Remuneration, commissions, payments and fees
Introduction
5.1 Over the last two decades in Australia, there has been a significant
shift in the approach to the regulation of financial markets including the
conduct of the industry participants. Much of that shift can be attributed to
the fall-out from the global financial crisis.
5.2 Back in 1996, the Wallis inquiry into the Australian Financial System
was established to assess the results of financial deregulation since the
1980s.
5.3 In terms of conduct and disclosure, the Wallis inquiry identified the
need for:
- a single set of requirements for investment sales and advice
concerning minimum standards of competency and ethical behaviour;
- the disclosure of fees and adviser's capacity;
- rules on handling client property and money;
- financial resources or insurance available in cases of fraud or
incompetence; and
- responsibilities for agents and employees.
5.4 However, in 2009, in the aftermath of the global financial crisis, ASIC
commented that the disclosure-focused approach to protecting consumers from
remuneration incentives as advocated by the Wallis inquiry may no longer be
appropriate, particularly given the breadth of retail investors:
[ASIC is] querying whether it has gone far enough in
protecting retail investors, given the important role, which was not foreseen
by the Wallis inquiry, that retail investors would play in the market. They had
not foreseen and could not have foreseen the impact that the superannuation
levy has had on investment in our markets. In that situation, you have a much
broader range of retail investors and retirees. You have groups of people who
lose money at the wrong time in their life and it is no answer to them to say:
Well, it was a risk, you know. There was disclosure. You should have read the
disclosure statement. The fact is that they cannot easily come back into the
workforce.
5.5 Particularly since the corporate collapses triggered by the global
financial crisis, the issue of remuneration has been front and centre of debate
about the problems that have plagued the financial services industry. In the
last few years, a range of stakeholders have highlighted the way in which
remuneration structures in the financial services sector generate conflicts of
interest that have led corporations and advisers to put their interests
(maximising their own revenue, remuneration and profit) ahead of the interests
of the client (ensuring that the client gets the right product and service that
suits their needs).
5.6 For example, Mr Greg Medcraft, then Chairman of ASIC, noted that the
wrong type of financial incentives have contributed significantly to a range of
poor practices and misconduct in the financial services industry including
misleading advice and mis-selling.
5.7 In its 2009 inquiry into financial products and services in Australia,
the committee concluded that commissions (both up-front and trailing), volume
bonuses, sales target rewards, and soft-dollar incentives place financial
advisers in the role of both broker (that is, seller) and expert adviser. The
committee commented that:
A significant conflict of interest for financial advisers
occurs when they are remunerated by product manufacturers for a client acting
on a recommendation to invest in their financial product.
These payments place financial advisers in the role of both
broker and expert adviser, with the potentially competing objectives of
maximising remuneration via product sales and providing professional, strategic
financial advice that serves clients' interests.
5.8 The 2009 inquiry made recommendations to address these conflicts of
interests including:
- a fiduciary duty requiring advisers to places their customer's
interests ahead of their own;
- surveillance of advice and annual shadow shopping exercises;
- disclosure of conflicts of interest; and
- that the government consult with industry on removing payments
from product manufacturers to advisers.
5.9 In recent years, governments have enacted legislation in response to a
series of scandals in the financial services sector. Much of this legislation
has been directed at trying to remove or reduce the conflicted remuneration and
inappropriate incentives that have permeated the financial services sector.
Further detail on these reforms is provided later in this chapter.
5.10 This chapter focuses on the remuneration arrangements in the life
insurance industry. The chapter begins by illustrating the web of money flows
between industry participants within the three industry sectors: direct, group,
and retail. The extent of existing and proposed regulation of remuneration
arrangements is then discussed. This is followed by consideration of shelf
space and training fees.
Remuneration, commissions, payments and fees in the life insurance industry
5.11 During the course of the inquiry, it became apparent that a range of
commissions, payments and fees exist in some form or another within the life
insurance industry.
5.12 The committee was greatly assisted by ASIC in identifying the types of
payment or remuneration that occur between participants of the life insurance industry.
ASIC provided the committee with a series of diagrams (Figures 5.1, 5.2, and
5.3) that illustrate some of the money flows within the life insurance industry
of which ASIC is currently aware.
