New Product Development
Coopers & Lybrand:
Assessment of Internal Controls
EDITOR'S NOTE:This report was among documents regarding an investigation of Prudential Insurance Co. of America that were released in December 1997 by the Florida Department of Insurance.
This particular document is the introduction (or "Executive Report") to a Coopers & Lybrand "Assessment of Internal Controls." It was commissioned by Prudential and presented to the company June 30, 1994. The introduction is the first nine pages of the 120-page report, and spells out some of the problems faced by the insurance giant.
The people of Prudential Insurance and Financial Services (PIFS) are its greatest asset. These people, particularly long-term employees, believe in The Prudential and in the values that the Company strives to uphold. This has been consistently evident throughout our work over the past few months.
Equally evident, based on interviews with over 415 people in more than 50 locations throughout PIFS, is a long-standing corporate culture motivated primarily by the concept of "production." This is despite a number of efforts in recent years to raise the importance of compliance and an incumbent senior leadership team that is committed to changing the culture. Within the PlFS environment, control, including compliance, is frequently viewed as a barrier to achieving production objectives. The current negative publicity and regulatory focus on questionable sales practices have resulted in a renewed emphasis by management on control, including compliance. However, it is clear that not everyone fully understands the message or has come to terms with the behavioral changes it requires. There is still considerable sentiment in the field (especially at the general manager and sales manager levels) that the problems are not theirs and that "it will all blow over." The attitude that these issues are more a product of overzealous regulators or internal bureaucrats, rather than substantive industry issues that must be dealt with, represents a significant impediment to change.
Definition of a corporate culture is an emotive issue for many people. Culture incorporates many elements, most importantly the values and beliefs of the people who comprise the company. It is primarily driven by the actions and examples of key leaders, by the corporate value statements that people believe in and strive to uphold, the organization and infrastructure in place to support their activities, and compensation plans that encourage specific actions, among other factors.
Our findings indicate that the PIFS culture must change to support effective control, including compliance. Effecting the necessary cultural change is not a simple process. It requires an integrated series of actions designed to promote the achievement of corporate and individual objectives in an ethical manner. Senior management has embraced the need for change. The future actions to inculcate control in PIFS should address:
- Organization and infrastructure changes that support control processes, including proactive monitoring and surveillance of business practices;
- Clear definition of roles and responsibilities, with associated authority and accountability;
- Hiring standards and practices;
- Incentive and compensation plans;
- Training, education and development;
- Technologies and systems that support the business;
- Products offered and the associated delivery mechanisms;
- Sales practices and materials;
- Recognition programs for employees who achieve success and promote good business practices; and
- Appropriate sanctions and enforcement mechanisms for unsatisfactory behavior.
We were asked to determine the following: (1) Does the sales force use techniques that would be approved by the leadership of The Prudential? (2) Are new products being developed that strike the right balance between competitive advantage and business prudence (including compliance with laws and regulations)? (3) Can senior management be assured that all sales agents are properly licensed and that the applicable products are being sold only by licensed agents?
Our approach encompassed a review of the internal controls that govern PIFS sales practices (including the use of sales materials), licensing and registration and new product development processes.
Sales and Marketing Materials
During a recent "moratorium" on the use of sales materials, an enormous volume of material was submitted for review, and a good deal of this was found to be unacceptable. The practice of creating and/or modifying material without approval was clearly widespread across the agency force. Thus it was evident that existing policies and procedures that required submission of sales materials for review were not effective and not enforceable by management.
The specific issues identified with respect to the review process were:
- The length of the review cycle in the Regional Operating Companies (ROCs) and Home Office was a significant deterrent to submission. Insufficient review resources were a key factor.
- The review process was not designed to ensure that those materials that were approved met both National Association of Securities Dealers (NASD) and applicable state requirements, nor was there a mechanism to provide for consistent application of review criteria across the ROCs. There was confusion in the field and on the pan of reviewers over what constituted acceptable material.
Our field visits identified numerous instances in which marketing material had never been submitted for Home Office review and was still in use following the moratorium. Field management also did not consistently enforce existing policies, recently reissued, that only authorized materials be used. Field management failure to enforce this policy reflected poor understanding of the risks of using unauthorized materials and the view that enforcement of the policy was not their responsibility.
