Could complying with the DOL rule give insurers a competitive advantage?

By Warren S. Hersch

December 15, 2016 at 11:53 AM

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Among the industry's many gripes about the Department of Labor's conflict of interest rule, one that rises to the top is cost.

Industry estimates peg the cash outlay needed to align company operations with the rule to be in the billions — $11 billion for brokerages alone, if a recent estimate by consulting firm A.T. Kearney proves accurate.

But there's a flipside to the mountain of money. And that's this: Companies that outperform with their compliance initiatives are more successful than competitors. Best-of-breed insurers do better financially their peers on key business metrics such as premium revenue, return on equity and the bottom line.

The source of this contention: The Deloitte Center for Financial Services.

In its recently unveiled "2016 Insurance Ethics and Compliance Survey," the professional services firm interviewed senior executives from 15 of the largest U.S. life and property and casualty insurers, including chief compliance officers (37 percent of the study's respondents), who rated their companies on key compliance and spending parameters. Deloitte used these responses to classify carriers in terms of their "compliance maturity," then compared their answers to financial parameters disclosed in the companies' financial statements.

The report's conclusion: "Today's great compliance function," the authors write, "should be considered an asset to insurers, where investment in the function is associated with increased top and bottom lines, as well as lowered danger of reputational and other risk."

The growing regulatory burden

Compliance demands on life and property and casualty insurers have increased markedly in recent years. One factor underpinning the rise is ever greater regulatory oversight.

The carriers, once exclusively the concern of state insurance commissioners, are now also overseen by the federal government, including the Federal Insurance Office and the Financial Stability Oversight Council, both outgrowths of the Dodd-Frank Act of 2010. There are also global regulators to contend with, such as the International Association of Insurance Supervisors.

Another factor ratcheting up compliance demands are potentially high penalties for being out of compliance. Case in point: Regulators' discovery that life insurers were failing to report unclaimed death benefits.

As LifeHealthPro has reported, the carriers referred to the Social Security Administration's "Death Master File" — a computer database of individuals with Social Security numbers whose deaths were reported to administration — to verify the status of those who received annuity payments. But many were negligent in reporting (as required by state unclaimed property laws) that life insurance policy beneficiaries had failed to claim death benefits of contracts covering insureds who had died.

The result: 10 life insurers paid aggregate fines topping $150 million. This case, among others, has prompted life insurers to invest significantly more in compliance infrastructure, including people, technology and businesses processes, to keep from running afoul of the regulators.

Damaging the brand

The cost of fines isn't the only issue. Also to consider, Deloitte notes, is "reputational risk" because not following the rules is bad for the brand. And that could prompt clients and advisors to bolt.

"A company's reputation is paramount for any producer," says George Hanley, director of financial services risk and regulatory consulting at Deloitte. "They want to be affiliated with companies with outstanding brands, trust and integrity — companies that offer excellent products, and have superior servicing capabilities.

"Reputation is a byproduct of many things, including the corporate culture, ethics and compliance," he added. "Producers gravitate to companies that enjoy a sterling reputation."

Complementing companies' compliance investments are corporate ethics initiatives for executives and managers, from the C-suite on down, to become better attuned to actions that, legal or otherwise, might be pushing the regulatory envelope. These efforts point to an evolution in the compliance officer's responsibilities and mindset.

In years past, the report notes, it was sufficient to "check all the boxes," adhering to the letter, if not the spirit, of federal and state regulations. That's no longer true.

In the wake of the unclaimed benefits scandal, regulators' expectations as to what constitutes good corporate conduct are rising. Hence the heightened regulatory scrutiny of "standard business practices," which no longer provide insurers with a "safe harbor" from which to mount a defense.

And there will be few safe harbors for insurers under the Department of Labor's fiduciary rule, substantive provisions of which take effect in April 2017.

"The DOL fiduciary rule raises the bar substantially on insurers, including their product, sales and compliance divisions," says Hanley. "Demands to comply with the rule, including the impartial conduct standard, will impact the corporate culture — the solutions insurers offer, advisors' product recommendations, and how producers document that they're acting in the best interest of the client."

Compliance budgets will also be affected. Hanley said some of Deloitte's clients have pegged initial fiduciary rule compliance costs at up to $10 million. Subsequent add-on investments will be needed to become fully compliant with when the final phase of the rule takes effect in 2018.

Weighing the pros

The expenditures need not be viewed solely as additional costs to the carriers. As Hanley observes, insurers that build highly effective compliance programs are actually "more successful" that competitors who lag in their compliance efforts.

When measured against several financial benchmarks, the Deloitte report notes, these "higher maturity" companies surpass their "lower maturity peers." This performance difference is observed both at life and property and casualty insurers.