Terminology
5.13 With respect to the terminology used around conflicted remuneration,
Transparency International defines conflicts of interest as arising in
situations where an individual or entity is confronted with choosing between
the duties of their position and their own private interests. Transparency
International also defines corruption as the abuse of entrusted power for
private gain.
5.14 The above terminology can be useful when exploring some of the
situations that may arise in the life insurance industry involving conflicted
remuneration. For example, as illustrated later in this chapter, there is the
potential for the risks inherent in a conflict of interest to manifest as
corruption if an individual adviser (who holds a position of trust) makes a
personal financial gain from financial incentives to recommend products that
are not in a customer's best interests.
Remuneration arrangements in direct
life insurance
5.15 This section outlines the remuneration flows associated with direct life
insurance sales. Figure 5.1 indicates two remuneration scenarios:
- where a distributor is involved, and the life insurer may pay
fees and commissions to the distributor and the distributor may pay salary and
performance payments to staff; and
- where no distributor is involved, and the life insurer may pay
salary and performance payments may be made to the insurers staff.
Figure 5.1: Who gets paid in direct life insurance sales
Source: Australian Securities
and Investments Commission, answers to questions on notice, 3 April 2017 (received 9 August 2017).
5.16 While the committee did not receive evidence specific to the money flows
within direct life insurance sales, the committee makes some preliminary remarks
about potential concerns with the remuneration flows indicated in Figure 5.1
above.
5.17 Firstly, there appears to be the potential for performance related pay,
commissions, and fees to create incentives to upsell products that are not in
the customers best interests. In essence, there is the problem of conflicted
remuneration. Conflicted remuneration and recent reforms are considered further
in later sections on retail-advised life insurance and government reforms and
are also set out in Table 5.2.
5.18 Secondly, as noted in chapter 2, direct insurance occurs without the
provision of financial advice. Consequently, some of the consumer protections
associated with personal advice do not apply because there is no 'personal
advice' from an adviser.
5.19 Thirdly, because direct insurance does not contain an intermediary in
the form of an adviser, consumers may have an expectation that direct life insurance
would be free from hidden fees, commissions and performance related pay.
Remuneration arrangements in group
life insurance
5.20 This section summarises some of the issues identified during the inquiry
with remuneration arrangements in group life insurance. The remuneration flows
associated with group life insurance shown in Figure 5.2 indicate three
scenarios:
- where a consumer is defaulted into a super fund by their
employer;
- where a consumer becomes a member of a super fund by choice
without personal advice; and
- where a consumer becomes a member of a super fund by choice with
personal advice.
Profit sharing arrangements
5.21 Figure 5.2, which is a reproduction of a diagram provided by ASIC, shows
that profit sharing arrangements appear in all three models for group life
insurance.
5.22 Mr Brett Clark, Chief Executive Officer and Managing Director of TAL,
told the committee that rebate arrangements occur where premiums exceed claims
paid and operating expenses. Mr Clark argued that excess premiums and rebates
provide price stability for premiums.
5.23 Mr Clark also made the point that, in line with the FOFA regulations,
some insurers require the rebates from any excess profits or excess premiums to
be used entirely for the benefit of members. He indicated that the contracts
that TAL had with trustees gave it audit rights that would allow TAL to verify
that those rebates are used for the benefit of members. However, the committee notes that trustees of superannuation funds are legally
required to act in the best interests of their members. It would not be in the
interest of members to have premiums, paid out of members' funds, returned to
trustees and taken as profit.
5.24 ASIC informed the committee that of the
47 trustees involved with its review of insurance and superannuation, seven or
eight have some form of profit sharing, premium sharing, or other arrangements
with life insurers. ASIC indicated that when its review is completed it may be
able to clarify whether profit sharing arrangements have been used by life
insurers as inducements to trustees.
Figure 5.2: Who gets paid in group life insurance
sales
Source: Australian Securities
and Investments Commission, answers to questions on notice, 3 April 2017
(received 9 August 2017).
5.25 The Insurance and Superannuation Working Group (ISWG) draft code of
practice for life insurance in superannuation includes a standard on premium adjustments. This code was discussed in
chapter 4. The ISWG consultation paper released in September 2017 indicates
that:
Some trustees have in place a premium adjustment arrangement
with their insurers, to either return surplus premium to the trustee's
insurance reserve when the cost of members' claims turns out to be less than
the insurer expected when determining the pricing of our insurance cover, or to
adjust future premiums to reflect a premium deficit.
