As we put the finishing touches on this edition of riskinfo eMagazine, the David Murray-led Financial System Inquiry released its highly anticipated Final Report. This article summarises the key issues impacting advisers, their practices and their clients, taken from our previously-published weekly news stories on the Murray Inquiry Report…
The Financial System Inquiry’s (FSI) Final Report has delivered 44 recommendations to Government, covering a broad spectrum of industry issues, including superannuation, innovation, advice and the regulatory framework.
“Our recommendations on consumer outcomes reflect a view that disclosure and financial literacy are not sufficient by themselves for the system to work in the interests of consumers,” explained FSI Chair, David Murray, AO.
“This represents a paradigm shift for the system. We have recommended higher obligations on product manufacturers and distributors; our stronger regulatory framework and a more proactive regulator. This is designed to ensure that there are incentives for firms to improve their culture and fair treatment of their own customers.”
Restrictions on life insurance commissions
Recommendation 24 in the final report relates to aligning the interests of financial firms and consumers. Within this recommendation is the call by the Inquiry to effectively ban upfront risk commissions.
The report calls for Government to amend the law to require that ‘an upfront commission for life insurance advice is not greater than ongoing commissions’. The report’s rationale for this recommendation is based on the Inquiry’s concern with findings handed down in the recent ASIC Review of Retail Life Insurance Advice.
The FSI report states:
‘A recent ASIC report on life insurance revealed significant problems with both compliance and the consequences for consumers. More than a third of the personal advice reviewed failed to comply with the laws relating to appropriate advice and prioritising the needs of the consumer.
‘Upfront commissions can affect the quality of advice. ASIC found that 96 per cent of advice rated as a ‘fail’ was given by advisers paid under an upfront commission model. ASIC also found high upfront commissions encourage advisers to replace a consumer’s policy rather than retain it. In some cases, this may result in inferior policy terms. To date, industry approaches to address the issues in life insurance have not worked.’
The FSI says that the measure would reduce incentives for churning and improve the quality of advice on life insurance.
The report goes on to explain how the FSI envisages a level commission remuneration environment would operate:
‘For life insurance, the Inquiry recommends a level commission structure implemented through legislation requiring that an upfront commission is not greater than the ongoing commission. This would provide a balanced and cost effective approach to better align the interests of advisers and consumers. The remuneration model needs to be sustainable; otherwise there is a risk that providers may exit the market, making it more difficult for consumers to obtain life insurance advice.’
The report acknowledges that the findings of the yet-to-be-released Financial Services Council and Association of Financial Advisers working group should also be considered during the development and implementation phases of the recommendations.
Better alignment of interests of consumers and financial firms
Along with a proposal to limit life insurance commissions to a level-only model, Recommendation 24 of the FSI Final Report calls for raised standards of conduct and professionalism across all those operating in the industry.
The Report says that recent cases of poor financial services provision have raised serious concerns about the culture within financial services firms, and their apparent lack of customer focus:
‘The Inquiry considers that cases of consumer detriment and poor advice reflect organisational cultures that do not focus on consumer interests. Such cultures promote short-term commercial outcomes over longer-term customer relationships. This has contributed to a lack of consumer confidence and trust in the system. In research undertaken by Roy Morgan, only 28% of participants gave financial planners ‘high’ or ‘very high’ ratings for ethics and honesty, and trust in bank managers was held by just 43% of participants. In addition, ASIC found only 33% of stakeholders agreed that financial firms operate with integrity.’
To drive cultural change, the FSI recommends that the industry raise standards of conduct and professionalism. According to the FSI, this would require both a coordinated industry approach and focus by individual firms. It is suggested that industry associations could lead this initiative, with stakeholder input from ASIC and consumer organisations. The Report also proposes the introduction or enhancement of individual firm or industry codes of conduct as one way in which industry could set raised standards and hold themselves accountable.
The FSI Report also calls for ASIC to be granted additional powers to ban individuals from managing financial firms. Currently, ASIC can prevent a person from providing financial services, but cannot prevent them from managing a financial firm. Nor can ASIC remove individuals involved in managing a firm that may have a culture of non-compliance.
Product issuer obligations and ASIC intervention power
Recommendations 21 and 22 of the Final Report focus on improving the accountability of financial product manufacturers.
The FSI has recommended that a new, targeted and principles-based product design and distribution obligation be introduced, to reduce the incidence of product failure. The obligation would require product issuers to identify target and non-target markets for the product before it is released, and in some cases to conduct consumer testing prior to implementation.
Greater engagement between product issuers and distributors is also sought, to reduce inappropriate distribution incentives being paid.
Further, because the Inquiry believes industry-led standards have not been sufficient by themselves to address serious conduct issues, a new, pre-emptive power should be granted to ASIC to allow it to intervene if the regulator believes a product would cause significant consumer detriment.
This power would allow ASIC to:
- Request changes to product disclosure and/or marketing materials
- Issue warnings to consumers
- Enact distribution restrictions
- Ban products from entering the market
Currently, ASIC can only take action against a product manufacturer after a breach has occurred, and only on a firm-by-firm basis.
Raised adviser competency standards
Recommendation 25 of the Final Report calls on the Government to continue its current process to raise the minimum competency standards for financial advisers, and to implement an enhanced register of advisers.
