Remuneration and Incentives

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1 Remuneration and Incentives FSA s Final Guidance on the risks to customers from financial incentives. Covering best practice solutions and guidance on monitoring February 2013

2 Risks to Customers from FinaNcial Incentives Introduction In January 2013 the Financial Services Authority (FSA) published its Final Guidance on the Risks to Customers from financial incentives. The Guidance is a result of a consultation process arising from concerns that adviser s remuneration packages were encouraging unsuitable sales. While the FSA recognises that firms want to incentivise their staff, it is generally accepted that bonus schemes can negatively influence the behaviours of sales staff. The FSA is looking for a large-scale cultural change in the industry, with a move away from purely sales-driven remuneration. It expects senior management to take a strong lead in achieving this. Scope of the Guidance The FSA s guidance applies to staff who sell products such as investments, general insurance, packaged bank accounts and mortgages, among others. The Guidance does not prescribe the type of incentive schemes which firms should operate. It is intended to be helpful to all firms, but it is recognised that the risks will vary according to product type and method of distribution. It provides examples of incentive scheme features which might increase the risk of mis-selling and examples of good business practices. A regulator s journey Many of the ideas in the paper, alongside the examples of good and poor practice, are not new. Indeed the sentiments expressed build upon an earlier FSA remuneration paper from 2011 and some of the stated requirements of the treating customers fairly (TCF) initiative. Whilst the sentiments are not new, what we are seeing is an increased willingness from the FSA to intervene in areas where it believes a consumer is at high risk of detriment. The paper is very clear in its expectations: FSA has already reviewed 22 firms (with one being referred to enforcement) and it will be widening its scope of review in 2013 following legal cutover to the Financial Conduct Authority (FCA). Risks to Consumer Outcomes As part of its consultation and review, the FSA looked at the remuneration policies and practices of 22 regulated firms and identified a pattern of issues which were likely to result in poor customer outcomes. These include: Rewards based primarily on volume sales. Poor oversight and supervision. Failure to carry out critical assessments of the scheme and to identify risks to customers. Over-complexity resulting in schemes being difficult to manage. Monitoring being conducted on a routine basis and not taking account of specific features of the incentive scheme. Conflicts of interest for sales managers. Insufficient oversight and monitoring of sales techniques used in meetings with customers. Share this Remuneration and Incentives February

3 Senior management at firms often agreed to incentive schemes without sufficiently understanding the risks that could arise Industry Feedback The industry has largely welcomed the FSA s approach in this area and it received some strong responses in support of the proposals. Many respondents said that it is not the structure of the bonus scheme in itself which causes potential for mis-selling, but rather the culture in the firm and the performance management techniques employed to put pressure on sales teams. Examples given include extremely challenging sales targets and constant monitoring of staff (although not necessarily for their compliance with expected standards), including hourly reporting of sales results, and staff not being permitted to leave the office until targets are met. The strength of feedback underlines the risk to consumers and the need for senior management to ensure that the structure, operation and outcomes of the firm s incentive scheme are subject to rigorous oversight and monitoring. Finalising this guidance is important because it gives financial firms a clear idea of what we expect from them and how they should manage their incentive schemes. It also marks a key step in changing the culture of viewing consumers as a sales target to somebody to serve. High Risk Features Senior Management should consider how an incentive is likely to affect the behaviour of staff. Any remuneration packages which result in staff being highly dependent on sales volumes, or the sale of particular products, in order to receive remuneration could potentially lead to the risk of consumer detriment or the mis-selling of products. Examples of incentive scheme features which could significantly increase this risk include: Accelerated bonus rates once a sales target is reached, the rate at which bonus accumulates increases significantly. First past the post higher rates of rewards, financial or otherwise, for the first staff member to reach a sales target, i.e. competition targets. Lock-in of bonuses if targets are reached this year, it locks-in enhanced bonus for the next year regardless of sales volumes actually achieved. Stepped payments once a sales target is reached in a set period, all subsequent sales during that period are rewarded at a higher rate. Product bias higher incentives are paid for certain product types. The risk of mis-selling is increased where there are differing incentives for equally suitable products. Variable salaries basic pay varies based on performance. The risk is increased where there is a large variance between salary bandings. Inappropriate barriers to payment bonuses are accrued but only paid out if minimum sales volumes are achieved across all product types. 100% variable pay pay is purely dependent on sales performance. Remuneration and Incentives February