Section 8 of the Code requires any premium adjustment
payments to be passed onto insured members through adjustments to future
premiums.
Other payments
5.26 Other payments from life insurers to trustees and from trustees to life
insurers are shown in Figure 5.2 for situations when a consumer becomes a
member of a superannuation fund by choice. This appears to occur regardless of
whether the customer sought personal financial advice.
5.27 It is unclear what the nature of these other payments are, how much they
are, whether they are one-off or ongoing, to what extent they are deducted from
a consumers super contributions and life insurance premiums, and whether there
are any consumer protections in place.
5.28 It is also unclear whether these payments are creating a disincentive
for consumers to choose their super fund rather than accept the default fund.
Fee for service with advised group
life insurance
5.29 Figure 5.2 also indicates that when a consumer becomes a member of a
super fund by choice with personal financial advice, the trustee pays a salary
or fee for service directly to the adviser. It is unclear what practical choice
a consumer has in relation to who the financial adviser is and what control the
consumer has over the fee paid.
Remuneration arrangements in retail
life insurance
5.30 This section summarises some of the issues identified during the inquiry
with remuneration arrangements in retail life insurance.
5.31 Figure 5.3 depicts the financial flows when life insurance is purchased
in the retail sector. Figure 5.3 indicates that four different types of
remuneration models operate within retail life insurance.
5.32 In the three commission-based models, namely upfront, hybrid, and level:
- the commission is built into the premium that is paid by the
customer to the life insurer;
- the life insurer pays the commission to the advice licensee; and
- the licensee then pays the adviser an agreed commission.
5.33 Up until 31 December 2017, the following arrangements operated in the
three commission-based systems:
- Upfront commissions—the life insurer pays the advice licensee up
to 130 per cent of the first year's premium and up to 10 per cent of renewal
premiums.
- Hybrid commissions—the life insurer pays the advice licensee up
to 70 per cent of the first year's premium and up to 20 per cent of renewal
premiums.
- Level commissions—the life insurer pays the advice licensee a flat
rate commission of around 30 per cent of the first year's premium every year
for the life of the policy. In other words, there is an ongoing flat rate
commission of around 30 per cent on renewal premiums.
5.34 By contrast, in fourth model, the no commission model, a fee for service
is charged. However, Figure 5.3 indicates that, as ASIC understands it, in
parallel with the fee for service being paid to an adviser by a consumer, the
adviser and licensee are still receiving a commission from the insurer which is
then rebated to the customer.
5.35 Table 5.1 below sets out:
- the different types of commissions that are used in retail life
insurance;
- the flow of the commission;
- the amount of the commission;
- the ongoing nature of the commission; and
- the changes that will be required in commission models from 1
January 2018.
Figure 5.3: Who gets paid in retail life insurance sales
Source: Australian Securities
and Investments Commission, answers to questions on notice, 3 April
2017 (received 9 August 2017).
Table 5.1 Flow of commissions in advised sales of life
insurance
|
Commission
type
|
Flow
of commission
|
Amount
of commission
|
Ongoing
commissions
|
Changes
from 2018
|
|
Upfront
commission
|
The
commission is built into the premium that is paid by the customer to the life
insurer.
The
life insurer pays the commission to the advice licensee.
The
advice licensee then pays the adviser an agreed commission.
|
Insurer
pays the advice licensee up to 130% of the first year's premium.
A
percentage of this will be paid to the adviser.
|
Up
to 10% of renewal premiums.
Volume
bonuses may be paid.
|
From 1 January 2018, upfront commissions will
reduce to 80% of the first year's premium.
Ongoing commissions will be capped at 20%.
By January 2020, upfront commissions will be
further reduced to 60% of the first year's premium. Ongoing commissions will
be capped at 20%.
Volume bonuses will be banned.
Two
year clawback requirements commence on 1 January 2018.
|
|
Hybrid
commission
|
Insurer
pays the advice licensee up to 70% of the first year's premium.
A
percentage of this will be paid to the adviser.
|
Up
to 20% of renewal premiums.
Volume
bonuses may be paid.
|
|
Level
commission
|
Flat
rate commission of around 30% of the first year's premium and for every year
of the life of the policy.
A
percentage of this will be paid to the adviser.
|
Flat rate commission of around 30% on renewal
premiums.
