Canada: CCIR And CISRO Release Proposed Incentives Management Guidance

On February 17, 2022, the Canadian Council of Insurance Regulators ("CCIR") and the Canadian Insurance Services Regulatory Organizations ("CISRO")  released proposed guidance ("Draft Guidance") on compensation and incentive arrangements that are linked to the sale and servicing of insurance products. The Draft Guidance, which applies to insurers and intermediaries, complements and supplements the  Fair Treatment of Customers Guidance ("FTC Guidance") issued in by CCIR and CISRO in 2018 and is similar to  draft guidance issued by Québec's AMF in November 2021. (For more information, see our commentaries on  the FTC Guidance and  the AMF's draft guidance.)

The Draft Guidance reflects CCIR/CISRO consultations with insurers and intermediaries, respecting incentives, since the release of the FTC Guidance. It is open for public comment until April 4, 2022.

General Principles

The preamble to the Draft Guidance states that "Insurers and Intermediaries are expected to put in place risk management policies, procedures and controls" to meet their obligation to "develop incentive arrangements that achieve FTC". Because CCIR and CISRO are taking a principles-based approach, each insurer or intermediary will have the latitude to determine the strategies, policies, processes, procedures and controls that are necessary to achieve FTC in its specific context. However, insurers bear the ultimate responsibility for FTC through the product's lifecycle. All insurance products, types of insurance and distribution channels are subject to the Draft Guidance.

The Draft Guidance defines several key terms, generally in a manner that is consistent with common usage in the industry and as defined in the FTC Guidance and CISRO's 2021 Draft Principles of Conduct for Intermediaries. Note, however, that "intermediary" is defined broadly to include licenced, registered and exempted entities, while "customer" includes prospective policyholders "with whom an Insurer or Intermediary interacts", as well as "claimants with a legitimate interest in the policy". "Incentives" can be either monetary (bonuses, commissions, etc.) or non-monetary (travel, goods, entertainment, client referrals etc.).

Governance

The "governance and business culture" of insurers and intermediaries will be expected to prioritize FTC when incentive arrangements are being designed and managed. Boards and senior management are expected to ensure that the appropriate strategy, risk appetite and culture are in place and will be responsible for designing, approving, implementing and monitoring adherence to FTC-focused policies, procedures and controls.

Design and Management of Incentive Arrangements

In designing and managing their incentive arrangements, insurers and intermediaries are expected to include criteria that minimize the risk of unfair outcomes to customers.

Design

The design process is expected to include the assessment of risks of unfair outcomes to customers and specifically to ensure that:

• Incentives are consistent with the level of service provided throughout the life cycle of the product;
• Performance targets, whether quantitative or qualitative, are defined, measurable and aligned with FTC; and
• The customer's cost does not depend on the distribution method.

Management

The Draft Guidance includes several expectations that apply to the management of incentive programs. Among these expectations is that "key indicators" will be examined to ensure that implemented incentives are continuing to align with FTC goals. Key indicators could include:

• Sales patterns before and after a target has been met (looking for indications that a commission grid influences the selection of products sold);
• Penetration rates for cross-selling;
• High lapse rates on new business, poor persistency rates, etc.;
• Claims repudiation rates and trends in reasons for rejected claims;
• Trends in sales-related complaints; and
• Evidence of bias toward selling products that carry a higher level of incentive.

Other expectations relating to the management of incentives programs include:

• Periodic reviews to improve controls that promote FTC;
• Implementation of controls to discourage, detect and correct practices that could cause unfair outcomes to customers (including mechanisms for recovering compensation that has already been paid);
• Timely adjustment of incentive arrangements whose FTC risks cannot easily be managed or monitored; and
• Subject any incentive arrangements that could reasonably be expected to impact FTC to a conflict of interest analysis (see the CCIR/CISRO FTC Guidance, s. 6.2).

Risks of Unfair Outcomes to Customers

Insurers and intermediaries are expected to identify and assess the risk that incentive arrangements might lead to unfair outcomes for customers, in order to introduce controls to reduce any such risk and/or to adjust the incentive arrangements appropriately.

Situations that create risk

The Appendix to the Draft Guidance provides examples of incentive arrangements that, in the absence of proper design, management and controls, have the potential to increase the risk of unfair outcomes to customers.

Among the arrangements that raise red flags with CCIR/CISRO are insurer-intermediary agreements that potentially incentivize intermediary conduct that is inconsistent with FTC. These include minimum volume requirements or deadlines and loyalty arrangements under which an intermediary receives a bonus or shares in profits or is incentivized in some other way – such as the promise of signing a distribution agreement – to place more business with a particular insurer than could be justified by customer needs.

Other potential "red flags" in incentive arrangements include:

• Bonus rates that rise as sales volume thresholds are achieved;
• Excessive cross-selling incentives;
• Commissions linked to premium level or size of investment;
• Differences between initial sales and renewal commissions that could incentivize intermediaries to propose a replacement transaction rather than a simple renewal;
• Lifetime vesting of renewal commissions to intermediaries (which can lead to "client orphaning");
• Incentives paid before the provision of a service or the achievement of targets;
• Incentive arrangements that can result in fees or penalties for the customer (e.g. exit fees);
• Incentives paid to intermediaries who are uninvolved in the sale and servicing of the product;
• Performance criteria that are linked mainly to quantitative objectives;
• Performance criteria that, while linked to qualitative objectives, are ineffective in aligning the insurer or intermediary's incentives to the interests of the customer;
• Sales contests, quotas, bonuses and benefits that are linked to sales of specific products over a limited period;
• Contests, campaigns, promotions, loyalty or recognition programs that emphasize quantitative targets – such as sales volume thresholds – as a basis for receiving bonuses, rewards or privileges; and
• Chargeback mechanisms that could incentivize an intermediary to advise a customer to retain an inappropriate product.

Avoiding these risks

To help ensure that risks do not materialize as a consequence of misaligned incentive arrangements, the Draft Guidance recommends that insurers and intermediaries:

• Regularly review incentive arrangements, paying special attention to those features that could increase the risk of unfair outcomes to customers, such as quantitative performance criteria or time-limited campaigns and product promotions (or any of the others listed above);
• Consider whether persons and entities acting on their behalf are granting incentive arrangements that, in combination with the insurer or intermediary's own incentive arrangements, could increase the risk of unfair outcomes, and share information in a way that will help to prevent this; and
• Consider the addition of different types of incentives for the same basket of sales.

Post-sale Controls

The Draft Guidance states that insurers and intermediaries are expected to establish effective post-sale controls to identify incentive arrangements that lead to unsuitable sales. Effective post-sale controls are particularly important where the insurer or intermediary has implemented an incentive arrangement that involves an elevated degree of risk. Such controls can also assist in determining residual FTC risks, while improving the design of incentive arrangements going forward.

To achieve these outcomes, insurers and intermediaries should:

• Ensure that those conducting post-sale monitoring are competent, experienced and independent from the sales functions they are monitoring;
• Ensure that risk-based post-sale controls are consistent with:
  • the assessed levels of FTC risk for the specific incentive arrangements that are being monitored; and
  • any areas of elevated risk (whether related to particular persons, teams, lines of business, sales practices, etc.) that have been identified in the monitoring of information and key indicators; and
• Regularly review the results of post-sale controls to ensure that areas of concern and common issues are being identified and that post-sale monitoring focuses on FTC risks by considering sales suitability and customer outcomes.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.