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SUBMISSION

Corporations

Amendment (Life

Insurance Remuneration

Arrangements) Bill 2016

March 7 2016

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ABOUT INDUSTRY SUPER AUSTRALIA

Industry Super Australia (ISA) is an umbrella organisation for the industry super movement. ISA manages collective projects on behalf of a number of Industry SuperFunds with the objective of maximising the retirement savings of five million industry super members. Please direct questions and comments to:

Robbie Campo

Deputy Chief Executive

Ailsa Goodwin

Senior Manager – Regulatory Policy

Lygia Engert Policy Analyst

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EXECUTIVE SUMMARY

Industry Super Australia (ISA) welcomes the opportunity to comment on the Corporations Amendment (Life Insurance Remuneration Arrangements) Bill 2016.

Industry Super Australia (ISA) has long been a vocal critic of the impact of all forms of conflicted

remuneration in financial services including for life insurance advice and have consistently argued for a ‘no exceptions’ approach to banning commissions in advice.

ISA does not support the package of measures announced by the Government on 6 November 2015 which provide a carveout for commissions for life insurance advice in certain circumstances.

1.1 Background

There is a longstanding and strong evidence base pointing to the fact that commissions lead to conflicted and poor quality advice.

While the FoFA reforms prohibited most conflicted remuneration in financial advice, advice in relation to life insurance was exempt from this prohibition due to strong lobbying by life insurance companies and banks, who were successful in arguing that there was no evidence of problems in life insurance advice. As a result of this carveout, sales commissions and other incentives between life insurance product providers and financial advisers remain the dominant remuneration structure in the market for life insurance - with many of these arrangements underpinned by vertically integrated product and advice businesses.

In the market for life insurance, commission structures do not just lead to biased advice. Commission structures result in excessive churn of life insurance policies, with clients often recommended to change cover to attract the more generous level of commissions in the first year of cover. There are documented instances in which this was found to occur without the client’s personal circumstances being taken into account and often executed through the falsification of client information.1 According to the estimates of

members of the Financial Services Council (FSC), ‘around one in six (and as many as one in three) new business applications for life insurance may be existing policies moved from one insurer to another.’ Moreover, ‘this practice is not in the best interest of consumers as it inevitably leads to an overall increase in the cost of insurance for all policyholders’2 and may impact the level of cover and exclusions for policy

holders.

In October 2014 ASIC’s review of Retail Life Insurance dispelled the myth that there were no problems in insurance advice, providing a damning report card on Australia’s retail life insurance advice industry. According to ASIC’s Review:

 More than a third of advice (37 per cent) did not meet the laws relating to appropriate advice, a result that ASIC describes as an ‘unacceptable level of failure’

1 Peter Kell (2013) FoFA and the new reality, speech at Money Management and Financial Services Council (FSC) Breakfast Series,

12 March 2013.

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 96% of the poor advice was given by advisers paid under commission models

 Where an adviser is paid under an upfront commission model it has a statistically significant bearing on the likelihood of that adviser giving advice that did not comply with the law

Above all, the Review demonstrated the prevalence of mis-selling in the life insurance advice industry and highlighted the need for stronger consumer protection in this sector.

The Review ultimately concluded that there was a clear link between conflicted remuneration and the quality of advice.

“Our findings confirm that adviser incentives affect the quality of advice consumers receive.”3

“A remuneration arrangement tied to a product sale creates an incentive for the adviser to make a sale, rather than provide non-product-specific advice or strategic advice for which the adviser may not be paid.”4

The conclusions reached by the report regarding poor advice quality and the primary role played by conflicted remuneration structures are not new.

Research over the past decade has shown that an unacceptably high proportion of financial advice

continues to be of poor quality. In 2003, an ASIC survey found only 50 per cent of financial advice was at an acceptable level.5 In 2012, only 58 per cent of retirement advice surveyed was at an acceptable standard.6

The main features of poor advice in the surveys were inadequate assessment or addressing the client’s personal circumstances, needs or objectives; conflicting remuneration structures (e.g. product commissions and percentage asset-based fees) affecting the type of advice and recommendations, and the quality of advice given; and the failure to provide adequate justification for recommendations.