Volume
bonuses may be paid.
|
The commission caps and
clawback requirements will not apply to level commissions.
Volume
bonuses will be banned.
|
|
No
commission
|
Client
pays fee to adviser.
|
Fee-for-service
remuneration.
|
None
|
The
commission caps and clawback requirements should not affect fee-for-service
arrangements.
|
Source: Australian Securities
and Investments Commission, answers to questions on notice, 3 April
2017 (received 9 August 2017).
5.36 Table 5.1 shows that, from 1 January 2018, when the Corporations
Amendment (Life Insurance Remuneration Arrangements) Act 2017 (also known
as the LIF reforms) comes into effect, the commission caps within life
insurance will change for upfront and hybrid commission structures, but will
not change for level commissions. These changes are explained below.
5.37 It should be noted that these reforms will also apply to commission
structures within direct life insurance sales. For example, while the
paragraphs below relate to, for example, payments from a life insurer to an
advice licensee, payments from a life insurer to a distributor within direct
life insurance sales would also be captured by the government's reform package.
This is illustrated later in Table 5.2.
5.38 For upfront commission structures, the amount the life insurer will be
able to pay the advice licensee is reduced from 130 per cent to 80 per cent of
the first year's premium. However, the cap for ongoing commissions is increased
from up to 10 per cent to 20 per cent of renewal premiums. By January 2020, the
upfront commission will be further reduced to 60 per cent of the first year's
premium, with 20 per cent ongoing commissions.
5.39 For hybrid commission structures, the amount the life insurer will be
able to pay the advice licensee is increased from 70 per cent to 80 per cent of
the first year's premium. The ongoing commissions remain unchanged at 20 per
cent of renewal premiums. By January 2020, the upfront commission will be
reduced from 80 per cent to 60 per cent of the first year's premium. Ongoing
commissions will remain unchanged at 20 per cent of renewal premiums.
5.40 For level commission structures, the commission caps will not apply. In
other words, the life insurer will continue to be able to pay the advice
licensee a flat rate commission of around 30 per cent of the first year's
premium and for every year of the life of the policy.
5.41 The commission caps should not have any effect on fee-for-service
arrangements.
5.42 The remainder of the changes arising from the LIF reforms, including in
relation to clawback arrangements and volume bonuses, are discussed in the
later section on the government reform package.
The impact of FOFA on retail life
insurance commissions
5.43 The Future of Financial Advice (FOFA) reforms to the Corporations
Legislation which commenced in July 2012 implemented a ban on conflicted
remuneration structures, including commissions and volume based payments, in
relation to the distribution of, and advice on, retail investment products.
5.44 The Corporations Act now defines conflicted remuneration as:
…any benefit, whether monetary or non-monetary, given to a
financial services licensee, or a representative of a financial services
licensee, who provides financial product advice to persons as retail clients
that, because of the nature of the benefit or the circumstances in which it is
given:
- could reasonably be expected to influence the choice of
financial product recommended by the licensee or representative to retail
clients; or
- could reasonably be expected to influence the financial
product advice given to retail clients by the licensee or representative.
5.45 However, the FOFA reforms contain provisions that exclude most forms of
life insurance from the bans on conflicted remuneration:
- direct and non-adviser group life insurance are excluded from the
conflicted remuneration bans, because they are not sold with 'financial product
advice' and therefore fall outside the above definition of conflicted remuneration;
and
- retail life insurance is explicitly exempted by section 963B of
the Corporations Act.
ASIC review of retail life
insurance advice
5.46 In October 2014, ASIC Report 413 reviewed retail life insurance advice.
The report showed poor advice about life insurance was being provided to
consumers. Specifically, the report found that 37 per cent of personal
advice failed to comply with the quality of advice obligations.
5.47 Some examples of poor advice reported on in Report 413 included:
- cases where advisers were selling clients policies with premiums
that became unaffordable, even after the clients specifically said they wanted
affordable policies;
- advisers recommending clients pay premiums from superannuation in
a way that ran down clients' superannuation balances; and
- advice where there was inadequate consideration of a person's
circumstances.