4 Cross-selling a disproportionate reward for cross-selling products. Thresholds staff have to reach a certain sales target before earning any bonus. Any incentives linked to level of premium, investment amount or term. These examples do not take account of sales techniques or practices used to increase sales in order to achieve the incentive payments. For example, unreasonably high sales targets or continuous monitoring of targets as mentioned above. Cultural and management behaviours such as these are unlikely to feature in incentive schemes or sales procedures. Consequently, compliance monitoring will be key to identifying corresponding risks. Robust management information (MI) and KPIs are required for a quality-based system of incentives to be effective. The scheme would fail as a result of ineffective monitoring of KPIs, or lack of enforcement of sanctions which should be effective and applied consistently. The claw-back of bonuses for policies that are cancelled early is an effective and common approach. However, it is important that the firm can identify the root cause of the reasons for cancellation and take appropriate action. Capped incentives or rolling target thresholds are methods which can be used to discourage high sales volumes towards the end of bonus periods. Risk Controls Incentive schemes which are likely to promote good behaviours, reduce the risk of customer detriment and discourage mis-selling will include some of the following features: The scheme emphasises the need to achieve high standards of advice and compliance and the fair treatment of customers. A balanced score card approach can provide consistency and typically includes a range of measures of quality including advice standards, contribution to the overall financial results of the business, growth in client base, customer satisfaction feedback, the results of T&C monitoring such as technical testing and sales observations, customer complaints and other key performance indicators (KPI)s. It can provide a broad indication of quality and the risks to good customer outcomes. However, it is important that the level of financial incentive applying to each measure is fair and balanced. Share this Remuneration and Incentives February

5 Action Required Senior Management Responsibilities The responsibility for regulatory compliance rests with the senior management of the firm. They must take reasonable care to organise and control the firm s affairs responsibly and effectively with adequate risk management systems. They must approve and regularly review the risk management arrangements that are put in place, including remuneration and incentive schemes. Firms must critically assess their incentive schemes for potential risks that could result in mis-selling or other poor customer outcomes. This assessment should be made having regard to the nature, scale and complexity of the firm. Senior management should approve the incentive scheme structure and ensure that it is designed with input from relevant business areas including risk and compliance and human resources. Some specific actions for firms to take include: Identify how your firm s incentive scheme correlates to your overall business strategy and how senior management can ensure that the business culture is aligned to good customer outcomes. Consider your corporate governance structure and whether senior management oversight and supervision is sufficient and if the firm s monitoring programme is fit for purpose. Determine whether MI is being used effectively. It is not sufficient that MI reports are produced; they must be analysed and acted upon to effectively identify risks to the business and customers. MI should be capable of identifying trends and patterns in sales activity which can identify risks of inappropriate sales. Review other business areas where sales targets and performance management can influence the treatment of customers, for example complaints handling, training and competence supervision, management of conflicts of interest, and the supervision of appointed representatives. Consider how to mitigate risks most effectively, e.g. change the scheme to eliminate the risk or put controls in place to monitor the risk and reduce the likelihood of occurrence. Management must identify and manage potential conflicts of interest, for example where sales managers are incentivised based on the sales volumes achieved by the staff who they manage. If the review identifies a risk that the firm s arrangements may have resulted in mis-selling, ensure an appropriate management response which may include a wider past business review and remedial action. The FSA is planning to widen its review of sales incentives and will review how firms are acting on its guidance. The FSA will be assessing high street banks and other firms in addition to the 22 firms that were originally assessed Treating Customers Fairly Senior management should consider how the sales strategy and incentive scheme encompass the treating customers fairly (TCF) initiative. This should include how a TCF culture in the firm will be promoted and how to measure its effectiveness in terms of customer outcomes. The FSA consultation feedback states Quality measures should reflect the fair treatment of customers and not just customer satisfaction. The customer may not be aware that they have not been treated fairly, and sales monitoring and customer contact programmes should reflect this. Remuneration and Incentives February

6 Regular Monitoring Where an incentive scheme increases the risk of misselling, this must be taken into account in the approach to monitoring. For example, high risk sales techniques cannot be effectively monitored by review of paper-based files alone and therefore the monitoring activity must include oversight of sales meetings and conversations with clients. If a particular feature of the incentive scheme cannot be measured and monitored effectively and if the firm cannot implement other appropriate controls, it should consider whether it is appropriate to retain that incentive. The monitoring function must be led by appropriately skilled and qualified staff and operate with independence from the sales function. Conclusion While it is accepted that firms want to be able to incentivise staff and to reward good sales performance, it must not be to the detriment of quality of advice and good customer outcomes. The firm s senior management must promote a culture of high business standards and avoid high pressure sales techniques. Sales processes should be subjected to regular and rigorous monitoring. Firms should take immediate action to critically review their incentive schemes for all staff involved in advising customers or promoting services. The firm s approach should be aligned to TCF principles and the Conduct Risk agenda. Do any of the examples of incentives that will raise the risk to customers happen to feature in your incentive schemes? It is likely that most firms could make improvements to either their incentive scheme or sales practices to reduce the risk to customers. This paper provides only a high level indication of the actions required in response to the FSA s review and we recommend all firms thoroughly analyse the FSA s statements in this complex area. How can we help? As stated by FSA Inappropriate staff behaviour during sales conversations, motivated by financial gain, is unlikely to be identified by firms undertaking reviews of written sales records or from training and competence schemes. TCC can assist firms by providing independent oversight to assess the business and regulatory risks of their incentive schemes, and implement an effective monitoring framework. Share this Remuneration and Incentives February

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