For example, between 2011 and 2015, high maturity life insurers achieved an 8.1 percent average growth rate in total premiums, as compared to 2.5 percent among low maturity companies. Over the same four-year period, life insurers achieved an average 9.6 percent return on equity, as compared to 8.2 percent among low maturity carriers.

Attaining these superior metrics, the report adds, can't be a middle management affair. The "tone at the top" — holding senior management accountable for establishing and fulfilling balanced performance metrics — has to be set by the company's CEO. Those chief executives who aspire to catapult their companies from "good to great" also distinguish compliance efforts in terms of:

Implementing appropriate controls with "dynamic" testing.
Establishing a culture of diversity and values.
Empowering chief ethics and compliance officers to "create a competitive edge" for their companies.
Instituting "robust risk assessments" to uncover business risks to the insurer.

These initiatives produce not only superior financial results for high maturity carriers, the report notes, but also tangible gains in:

Annual training on ethics (100 percent of high maturity companies have such training, as compared to 67 percent of low maturity insurers).
Regular updates and communications around codes of conduct (100 percent vs. 87 percent, respectively).
Regular surveys of employees on their organization's ethics culture (67 percent vs. 50 percent).
The inclusion of ethics issues in employee evaluation and compensation decisions (44 percent vs. 33 percent).

"Companies that invest in compliance and build a highly effective compliance program, one that creates an ethical corporate culture, are achieving greater success in the marketplace," says Hanley. "There is a definite correlation between investing in compliance and company performance, both in terms of revenue and profitability."

These best-in-class insurers, he adds, boast chief compliance officers who "command authority and presence" in the organization, making middle managers "better at their game."

Underpinning Hanley's claim is this finding: 89 percent of insurance executives surveyed at high maturity companies say their company is "very effective" in setting standards for ethical behavior and compliance. This compares with just half of low maturity companies.

Best-in-class companies

Compliance-attuned insurers, says Hanley, distinguished themselves in other ways, including their breadth of product, industry, regulatory and technical knowledge. They also are more sophisticated in their deployment of data analytics and other technologies able to "ferret out" problems" that could pose compliance or ethical issues.

As the technology solutions evolve, they're also giving chief compliance officers and their staff better data about company operations, distribution channels and customer interactions. Key reason: These systems are increasingly bridging once-impenetrable corporate silos — policy administration, finance, sales, marketing and other key divisions — giving chief compliance officers a complete view of business activities.

"Insurers are no longer reliant, as they historically have been, on the IT department to create queries and generate reports of value for compliance or other business purposes," says Hanley. "That's a key differentiator among high-maturity firms — their ability to efficiently analyze business risks, be it about underwriting or sales practices."

These technology gains, he adds, are driving a convergence of compliance and business operations. Premium rates generated by a carrier's underwriters, for example, are both a regulatory concern (as their disclosure is required by state insurance authorities) and a potential issue for advisors selling policies based on these rates, as well as for policyholders who must foot the premium.

"You see this convergence — using monitoring, testing and controls to minimize business and compliance risks — both at the [customer-facing] front-end and in the back-office," says Hanley. "This convergence between business and compliance processes is a growing trend at both life and P&C insurers."

In tandem with this trend, he adds, insurer increasingly view the chief compliance officer as no longer a "chief naysayer" (someone's whose job it is to reject business initiatives because of regulatory risks), but as a trusted "senior business partner and strategic advisor" who can "say 'yes' to effective risk-taking and innovation."

See the slides beginning on the next page for additional highlights from the "Deloitte Insurance Ethics & Compliance Survey, 2016."

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When measured against several financial benchmarks, the Deloitte report notes, best-in-class "higher maturity" companies surpass their "lower maturity peers." This performance difference is observed both at life and property and casualty insurers. (Click on slide to enlarge.)

To attain the superior financial results noted above, insurers' CEOs must establishin the right "tone at the top" — holding senior management accountable for establishing and fulfilling balanced performance metrics. (Click on slide to enlarge.)

High-maturity insurers achieve not only superior financial results, but also tangible gains in training on ethics, communications about appropriate codes of conduct, surveys on the company's ethics culture and inclusion of ethics considerations in employee evaluations and compensation. (Source: Deloitte. Click on slide to enlarge.)

As this slide shows, about 9 in 10 business leaders and CEOs are provided compliance updates at least every six months, as are a committee of the board of directors in every company surveyed. Also, 20 percent of the full boards received such updates. (Click on slide to enlarge.)

As revealed in this slide, the chief compliance officer has "four faces," acting as a communicator, strategist, steward and risk manager. By providing compliance leadership and promoting a culture of ethics, the CCO is better able to perform the latter two functions, the report notes. (Click on slide to enlarge.)

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