New Product Development
The new product development process is characterized by a lack of formality and documentation. The primary problem is a lack of accountability, as it is unclear who should make decisions regarding the introduction of new products and who is responsible for the development and implementation efforts. Additionally, the criteria (used in determining if new products should be introduced) may rest on faulty beliefs about market demand and projections of sales volume and may not represent the interests of all key stakeholders.
With a cycle time of one to two years, the new product development process does not allow for rapid responses to changes in market forces. The lengthy development cycle can be attributed primarily to the limitations of the administrative system, Advanced Ordinary Systems (AOS). However, delays in product implementation can also be attributed to an inefficient process.
Licensing and Registration
Our analysis of the licensing and registration processes supports a conclusion that management has reasonable assurance that people are licensed and registered as required. There are exceptions, and there are opportunities to improve the efficiency and the effectiveness of these manually intensive processes. However, there is no indication that these processes are in need of significant revision.
Within PIFS the terms "control" and "compliance" are often used interchangeably. However, "compliance" ix universally understood by PIFS personnel to mean only NASD compliance. The broader meaning of control, including management's responsibility for ongoing compliance with company policies and procedures and laws and regulations, is not understood, particularly in the marketing organization. The responsibility for sales practices and compliance with all applicable rules and regulations rests with all levels of field management, including Vice President, Regional Marketing (VP,RM); however, many do not accept their role and are not held accountable for compliance, via their performance assessment or compensation.
District managers' acceptance of responsibility for control over sales practices is limited and varies from office to office. Sales managers, who maintain the closest contact with representatives, perceive their role exclusively as marketing support and not as pan of the PIFS control system. The ROCs' control focus is historical rather than proactive.
Responsibility for oversight of control, including compliance, activities in the field, is divided among numerous departments, including Business Practices, Compliance, Complaints/Consumer Affairs, Field Operations, Registration (routine and special), Legal and Internal Audit. Among them all, the concept of risk assessment has not been applied to sales practices. As individual sales representatives, groups of representatives, district offices or groups of offices emerge as outstanding producers, no one is effectively questioning how this happened. Significantly, several of these groups are components of Marketing, which represent a conflict of interest, and all groups lack the authority to enforce control and compliance. Authority rests with the VPs,RM. The timing and nature of VPs,RM's response to issues raised by the oversight groups often communicates a view that "controls inhibit production."
The Home Office has no support function to monitor and coordinate the control and compliance activities. There has been no routine focus on sales practices by senior management. Historically, PIFS has reacted to issues in this area only after the problems have become acute.
The three insurance business units share The Prudential's name and attendant goodwill. Likewise, the marketplace, including consumers, the media and regulators, largely views The Prudential as a single company. These factors suggest that it is important that there be closer coordination of control and compliance activities across these units. In addition, substantive diversity in compliance and control practices exposes PIFS to regulatory embarrassment and could be detrimental if subject to discovery in litigation.
Training of field management with respect to supervising sales practices and identifying and dealing with compliance-related issues has been inconsistent at best. As such, managers are not always sure as to what constitutes "good" vs. "bad" sales practices, are reactive toward compliance issues, and are not held accountable for their own actions or those of their representatives.
Training is critical to developing new sales representatives, and their experiences during the first 6-12 months are the crucial determinant of their future behavior. The current training system offers broad training guidelines and provides many training tools; however, determination of the specific methods, areas of focus and tools utilized was left to the discretion of each district office Thus there was little assurance of consistency among the hundreds of new representatives joining PIFS each year,
The existing procedures and tools for monitoring and surveillance of sales practices are inadequate to provide assurance as to regulatory compliance or compliance with The Prudential Values. The process of monitoring and surveillance of field activities is reliant upon the actions and attitudes of individual field managers (including VPs,RM), that too often lean toward indifference and/or leniency -- no specific guidance exists regarding how individual managers should fulfill their responsibilities. The managers/VPs,RM are also not held accountable for the actions of the field staff under their control.
Apart from the CORE reports, which relate to business practices as distinct from sales practices, there are few tools to assist in the monitoring and surveillance process -- the CORE reports themselves are not timely nor adequate to meet the overall objectives for the monitoring and surveillance process.