In 2006, ASIC found that superannuation advice was three to six times more likely to be unreasonable in the presence of a commission or the recommendation of an associated product. 7 A follow-up investigation

into retirement advice in 2012 found that the scoping of advice was only adequately disclosed in half of all advice examples where limited advice was provided, while in ‘several instances, particular topics were excluded from the scope of the advice, to the potential benefit or convenience of the adviser, and to the significant detriment of the client.’8

The 2014 Financial System Inquiry identified conflicted remuneration in insurance as an important issue to be resolved if public trust and confidence in the financial system is to be restored.

Despite recognising the ill effects of commissions in insurance, the Inquiry took a conservative approach, recommending revisiting a ban on commissions only after another unspecified period of trailing level commission structures.

“At this stage, the Inquiry does not recommend removing all commissions, as some consumers may not purchase life insurance if the advice involves an upfront fee. However, if level commission

3 ASIC, Report 413, p 42. 4 ASIC, Report 413, p 43.

5 ASIC (2003) Report 18 Survey on the quality of financial planning advice, p 5 6 ASIC (2012) Report 279 Shadow shopping study of retirement advice, p 8

7 ASIC (2006) Report 69 Shadow shopping survey on superannuation advice, p 8. Note: ASIC (2006) Report 69: Shadow shopping

survey on superannuation advice, April 2006, did not publish advice quality measures equivalent to ‘adequate’ or ‘acceptable’.

However, it did find that 21% of advice was not compliant with the law and that in 46% of cases where a Statement of Advice was required to be provided, it was not

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structures do not address the issues in life insurance, Government should revisit banning commissions.”9

Five years before the Inquiry, the original Future of Financial Advice (FoFA) legislation excluded a ban on commissions on personal risk on the basis that there were no problems to address in the industry. The ASIC Report made tragically clear the false nature of that assumption.

In March 2015, The Trowbridge Report, commissioned by Association of Financial Advisers (AFA) and the Financial Services Council (FSC), was released in response to ASIC’s damning review of life insurance financial advice in ASIC Review of Retail Life insurance Advice.

The Trowbridge report made a number of recommendations to tackle the alarming problems identified in the ASIC Review, including:

 To cap lucrative up-front commissions for advisers to $1200, or for customers with annual premiums below $2000, no more than 60 per cent of the first year's premiums

 A five-year rule which would prevent advisers from receiving an upfront payment for advising any client who has received advice within the last five years

 Licensees be prohibited from receiving benefits from insurers that might influence recommended product choices or the advice given by the licensees’ advisers.

Despite the extensive body of evidence documenting the ill effects of conflicted remuneration, the report failed to adequately consider a shift to the fee-for-service model and to seriously consider the widespread evidence of the impact of commissions on the quality of advice.

1.2 The Government’s Rationale for the Changes

The Government’s stated rationale for the changes is to better align the interests of consumers and those providing advice,10 yet the conditions fall short of the recommendations of the Trowbridge review into Life

Insurance Advice and the Final Report of the Financial System Inquiry.

We agree with the Government’s observation that ‘the evidence of poor quality of advice in insurance justifies further efforts by the Government and the industry to reform the remuneration arrangements in the life insurance industry.’ 11 Yet, despite the extensive body of evidence documenting the ill effects of

conflicted remuneration, the government has failed to seriously consider reform that phases out commissions in life insurance advice.

Dismissing a no commission arrangement as a potential option ultimately prevents proper consideration of the one measure that can deliver long-term effective reform – a ban on all conflicted remuneration. The Government continues to argue that the need to ensure that insurance is affordable justifies treating life insurance differently from other financial products. However, this is at odds with ASIC’s findings that commissions actually increase the cost of life insurance policies.

Underinsurance has persisted despite sales commissions being an almost universal feature of the insurance industry since its inception. There is no evidence that sales commissions lead to or are necessary for higher levels of insurance coverage.

