employees who turn a blind eye to workplace wrongdoing because they are afraid to speak up; and
  • Within the firm, there exist elements of indecision, when important decisions are postponed. As a result, long-standing flaws may not be remedied with timely and decisive action.

Firms should strive to promote good behavior in all facets of their operations and cultivate a culture that makes it apparent that wrongdoing is not tolerated. TCF has long been a component of the retail regulatory system, but Conduct Risk should not be considered an extension of it.

What are the three components of conduct risk?

The study has been a vital and valued resource for enterprises and their compliance officers since its beginning, highlighting distinct industry-wide and year-over-year patterns against which organizations can evaluate their own development. More than 5,000 entities, including global systemically important financial institutions (G-SIFIs), regulators, local governments, law firms, and consultancies, read last year’s report.

– There have been continuous issues in developing a discrete operational definition of conduct risk, distinct from other, related categories such as “regulatory risk,” during the course of the survey’s five years. Overall, progress has been achieved, with the number of firms with a bespoke definition of conduct risk having increased by thrice since the report’s launch. In 2018, over half of companies (43%) said they have a separate working definition of conduct risk, up from only 16% in 2013. The G-SIFIs have made the most progress, with 66% claiming to have a separate workable definition of conduct risk.

– The top three components of conduct risk have remained consistent over the last five years of the poll, indicating that there is international agreement on them. Culture, ethics, and integrity (54 percent); corporate governance, tone from the top (44 percent); and conflicts of interest (44 percent) were again listed as the top three main components of conduct risk this year (41 percent).

– Measuring culture and conduct risk remains difficult for businesses, with compliance monitoring findings, employee opinion surveys, complaints analyses, and internal audit results all being utilized as indicators. Internal attestations on culture and conduct risk were also mentioned as a cultural indicator by G-SIFIs.

What causes conduct risk?

This area includes the behavioral risks posed by seller governance and business procedures. The structures, management, operations, and governance framework of a company are all designed to maximize profits. These are not carried out with the consumer’s benefit in mind, resulting in negative customer feedback. This can be broken down further into three categories:

  • Conflicts of interest: One of the most serious dangers to ethical behavior is a dispute between the interests of the vendor and the client. When the interests of sellers do not align with the interests of customers, conflicts of interest arise.
  • Culture and incentives: A company’s culture or incentive scheme can lead to conflicts of interest, which can lead to misconduct.
  • Ineffective competition: When there is preliminary rivalry in the market, conduct concerns are quite likely to appear. When vendors sell their goods and services at considerably higher prices in order to make huge profits, this is referred to as inadequate competition. Clients transfer brands as a result, and businesses lose key customers.

How do you conduct risk management?

The Risk Management Process in 5 Steps

  • Calculate the frequency and severity of your symptoms. What are the chances of a danger occurring, and what would be the consequences if it did?

Is conduct risk principle based?

The Financial Conduct Authority’s (‘FCA’) work has been guided by the idea of Conduct Risk since its formation in April 2013. The FCA defines conduct risk as “the risk that firms’ actions will result in negative results for consumers.” The FCA’s Treating a Customer Fairly (‘TCF’) premise and intended outcomes are carried forward by Conduct Risk.

Is conduct risk an operational risk?

Despite the regulatory pressure and the fact that it is a top priority, there is no universally accepted definition of conduct risk. According to an examination of survey participants’ definitions, many people conceive of conduct risk in terms of the acts that lead up to the occurrence rather than the event itself.

Almost half of the institutions polled conceive of conduct risk in terms of the acts that lead to the occurrence, i.e. misconduct. Approximately one-third of the participants are concerned with the event’s outcome, which is usually described in terms of the harm caused to their clients, consumers, or the wider market. In their definitions, a smaller group of companies reconciles these features.

Progress being made on addressing conduct risk under the operational risk umbrella

The majority of the institutions we polled said they manage conduct risk as part of their overall operational risk management strategy. More than a third of respondents claimed conduct risk is entirely addressed inside operational risk. In the operational risk and compliance frameworks, just over 20% manage it.

Culture is key for managing conduct risk

Establishing and embedding a strong organizational culture is maybe more important than any other risk type for effective conduct risk management. “Risk culture is the single most essential part of risk management,” according to a Chief Risk Officer interviewed for the recently published Future of operational risk report.

We’ve found four main cultural elements that are used to encourage good behavior and decrease risks: