At the beginning of October the life insurance industry witnessed the release by ASIC of a damning report into the provision of retail life insurance advice. But there’s more to the report than the headlined bad news. Riskinfo’s Senior Journalist, Emily Saint-Smith, takes a deeper look into ASIC’s insurance investigation and the learnings for the industry…
In August 2013, Australian Securities and Investments Commission (ASIC) Deputy Chair, Peter Kell, announced the regulator would be undertaking a major, risk-based surveillance of life insurance advice.
Kell said there were a number of reasons for undertaking the review, including the fact that the regulator viewed insurance advice as a very important area for consumers.
“The second is that we’ve publicly said for some time that we would be more likely to focus on life insurance advice in the absence of an industry framework. That’s yet to be put in place, so we are delivering on what we said we would do.
“The third reason is that we’ve seen some poor practices in some of our recent surveillances,” Kell explained last year.
According to Kell, ASIC regularly came across inappropriate and non-compliant life insurance advice during its routine surveillance projects. One such example was AAA Financial Intelligence, whose license was cancelled in February 2013.
Speaking at the Association of Financial Advisers’ 2013 National Conference, Kell shared some of the poor examples of risk advice it found during its AAA investigation, saying these issues were also occurring in varying degrees repeatedly and commonly across other licensees.
“We reviewed more than 100 files,” Kell said of the AAA investigation. “Over 80% of those included risk insurance advice. Out of those files that included risk insurance advice, just over 80% of those contained inappropriate advice.
“In summary, what we found was inappropriate, conflicted advice that caused real, meaningful harm to the consumer.”
On this basis, ASIC undertook a project to better understand the life insurance advice sector.
Challenging the methodology myths
Headlining the report was the finding that more than one-third of retail life insurance advice failed to comply with the relevant legal standard.
Advisers were understandably concerned with the results of ASIC’s investigation, and many questioned the regulator’s methodology in compiling the report. Below are some of the criticisms levelled at ASIC, and their responses:
Myth #1: The report was only based on surveillance action and did not take into account the wider industry.
Two round tables were conducted with executives from 12 life insurers, to examine the scope of the project and ensure that ASIC’s questions were appropriately targeted. ASIC then used its notice serving powers to request significant data from the insurers, to gain an understanding of the insurance market.
The practice of only paying remuneration on a product sale works against the provision of balanced, strategic risk advice to clients.
Myth #2: The non-compliant advice was not given by risk specialists.
To identify the licensees included in the surveillance, ASIC asked the insurers to provide three licensees or authorised representatives who had:
- The highest number of new, in-force policies in the relevant period
- The highest number of lapses in the relevant period
However, it should be noted that the regulator did not select any licensee on the basis of the insurers’ response to the second point.
Myth #3: ASIC has no understanding of how advisers actually operate.
ASIC’s analysts used an advice review template to standardise the assessment of the files. Most of the analysts were former financial planners with significant practical experience. 101 files were reviewed a second time by analysts with a current Certified Financial Planner qualification. An independent advice review was also commissioned whereby an external consultant reviewed a sample of the case files to ensure ASIC’s ratings were consistent.
Myth #4: The review of the cases didn’t take into account the fact that the best interests duty only came in from 1 July 2013.
ASIC rated the advice by reference to the conduct obligations in the Corporations Act 2001 that were in force at the time the advice was given. If the advice complied with the law, it was given a ‘pass’. If the advice failed to meet the relevant legal standard, it was rated a ‘fail’.
Where there was some doubt as to the final rating for advice that was given under the new Future of Financial Advice (FoFA) regime, advisers were given the benefit of the doubt because the law was new.
Myth #5: Insurers have different definitions of a lapse, so the data can’t be analysed effectively.
On page 29 of its report, ASIC outlines examples of policy events that it does not consider to be true lapses. Insurers were asked to exclude these from their data. These policy events include but are not limited to:
- A claim
- Policy reaching maturity (eg: age 65)
- Change in ownership
- Policy reinstatement after missed premium
Myth #6: ASIC was obviously looking for lapses so they targeted the bad apples.
A range of licensees (small, medium and large) were selected, with the exclusion of any licensees that were the subject of recent regulatory action.
To maintain the integrity of its sample and analysis, ASIC excluded case files belonging to two advisers about whom the regulator had already received specific intelligence that they were delivering poor life insurance advice.
Speaking to media at the launch of the report, ASIC’s Kell said the regulator had gone out of its way to ensure it was fair and unbiased. He added that the findings were consistent with APRA’s lapse reporting.
Launching the report to the media on 9 October, Kell said the investigation showed there was significant room for improvement within the life insurance industry, and that ‘churning’ was an industry-wide problem.
“We saw too many instances where the adviser did not consider the needs of the client, where consumers were recommended policies they could not afford and were of questionable value. There were too many instances where consumers were switched to a different policy without good reason. This failure rate is simply not good enough,” he said.
Delving deeper into the report, it is clear there is more than one issue the industry needs to examine.
Upfront commission model
ASIC found that 96% of the non-compliant advice was paid for using an upfront commission model. Kell said that while the regulator was not advocating for the removal of life insurance commissions, the report highlighted that there was a direct correlation between upfront commissions and poor quality advice.
“I’d like to be clear: ASIC is not recommending or suggesting that commissions be prohibited. Commissions for life insurance are allowed under FoFA. They are part and parcel of the life insurance industry. But given that’s the case, ASIC’s message to the industry is clear: the industry needs to ensure that remuneration and incentive structures do not undermine good quality, compliant advice,” Kell said.
One of the key issues with commissions, according to the regulator, is that there is no relationship between the cost or complexity of the advice and the remuneration received by the adviser. This is because the value of the commission to the adviser directly relates to the dollar value of the business to the insurer. In other countries, insurers have begun to redefine this ‘value’, incentivising advisers for bringing in business which is:
- Quickly on-risk, due to minimal underwriting risks and/or electronically submitted
- Likely to be ‘sticky’, that is, to stay on the insurer’s books for longer than average
- Linked to good quality, strategic advice
ASIC believes Australia’s risk commission model also fails the consumer because it does not incentivise advisers to recommend a client retain or reduce their existing cover.
‘It was rare to find advisers who recommended clients hold an existing policy or marginally decrease the level of cover or suite of insurance, regardless of whether this advice would have been in the best interests of their clients,’ the ASIC report said of its surveillance.
‘The practice of only paying remuneration on a product sale works against the provision of balanced, strategic risk advice to clients.’
Another observation made by the regulator was that upfront commission payments represent remuneration for advice that is significantly higher than the estimated cost of providing comprehensive financial advice.
‘In 2010, we published Report 224 Access to financial advice in Australia. In that report, AFS licensees reported an estimate of the cost of providing comprehensive financial advice to a client in the range of $2,500-$3,500 (see paragraph 171). Even allowing for inflation, this cost is significantly below the remuneration we found advisers were receiving for life insurance advice in our surveillance,’ ASIC said in its report.
there is no barrier to an insurer providing information or intelligence about an adviser where they have concerns
In conducting its review of advice files, ASIC looked at both pre and post-FoFA cases. The surveillance showed that since the introduction of the FoFA reforms, there has been an improvement in the quality of life insurance advice.
However, one area of life insurance advice that does appear to have been impacted negatively by the reforms is where a recommendation relates to structuring insurance inside or outside super.
Under the FoFA reforms, no commissions are payable for the purchase or increase of cover under a group life policy inside superannuation, or an individual life insurance policy provided for the benefit of a member of a default fund.
ASIC observed: ‘In many cases, consumers had the option to increase their life insurance cover in their default superannuation fund at a low cost and obtain additional insurance cover inside that fund. In our file reviews, we found that such advice was rarely given to clients.
‘This would again suggest that commission payments generate a conflict of interest between the needs of consumers and advisers.’
While ASIC acknowledged that product innovation and policy upgrades are an integral part of a competitive market, they also pose a risk to customers.
For example, product innovation, in particular the bundling of policies and features, can lead to ‘overinsurance’, which may ultimately be unaffordable for consumers.
Product innovation may also provide a rationale for advisers to rewrite insurance for existing clients in a way that delivers only marginal benefits to the client but at significant additional cost to them.
ASIC’s investigation also highlighted that stepped premium policies lapse at a considerably higher rate to level premium policies, even within the first five years of the policy being taken out.
Changing an industry
ASIC’s recommendations on how to promote insurance advice that is in the best interests of consumers cut across insurers, advisers and their licensees.
The report recommended that insurers address ‘misaligned incentives’ within their distribution channels. A spokesperson for ASIC explained that ‘misaligned incentives’ refers to the fact that “… the incentives individual insurers pay to their distribution channels do not align (are in conflict) with other objectives. For example, an individual adviser’s interests (to gain or maximise commission income) is in conflict with the group interests of insurers which are to gain and retain business over time or where the long term interests of insurers (to win and retain premium income from consumers over time) are in conflict with the short term interests of advisers.”
Insurers were also encouraged to address lapse rates, which were described as ‘very high’.
“Lapse rates have real commercial impacts on insurers and on the price consumers pay for products,” ASIC’s spokesperson told riskinfo.
“There are, as we identify in the report, other factors that influence lapse rates such as broader economic conditions and the affordability of products. It is not appropriate for the regulator to set an acceptable lapse rate, but given industry concerns about underinsurance, you would expect that the industry would prefer the lowest lapse rate possible, that is, industry would prefer that consumers retained their insurance over time which means that insurer’s continue to receive premium income. It is in insurer’s commercial interests to keep lapse rates down.”
Finally, ASIC said insurers needed to review their remuneration arrangements to ensure that they support good quality outcomes for consumers. The report does not outline whether this would be best addressed at a ‘whole of industry’ level, or if individual advisers should be targeted with specific measures. However, ASIC did note that some insurers reported introducing specific measures to address high lapse rates among certain advisers. These measures included:
- Longer clawback periods
- Specific clawback mechanisms for policies re-written with the same insurer within a certain timeframe (eg: five years)
- Excluding level premium policies from clawback arrangements
- Restricting advisers to a level commission only model
Almost all of Australia’s insurers have given a greater focus to policy retention over the last few years, and many have implemented a dedicated team to manage increasing lapse rates. However, insurers tend to keep the specific details of these initiatives close to their chests. Advisers have previously suggested that insurers should do more to stamp out bad behaviour, by refusing to do business with ‘known churners’.
When asked whether the regulator could force insurers to ‘name and shame’, ASIC’s spokesperson told riskinfo that it is the licensees’ responsibility to report breaches of the law to ASIC, not the product issuers’.
“However, there is no barrier to an insurer providing information or intelligence about an adviser where they have concerns and we regularly receive reports about poor advice from a variety of sources,” they said.
One of the key questions arising from the report was how such a high level of non-compliant advice could have occurred without attracting the attention of licensees’ compliance officers. ASIC’s Kell said while it was considering taking further enforcement action against advisers and licensees identified during the investigation, the regulator had received a disproportionately low number of breach notifications from licensees over the last three years in relation to inappropriate life insurance advice.
Regular file audits are clearly a ‘must do’ for licensees, to avoid potential regulatory action if an issue arises as a result of the actions of an authorised representative. In its report, ASIC included a comprehensive, four-page checklist of factors to consider when giving life insurance advice. The checklist covers an adviser’s obligations under the Corporations Act, as they relate to life insurance advice, and recommendations that are considered ‘best practice’. At a time when some in the industry have criticised ASIC for a lack of transparency with regards the issues that prompt regulatory intervention, this checklist is an incredibly useful tool for licensees and advisers alike.
ASIC also suggested licensees should review the way remuneration is passed from the insurer on to the adviser, given they are usually the gatekeeper of commission payments. One option would be to provide advisers with some remuneration from clients for advice where there is no product sale. Another approach may be to offer incentives that encourage advisers to meet their compliance obligations.
While the report points a finger of blame firmly at advisers, there are also numerous indications that ASIC believes in the value of life insurance advice:
‘Advisers can help consumers in making key strategic decisions such as setting, and as personal needs change, revising their sum insured. Such strategic advice can help the client balance the competing priorities of insurance needs against cost…
‘Advisers can help clients ‘triage’ their insurance needs by prioritising the essential and non-essential and explain the costs, benefits and value of different options to the client to help them make an informed decision as to their insurance needs and priorities…
‘Advisers can give essential assistance to clients when a claim is made, reducing the need for lawyers to advocate for their clients where a claim may be denied or only partially paid by the insurer.’
Throughout the report, ASIC has provided specific case studies, taken from the files it reviewed as part of the investigation. These case studies represent both advice that did not comply with the relevant laws, and compliant advice, to illustrate how advisers can further lift the quality of that advice.
Included within these cases and the related notes are recommendations in relation to meeting specific regulatory obligations, including:
- The client priority rule (p41)
- Questions that identify what a client is looking to insure, to help the adviser satisfy the best interests duty (p45)
- A definition of strategic advice (p49)
- What must be covered when giving advice about insurance inside super (p57-58, 62)
The final observation that ASIC made in relation to case files was that more documentation was needed. In fact, in a small number of cases, the file notes were so brief as to make it impossible for the analysts to determine whether the advice was compliant or not. The clear recommendation from ASIC is that more is more. Without documentation that sets out the basis for the advice, the adviser’s recommendations may be deemed inappropriate, even if the client and adviser agreed on the approach.
To view a copy of ASIC’s Review of Retail Life Insurance Advice, click here.
Emily Saint-Smith is riskinfo’s Senior Journalist.