9 Financial System Inquiry, Final Report, November 2014, p 220.

10 P 3 Explanatory Memorandum, 2016, Corporations Amendment (Life Insurance Remuneration Arrangements) Bill 2016 11 2.13 Explanatory Memorandum, 2016, Corporations Amendment (Life Insurance Remuneration Arrangements) Bill 2016

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Behavioural reasons similar to those which lead to the low levels of retirement savings (compounded by low levels of trust in the financial advice industry) appear to be the cause of the level of underinsurance. The public policy solutions to these general behavioural tendencies are public literacy programs, strong consumer protections, robust defaults and affordable advice in the client’s best interest.

The argument that commissions are necessary to solve the underinsurance problem can only be seen as a self-serving justification to maintain a very profitable remuneration structure.

Moreover, the presence of highly profitable commission structures has prevented innovation and competition in the insurance industry that would drive an increase in insurance coverage within the Australian population.

1.3 Key changes

The Corporations Amendment (Life Insurance Remuneration Arrangements) Bill 2016 will repeal the exemption from the ban on conflicted remuneration for advice introduced as part of the Future of Financial Advice (FoFA) reforms, subject to the following conditions:

a) Capping upfront commissions at 80 per cent from 1 July 2016, 70 per cent from 1 July 2017 and 60 per cent from 1 July 2018

b) Introducing a two year clawback period consisting of 100 percent of the commission on the first year’s premium in the first year of the policy and 60 percent of the commission on the first year’s premium in the second year of the policy.

c) Level commissions will also continue to be permitted with no maximum cap.

Rather than implement all of the conditions directly, the Corporations Amendment (Life Insurance Remuneration Arrangements) Bill 2015 amends the Corporations Act to give ASIC the power to create a legislative instrument to implement the majority of these conditions.

On 15 December 2015, ASIC released Consultation Paper 245 Retail life insurance advice reforms (CP 245) which proposes giving effect to the Government’s proposals. ISA has made a submission to ASIC in relation to the proposals outlined in this paper. The paper sets out:

 the maximum levels of upfront and ongoing commission payments to be paid to advisers; and  the amount of upfront commissions to be repaid to life insurers under ‘clawback’ arrangements. ISA’s concerns with the key changes in the Government’s proposals are outlined below.

1.3.1 Capping upfront commissions and reducing ongoing commissions

The Government has proposed reducing the upfront commission paid to an adviser so that from 1 October 2018, upfront commissions will be capped at 60 per cent of the first year’s premium.

While imposing a maximum cap of the premium of 60 per cent of the premium in the first year will protect consumers from upfront commissions that exceed that level, the payment of any commission to an adviser in relation to the sale of life insurance is conflicted remuneration that has the potential to incentivise the sale or the provision of advice.

The Government has proposed capping ongoing commissions at 20 per cent of the premium in all

subsequent years. While the cap will set a maximum (albeit very generous) level of ongoing commissions, it fails to consider the well-documented impact of conflicted remuneration in life insurance. By enabling advisers to earn ongoing commissions resulting from the sale of life insurance, the Government is endorsing an environment whereby advisers have an incentive to put their own interests ahead of their clients.

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As noted above, capping upfront commissions and reducing ongoing commissions may be an improvement on current practice but sends a message that commissions are acceptable in the life insurance market. This is contrary to a body of evidence that suggests otherwise.

1.3.2 Introducing a two year clawback period

The second requirement to be eligible for an exemption from the ban on conflicted remuneration relates to clawback arrangements. ISA does not support the proposed law for the reason it will not eliminate the practice of churning, where advisers encourage their clients to frequently change policies so that the adviser can benefit from the commissions attached to the new policy.

Under the proposed arrangements, a certain portion of upfront commission payments will be paid back to the life risk insurer by the financial adviser for the first two years of the policy. ASIC will be empowered to determine how much must be clawed back each year.

ASIC has proposed the following clawback arrangements:

a) In the first year of the policy, 100 per cent of the commission paid to the financial adviser in the first year will be repaid to the life insurer.

b) In the second year of the policy, 60 per cent of the commission paid to the financial adviser in the first year will be repaid to the life insurer.

