Robo-advice: risks and rewards of the automated advisor

Fintech start-ups offering ‘robo-advisory’ services have enjoyed rapid success in recent years. One particular provider reported a 50% rise in assets under management in the first quarter of 2017 alone. More established providers are likewise seeking to embrace innovation and expand their online advisory services.

The FCA created an “Advice Unit” supervising firms offering automated advisory services in May 2015, and has now refocused attention on the area of robo-advice in its 2017/18 business plan. The key issue for insureds here is how to ensure — and evidence — adequate controls, and appropriate assessment of suitability in a virtual setting.

Financial services insureds should expect increased regulatory contact in the upcoming months as the FCA seek to ensure sufficient resources within firms are being dedicated to mitigating consumer risk.

What is robo-advice?

Robo-advisory services either fully or partially replace a human advisor with a computer or other device. Firms might undertake full ‘fact-finding’ and ‘client profiling’ through online forms, and algorithms then ‘advise’ the client as to suitable options.

The level of human involvement in the process will vary by firm, as will the products or services offered and the targeted clients.

Digitalisation offers an attractive cost-saving solution, particularly at a time when many firms face profitability concerns arising from the difficult market conditions since the 2008 financial crisis. New technology enables firms to expand their client base by reaching out to a younger generation who favour digital and mobile services, over traditional face-to-face advice.

Robo-risks

The significant regulatory hurdle to enter the automated advice arena has been acknowledged for some time — notably in September 2015 by Harriet Baldwin, the (then) economic secretary to the Treasury. The FCA appear to be acknowledging the increasing resource required to stay abreast of technological innovation within the financial services sector.

Whether advice is given by virtual means or face-to-face, insureds are nonetheless advising consumers and the normal regulatory standards will apply.

Firms will need to comply with the overarching requirement of suitability, and must take reasonable steps to ensure that the consumer understands the recommended product or service. Insureds should be careful to identify high-risk transactions/clients and ensure that an appropriate level of human involvement remains in place. This should include careful monitoring of:

• The integration of old and new processes
• The practices of third party providers.

What will constitute a high risk transaction/client will vary significantly, and a firm’s information on its client will depend entirely on the appropriateness and sophistication of its online forms.

Whilst targeting younger investors with online services is likely to be an attractive area for firms, these new clients carry with them increased risks for the advisor due to limited investment experience and lower cash reserves. Investment of a comparatively modest sum in a single product or fund could be outside of the appropriate suitability criteria for a first time investor. Equally, if firms are seeking to move towards automated advice for existing clients, firms should ensure proper integration of analogue and digital data to ensure that future advice will not overlook their existing knowledge of long-standing clients.

What should insurers be focusing on?

Some key considerations for underwriters at placement/renewal for insureds whose businesses include automated advice are:

• Sophistication of the forms and questions used when profiling clients.
• Adequacy of risk warnings provided and how readily firms can demonstrate these have been read and understood. 
• Firms’ retention procedures for automated advice.
• Nature and complexity of the products on offer.
• A firm’s ability to exclude certain clients or unsuitable products/services/transactions from being entered into without ‘in person’ advice. 
• Clarity and disclosures made as to applicable costs and charges. 
• Assessment and implementation of appropriate human involvement in the advisory process.
• In the case of FinTech newcomers, the insured’s own understanding of its regulatory obligations and compliance procedures.

With the significant increase in demand for robo-advice, underwriters may also wish to consider creating thresholds for the payment of additional premiums should the volume of business on which an insured is advising suddenly balloon.

The future

The Financial Ombudsman Service (FOS) is yet to publish any decisions concerning complaints relating to robo-advice. However, in December 2016, the Financial Services Consumer Panel published research which indicated that some automated advisers were already failing to comply with their regulatory obligations.

These findings should serve as a warning to firms that they must be proactive and diligent in ensuring regulatory compliance in the virtual arena. Failure to do so may place firms at significant risk of FOS claims and/or litigation in this growing area.

Read other items in Professions and Financial Lines Brief - May 2017