PIFS has taken steps toward tying management compensation with compliance activities through the introduction of a new management compensation plan in January 1994; however, the established benchmarks may not be sufficient to assure the desired behavior. The persistency benchmark, which can often be a barometer for the quality of sales, appears low compared to the industry, and there are no apparent penalties for low persistency.
To support ongoing compliance and control activities across the organization, the Law Department staff assigned to PIFS needs a sufficient number of experienced personnel who are familiar with the life insurance industry, PIFS's products and applicable laws. In addition, the Law Department does not have a formal process to identify applicable legal and regulatory changes on a timely basis.
Law Department personnel at the PIFS Home Office and in the ROCs must interact with each other, and both must interact with and support other department's with primary responsibility for compliance and control. The PIFS Home Office and ROC groups each report to a different individual at the Enterprise level.
There had been a perception by senior management that Internal Audit is an important aspect of PIFS's control activities (part of the policies and procedures designed to help ensure that management's directives are carried out). However, by its nature Internal Audit is, and should be, a monitoring activity designed for periodic assessment of the quality of the performance of control activities. This misperception had created a vacuum in the overall control structure. Line managers who had an incomplete understanding of Internal Audit's scope and objectives frequently presumed that field audits could substitute for direct supervision.
Issues raised in audit reports had not received appropriate attention at senior levels of management. Generally, these were treated as isolated cases requiring individual disposition. Overall, the organization had not recognized that audit exceptions represent the results of sampling and, therefore, may need to be addressed systematically and across districts or regions.
The relationship of Internal Audit's activities with respect to marketing and sales practices to the related activities of Compliance, Consumer Affairs and Marketing Practices required clearer definition.
Set forth below are the high-level themes which have been developed from our findings resulting from the review. Within each theme we have included observations in support of the theme, together with associated control and compliance implications.
In addition we have included the "Action Plan" developed by the PIFS Steering Committee which details specific activities, timeframes, and assigned accountability to address the control implications noted within each theme. Significant action plan items are as follows:
Sales and Marketing Materials
A new process has been designed and is being implemented that will provide consistent application of review standards and Home Office control. Field management has been instructed to remove and destroy materials rejected in the overall review. Longer term, the sales materials development process will be analyzed with a goal of reducing the field's desire to create their own materials.
New Product Development
Formalization and improvement of the new product development process will be accomplished in three phases: (1) establish decision criteria for selecting product concepts for implementation; (2) redesign of the implementation process, from product design to product rollout, including illustrations and state contract filings; and (3) address cross-business unit issues among the three insurance units.
Licensing And Registration
The opportunities to improve the efficiency and effectiveness of the manually intensive licensing processes will be addressed after PIFS completes the reengineering efforts at the ROCs. This low priority is appropriate as we did not find significant compliance gaps. A plan to fine-tune the controls over registration is being developed.
Compliance Resources: Marketing Practices Units integrating responsibility for all aspects of oversight of compliance and control are being established in the Home Office and in each of the ROCs.
Accountability and Responsibility: The action plan provides for defining accountability for compliance and control and incorporating compliance and control considerations into performance appraisals and compensation.
Monitoring: Specific responsibilities and guidelines will be developed for each level of management, promoting proactive monitoring and enforcement. Tools to support the monitoring process are to be developed.
Training: A compliance/sales practices module will be developed for presentation to all general managers later this year. The business unit will utilize the Prudential Leaning System (PLS) to improve the consistency of representatives' training in compliance and sales practices. In support of this, a program to use PLS technology to report representatives' progress will be developed.
An action plan encompassing the three insurance business units is currently being developed at the Enterprise level to address the findings related to identification and communication of applicable laws and regulations.
Internal AuditEnhanced reporting by Internal Audit to senior management was initiated as of the first quarter of 1994. The PIFS Chief Financial Officer has been charged with tracking the status of action plans in response to Internal Audit findings and with monitoring audit findings for global application across the five ROCs. Also, Don Southwell (CEO) has reaffirmed to all managers that they are responsible for internal controls and that they must be proactive when notified of an issue by Internal Audit.