6 minute read
A step too FAR
A step too FAR
Getting remuneration right for insurers requires the right processes, not oversight imposed by regulators
Advertisement
By Ewan Taylor
We are seeing significantly more interventionist regulation of the financial services sector after the Hayne royal commission – regulation that will give the regulators unprecedented powers and impact the independence and autonomy of boards to do what they believe is best for their organisation.
Chief among these interventions are the Australian Prudential Regulation Authority’s proposed CPS 511 and the extension of the Banking Executive Accountability Regime (BEAR) to the insurance industry.
These would be administered through the Financial Accountability Regime (FAR), which risks stretching APRA beyond its current capability and adding to costs in the sector.
A comprehensive and properly co-ordinated framework based on sound governance principles would be preferable to the current piecemeal approach to reform.
This approach is hardly surprising, given the royal commission’s criticisms and recommendations – the Government feels politically obliged to be seen to be doing something.
But it is time to make the point that the concepts of good regulation and process have not changed because of the royal commission.
APRA Chairman Wayne Byres has acknowledged the organisation is struggling with “difficult trade-offs” required to ensure the framework for remuneration to be prescribed in CPS 511 appropriately balances a wide variety of competing priorities and concerns.
Struggling with difficult trade-offs: Wayne Byres says APRA is trying to balance competing priorities and concerns
In a speech last November he indicated that APRA may respond to the consultation feedback and back away from its proposed 50% limit for financial measures in incentive plans.
Hopefully APRA recognises that the task it set itself of attempting to prescribe a single remuneration framework for all APRAregulated entities, including insurers, was always impossible. Such a perfect model does not exist.
It would be costly indeed if mandatory standards were to constrain the evolution of new or different remuneration frameworks.
For example, would the requirement for a set percentage of variable remuneration to be determined on non-financial metrics oblige insurers to provide incentives for “doing the right thing”?
Or should an insurer that regards behaving honestly and in the interests of customers as an expected minimum standard (breach of which results in termination of employment) be able to offer incentives based exclusively on financial performance?
A significant challenge of non-financial metrics is that they rely more heavily on discretionary judgement, which is something that boards could still apply to reduce variable remuneration that was, in the first instance, assessed off financial metrics.
A better solution that does not involve APRA making too many trade-offs and that will support the highest governance standards would be for it to take an entirely principles-based approach and then police the outcomes rigorously.
The goals that Mr Byres has enunciated for remuneration should be broadly embraced. These are:
• Achieving a better alignment of incentives with desired outcomes
• A more holistic assessment of performance across a range of dimensions
• Clearer accountability for (good or bad) performance.
These would result in “…remuneration systems that provide appropriate incentives, improve accountability and support the effective management of financial and non-financial risks”.
There are no trade-offs involved in APRA adopting these goals as the basis for its regulation of remuneration.
No-one will complain if APRA requires insurers to adopt remuneration arrangements that will produce these outcomes, and then seeks to enforce these standards.
Already, much of what APRA has proposed in CPS 511 is a principles-based codification of what should be good governance practice. Reactions are mostly focused on the prescribed elements – the 50% cap on financial metrics in variable remuneration for all employees, and the extended deferral and clawback requirements for special-role employees in significant financial institutions.
Less attention has been paid to APRA’s positioning of the proposed standards on remuneration as part of its agenda to lift industry practices in governance and culture more broadly.
A holistic approach addressing all aspects of corporate culture is required, rather than focusing on remuneration alone.
FAR is being rushed into effect, with inadequate time for effective consultation and consideration of its potential implications. More and more prescriptive regulation will not deliver a high-performing financial sector. It is the people in an organisation and the way they behave that determine outcomes.
What did the comprehensive prudential inquiry into the Commonwealth Bank of Australia, conducted by an APRA-appointed independent panel, show us? Essentially, the panel’s final report said that having all of the right policies in place will not produce good outcomes if the people involved do not have a proper mindset through which to implement those policies and associated processes.
Further, they need a sound frame of reference against which to assess the merits of actions and decisions. There would have been no need for the royal commission if financial services entities had always given priority to the best interests of customers over the short-term financial interests of employees and their employers.
Which, when you think about it, is pretty startling. It seems obvious that looking after your customers is one of the key ingredients to long-term success and profitability.
The royal commission’s interim report in September 2018 heaped the blame on incentives, noting that “…from the executive suite to the front line, staff were measured and rewarded with reference to profits and sales”, leading to “the pursuit of short-term profit at the expense of basic standards of honesty”.
The real problem in the cases before the royal commission was not the incentives so much as the dishonesty and lack of action when problems were identified.
No amount of regulation will eliminate dishonesty or lack of action on results that are clearly wrong. Rather, honesty and integrity should be basic requirements for everybody in an organisation, not rewarded by incentives – and with breach resulting in dismissal.
Reacting to the worst examples of corporate behaviour is not the best way to set the standards to apply in any industry. That will only lead to a level of bureaucracy and costs that are not in the best interests of customers.
We suggest the recommendations of the Commonwealth Bank inquiry panel provide a much better model for reform than the necessarily limited review undertaken by the royal commission and the resulting “one size fits all” solutions it is generating.
Similar governance, accountability and culture self-assessments have already been conducted by the other big banks and major financial entities at APRA’s request, and by a number of other companies on a voluntary basis.
The Commonwealth Bank inquiry panel’s specific recommendations were designed to strengthen governance, accountability and culture and focused on some key levers of change:
• more rigorous board and executive committee governance of non-financial risks
• exacting accountability standards reinforced by remuneration practices
• a substantial upgrading of the authority and capability of the operational risk management and compliance functions
• constantly asking the “should we?” question in relation to all dealings with and decisions on customers, and
• cultural change that moves the dial from reactive and complacent to empowered, challenging and striving for best practice in risk identification and remediation.
Similar actions are likely to be relevant for insurers, but it will always be best if they are able to follow an approach specifically tailored to their circumstances.
In any event, simply complying with minimum regulated standards, no matter how detailed they are, is not the path to success.
Boards and management need to get on the front foot and actively ensure their companies are positioned for success. They need a remuneration framework that is tailored to meet the specific requirements of the insurer rather than one determined by the regulator, and that will support the desired company culture to attract and retain high-quality talent.
They need governance and management structures that ensure accountability for corporate and individual decisions.
The regulators need to set and police standards but avoid intrusion into areas that are properly the responsibility of boards.