The Inquiry recommends the following minimum standards be adopted for financial advisers:
- A relevant tertiary degree
- Competence in relevant, specialist areas (eg: life insurance)
- Ongoing professional development
The Report suggests these standards are reviewed regularly, to ensure they take into account developments within the sector.
The Report cited a number of high-profile cases where consumers have suffered significant detriment through poor advice, and a series of ASIC studies, saying there are clearly issues with the quality of advice currently provided.
While the FSI acknowledged that some firms have moved to increase standards, ‘…low minimum competency standards have been a feature of the industry for a substantial length of time, and change is needed across the board. Many stakeholders are highly concerned about the low minimum education standards of financial advisers, with most supporting lifting education requirements to degree level.’
The FSI also gave its support to the Government’s enhanced adviser register, saying it will provide greater transparency for consumers, and ‘level the playing-field’ for employee advisers.
The Final Report did not, however, recommend the implementation of a national adviser exam, but suggested this initiative could be considered if issues around competency persist.
Rename general advice and require advisers to disclose ownership structures
Among the recommendations identified as ‘Significant matters’, which fall outside the five key themes of the Report, is a call for ‘general advice’ to be renamed.
The FSI says consumers may misinterpret or excessively rely on guidance, advertising, and promotional and sales material when it is described as ‘general advice’. Instead, it proposes the phrase be replaced with a consumer-tested term to reduce misinterpretation. The Report does not offer any alternative names, but says the Government should conduct consumer testing. ‘The Inquiry believes the benefits to consumers from clearer distinction and the reduced need for warnings outweigh these costs,’ the Report stated.
The FSI also recommends the Government make the ownership and alignment of advisers more transparent. The Report contends that consumers don’t necessarily understand if and when their advice provider is associated with or linked to a product issuer, and that this may limit scope of products recommended.
‘In particular, these disclosures should be broader than Financial Services Guide and Credit Guide rules currently require, and could include branded documents or materials. The Inquiry believes the benefits to consumers would outweigh the transitional costs to industry of effecting branding changes,’ the FSI said.
Product disclosure and consumer communication
The FSI believes there is a need for more flexibility within Australia’s current disclosure regime, and is calling for the removal of regulatory impediments that prevent the development of innovative consumer communications.
This recommendation follows the release of an ASIC consultation paper (CP 224) proposing changes to the way financial disclosure documents are delivered (see: ASIC Encourages More Electronic Disclosure). The Inquiry endorsed ASIC’s pilot project and encouraged industry to continue to engage with the regulator on innovative disclosure.
According to the FSI Final Report, consumers can more effectively use information that is accessible, engaging and understandable:
‘Research shows that presenting financial product information in shorter disclosure documents that are better signposted, and using plain English and graphics, can improve consumer understanding. Although there has been limited research on the benefits of new media compared with paper-based disclosure, new media offers opportunities for more engaging communication.’
The FSI said it had recommended no major changes to Australia’s overall regulatory system. However, along with the additional powers to be granted to ASIC in order to better protect consumers (see above), the FSI recommended the following enhancements to the regulatory framework:
- Establishment of a new Financial Regulator Assessment Board to undertake annual ex post reviews of overall regulator performance against their mandates. ‘Australia needs a better mechanism to allow Government to assess the performance of financial regulators,’ the Report stated.
- Strengthening ASIC and APRA through increased budget stability built on periodic funding reviews, and greater operational flexibility.
- Introducing a six-yearly capability review for ASIC, APRA and the payment systems function of the RBA. ‘These exercises should ensure they have the required skills and culture to maintain effectiveness in an environment of rapid change,’ the FSI said.
- That ASIC be the first regulator to undergo a capability review, along with the funding review that would take place under the recommendation for increased budget stability.
- That Government and regulators adhere to minimum implementation lead times for new regulation, and that they monitor impacts of new regulation more thoroughly post-implementation.
Australia’s superannuation system was an area of significant focus for the FSI. The key recommendations relating to super (contained within Chapter 2 of the Final Report) are:
- To enshrine in legislation the objectives of the super system
- The introduction of a new default fund allocation process for MySuper products (following a review of the current system to be completed by 2020)
- A requirement for superannuation funds to pre-select a comprehensive income product for members’ retirement (sometimes referred to as the ‘MyPension’ initiative)
- The removal of restrictions that prevent around 20% of super fund members from being able to choose their own fund
- The introduction of civil and criminal penalties for super fund directors who fail to execute their responsibility to act in the best interests of members
Other life insurance product changes
Between 2007 and 2010, the Government worked with industry and other stakeholders to develop a mechanism to facilitate the effective rationalisation of legacy products. However, this project was placed on hold, and the measures have not been implemented.
Given that 25% of funds under management are held in legacy products, and that legacy products increase costs to providers and prevent consumers from accessing better features in newer products, the FSI recommends that the Government re-commence this rationalisation project.
The FSI has also called for a change to the definition of unclaimed monies. In 2012, the time frame in which inactive bank accounts and life insurance policies were deemed to be ‘unclaimed monies’ and therefore transferred to the Government was reduced from 7 to 3 years. The FSI says the time frame should be reverted to 7 years.
For a full copy of the FSI Final Report, click here.