Effective corporate governance within insurers, including in particular those operating with-profits businesses, has been a high priority for the FSA for some time.
As far back as 2007, the FSA issued a Dear CEO letter emphasising the importance of having appropriate governance arrangements in place to provide appropriate levels of protection for with-profits policyholders, and went on to set out guidance about its expectations in this regard. A further consultation paper on rule changes was published in 2011, with the FSA making some further rules through Policy Statement 12/4 earlier this year.
Quite apart from these sector-specific developments, the design and operational effectiveness of firms’ governance and risk management frameworks has been a priority area for review in supervisory dialogue, including during ARROW visits.
As part of this, we are seeing an increasing number of firms being required to appoint skilled persons to review and report on the effectiveness of their governance arrangements to the FSA, as well as greater challenge from the FSA around (a) whether all relevant individuals have been approved by the FSA to perform controlled functions (for example SIFs within an international group structure) and (b) whether those individuals have the requisite competence and capability to perform the roles for which they are seeking approval. The failure to take reasonable steps to ensure an effective governance and risk management structure was in place formed the basis of the FSA’s (ultimately unsuccessful) enforcement case against John Pottage, the former chief executive of UBS’s wealth management business in London, as well as the FSA’s recent enforcement actions against Yohichi Kumagai and Peter Cummings.
Last week, a UK insurer was fined £600,000 (£750,000 pre-discount) for governance failures in relation to its with-profits business. Several failures were identified in the notice:
- Flaws in the design and operation of the with-profits governance arrangements;
- Inadequate review of 2 transactions by the with-profits committee;
- Absence of formal board approval for those 2 transactions; and
- A failure also to report the negative value of the inherited estate of the with-profits fund to the FSA in a timely manner.
The following points of interest arise from the disciplinary notice:
- The governance failures were said to have existed for less than a year, but were considered to be serious as they occurred in 2008/09, after issuance of the Dear CEO letter in 2007, and therefore at a time at which the firm should have had a greater awareness of the FSA’s expectations in relation to governance.
- The points of criticism identified by the FSA are consistent with our experience of the sorts of matters that the FSA would expect to see considered as part of an effective governance structure within an authorised firm, and with-profits insurers in particular – for example:
- ensuring that there are clear terms of reference for the Board and each governance committee, showing what matters have been reserved to or delegated by the Board and each relevant committee, and how responsibilities and decision-making powers have been allocated between different fora where they have overlapping remits. For example, the FSA appeared to regard terms of reference which provide significant discretion in relation to whether escalation is necessary (e.g. “where required” or “where considered necessary”) as unacceptably vague.
- ensuring that there is clarity about the role of any with-profits committee, what transactions/issues will be reviewed by it, how they will be reviewed in practice, and how any such committee will interact with the Board;
- ensuring that there is clarity about reporting lines and escalation routes within the governance framework;
- ensuring that there is adequate opportunity given to enable non-executive directors at Board level to review and challenge significant transactions prior to their finalisation/execution; and
- ensuring that there are clear records to evidence the process of independent review, challenge and decision-making around key transactions/decisions.
Firms would be well advised to review their own arrangements with these factors in mind, and to make enhancements where needed.
It is also relevant to note that a substantial financial penalty was levied despite the fact that the FSA:
- did not criticise the merits of the two transactions executed over the with-profits fund during the relevant period;
- accepted that consideration was given by the insurer to the interests of policyholders prior to executing the transactions; and
- accepted that the majority of the directors were aware of the transactions.
The notice shows that the FSA is as concerned about form and process as it is about substance – i.e. there should be appropriate systems in place to guard against the risk of proper independent judgment not being applied, irrespective of whether that risk has actually crystallised.