The effect of this is that advisers who churn clients after one year and one day will be able to retain 40 percent of upfront commission payments, while advisers who churn clients after two years and one day will be able to retain the full amount of upfront commissions.

This does not eliminate the incentive to churn clients to new products to receive new upfront commissions.

1.4 Grandfathering Arrangements

ISA has concerns regarding the application and transitional provisions of the Bill, which are expanded upon in the Explanatory Memorandum.

The EM states that the effect of the transitional provisions is to grandfather commissions and volume-based payments that are made under pre-existing policies prior to the commencement date of July 1 2016.12

ISA does not support the grandfathering of such arrangements and in particular does not support the carveout from the amendments in circumstances where a consumer and adviser agree to increase cover after July 1 2016, on a policy that was entered into prior to the commencement of the new law.

This is illustrated in the following example from the EM.

Example 1.3: Arrangement entered into before commencement date, life product issued before commencement date.

An insurer and a licensee have an arrangement in place before the commencement date under which the insurer pays the licensee upfront and ongoing commissions on life products sold by the licensee. Under the arrangement, if the premium increases due to additional cover being taken up, an additional upfront commission will be paid to the licensee by the insurer.

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The licensee has a client who has a life insurance policy with the insurer that was sold by the licensee. The life insurance policy was issued before the commencement date.

On 2 July 2016, the client seeks additional cover under the life insurance policy that results in a premium increase. As the arrangement was entered into before the commencement date, and as the life product was issued before the commencement date, the amendments do not apply, and the benefits paid do not need to meet the criteria specified by ASIC.13

The above example demonstrates the limited capacity of the proposed law. When consumers enter into a new arrangement on an existing policy they are effectively striking a new agreement. If this arrangement is agreed upon following the commencement of the new law, the caps in relation to upfront payments and ongoing commissions should apply.

The new Bill also extends the transitional requirements from the Exposure Draft consulted on in December. The new Bill provides that the amendment doesn’t apply to benefits that are given under an arrangement that was entered into before the commencement date but where the product is issued within three months after the commencement date. There is no three-month leeway in the Exposure Draft. ISA does not support this extension for the reason that the proposed law has a limited effect and should apply straight away.

1.5 Additional comments

1.5.1 Life insurance code of conduct

When the reform package was first announced on 25 June 2015, the package included a Life Insurance Code of Conduct to be developed by the FSC by 1 July 2016. The code was to be similar to existing codes for Banking and General Insurance, in that it would set out best practice standards for insurers, including in relation to underwriting and claims management.

The Minister’s press release of November 6 states that the work on the code is ‘already underway,’

however there has been no public update on the code so far. In light of the weak nature of the reforms, the code will play a critical role in developing standards for sales of life insurance and enhancing consumer protection. Further information and public consultation is therefore necessary before the passage of the legislation implementing these reforms.

1.5.2 Additional disclosure requirements

If the government proceeds with its proposed approach to continue to allow certain forms of conflicted remuneration for life insurance advice, stronger consumer disclosure about commissions is required. Under the current law, fee disclosure statements are not required to include commissions, so there is no mechanism for consumers to understand what commissions their adviser is receiving in relation to their life insurance policy on an ongoing basis.

The government should introduce a specific requirement that advisers must include clear, prominently displayed information about commission payments in Statements of Advice and fee disclosure statements.

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ASIC should publish regulatory guidance on these requirements, which should take account of the findings of behavioural economics and consumer testing to understand how to present information about

commission payments to maximise consumer engagement and understanding.

ASIC should also publish guidance on analysis advisers are required to undertake when recommending that a client use Superannuation Guarantee contributions to fund the purchase of insurance. This should be required to include consideration of the impact of this strategy on the client’s retirement savings. This should be accompanied by regulatory guidance on how this impact should be disclosed to clients so that they understand how this strategy will deplete their retirement savings.

1.5.3 ASIC data collection and reviews

ISA welcomes the government’s announcements that ASIC will undertake a review of life insurance

Statements of Advice commencing in the second half of 2016, as well as a review of the reforms themselves in 2018, with the life insurance industry compelled to report data on policy lapse rates to facilitate this review.

References

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