Managing the costs of misconduct
In a previous post, I wrote about the need for Licensees to implement effective and understood fraud controls.
A reader noted that his Licensee’s PI offer was now much more expensive and asked me to expand on the impact of adviser fraud on PI prices.
I appreciate that adviser fraud has a broader impact on Licensees, the industry, and consumers than simply increasing PI costs, but I also believe that incidents of adviser fraud have a more significant financial and pervasive business impact than is publicly acknowledged.
The impact of fraud and remediation
Personally, I’m not convinced that occurrences of adviser fraud are increasing, but they are being increasingly reported, and consequently exerting upward pressure on PI costs. It appears that Insurers are unwilling, or unable, to resist this pressure; one Adviser recently alerted me to the fact his PI costs have increased by 50% (from 1.2% of revenue to 1.8%) and he attributed the cost increase to this issue. Other Licensees have passed on similar increases to their Representatives.
The direct costs of adviser frauds are often dwarfed by the indirect cost of rectification. I’ve heard that one Licensee found that the amount misappropriated as a result of an adviser’s fraud was ultimately less than 30% of the total amount paid by the Licensee to remediate the fraud and manage the restitution program.
Given these facts, I can understand why the Insurers’ response is to raise premiums; it’s at least a better outcome than one Insurer’s decision to withdraw from the market entirely. The real risk is that the other Insurers may follow their lead if more incidents occur.
The impact of fraud
Unfortunately, many Licensees are particularly ill-equipped to detect, mitigate and prevent adviser fraud. In my view, they confuse their capacity to detect and prevent fraud with their capability of doing so. I think this confusion underpinned a colleague’s recent suggestion that no Licensee is capable of detecting and preventing fraud. I disagree, but I understand his point; compliance arrangements are generally designed to detect systemic, evident and procedural failures. They are often inadequate, where, as is the case in most frauds, the act is premeditated, subtle and actively concealed.
In fact, few Licensees have the measures, processes and integrated data systems that are capable of flagging issues, highlighting concerns and identifying root causes. Still fewer Licensees complement well-structured monitoring and supervision arrangements with formal, consistent and predictable consequence management policies. The reasons for these significant gaps vary; cost, ignorance, a misunderstanding of their importance or a fear that these may prove a commercial impediment to recruiting and retaining advisers.
In reality, the reverse is true; better data and clearly documented policies reassure Advisers that their Licensee will act rationally, consistently and predictably. They also help to protect the advisers, their clients and their businesses and they assist staff and representative to identify, and appropriately escalate, questionable conduct.
In the end, these are some of the cheapest ways to reduce the increasing costs of fraud, misconduct and non-compliance.
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Reports and Releases
The Economist Intelligence Unit (sponsored by the CFA Institute) A crisis of culture: Valuing ethics and knowledge in financial services.