5.48 ASIC also found evidence of poor life insurance advice that resulted in
considerable detriment to consumers, including:
- evidence that
advisers failed to adequately consider their clients' personal circumstance and
needs, leading to situations where consumers received inferior policy terms,
paid more for cover, had health issues excluded and, in some cases, had claims
denied where they previously had cover; and
- evidence of
unnecessary or excessive switching of clients between policies to maximise
commission income, with a failure to consider or recommend insurance that
reasonably correlated to clients’ personal circumstances or objectives.
5.49 ASIC recommended in Report 413 that insurers address misaligned
incentives in their distribution channels and review their remuneration
arrangements to ensure that they support good-quality outcomes for consumers
and better manage the conflicts of interest within those arrangements. In
particular, ASIC recommended that AFS licensees:
- ensure that
remuneration structures support good-quality advice that prioritises the needs
of the client;
- review their
business models to provide incentives for strategic life insurance advice;
- review the training
and competency of advisers giving life insurance advice; and
- increase their
monitoring and supervision of advisers with a view to building 'warning signs'
into file reviews and create incentives to reward quality, compliant advice.
5.50 The problems with life insurance advice are not confined to one segment
of the retail-advised industry. ASIC's Report 413 considered advice from both
unaligned financial advisers and the vertically integrated channel of advisers
and uncovered significant problems across both groups of advisers. The problems
were more acute in the independently owned financial advice licensees, for
which over half the advice failed to comply with the law.
5.51 Bombora challenged the validity of the findings in Report 413, arguing
that the review lacked a control group and did not focus sufficiently on
quality of advice.
5.52 However, ASIC's more recent general surveillance and enforcement work
identified similar advice failure rates to those set out in Report 413 from
2014. Once again, ASIC found that inappropriate financial incentives continue
to be commonly associated with poor sales practices in the life insurance
industry:
ASIC's recent general surveillance and enforcement work
reflects similar rates of non-compliant life insurance advice to that set out
in REP 413, that is, we have not seen changes in this trend.
5.53 Mr Peter Kell noted that of the 46 financial advisers banned during the
last financial year, about a quarter of those were in relation to poor life
insurance advice.
Trowbridge review of retail life
insurance advice
5.54 In March 2015, the Trowbridge review of retail life insurance advice
considered the remuneration paid to advice licensees. The Trowbridge review identified
a whole range of benefits commonly available to licensees, including:
…volume-based payments, free or subsidised business equipment
and services, hospitality-related benefits, shares or other interests in a
product issuer or dealer group, marketing assistance and some buyer of last resort
arrangements.
5.55 The Trowbridge review recognised that the incentives embedded in the
gamut of non-commission remuneration and benefits identified above had the
potential to create conflicts of interest:
These practices can create conflicts of interest for
licensees that affect advised clients because in effect the conflicts are
transmitted to their advisers. The advisers themselves may not always be aware
of these practices of their own licensees.
5.56 The Trowbridge review recognised that the attendant conflicts of
interest generated by benefits flowing from life insurers through to advice
licensees and advisers could undermine the attempts to reform the commission
structures prevalent in the life insurance industry. To this end, the
Trowbridge review recommended that 'licensees be prohibited from receiving
benefits from life insurers that might influence recommended product choices or
the advice given by the licensees' advisers'.
Government reform package
5.57 In November 2015, the government announced a reform package that
included proposals to address conflicts of interest in remuneration. The
resulting package was the Corporations Amendment (Life Insurance
Remuneration Arrangements) Act 2017 (LIF reforms).
5.58 ASIC confirmed that commissions within life insurance constitute
conflicted remuneration, but that the LIF reforms capped these commissions from
1 January 2018.
5.59 In June 2017, ASIC released the ASIC Corporations (Life Insurance
Commission) Instrument 2017/510, which set the caps and clawback arrangements.
The impacts of those changes for upfront, hybrid and level commissions are
summarised in Tables 5.1 and 5.2.
5.60 The commission caps were explained earlier. The 'clawback' reforms
require a certain portion of the upfront commission to be paid back to the life
insurer by the financial adviser in the event that the policy is cancelled or
the premium is reduced in the first two years seeks. The aim of the 'clawback'
reform is to neutralise the incentive for 'churning', which is the incentive
for an adviser to move an existing client onto a new policy in order to receive
another high upfront commission.
5.61 The LIF reforms also ban the volume bonuses that were previously
available under upfront, hybrid, and level commission structures. A volume
bonus was an arrangement under which the insurer pays the licensee a
volume-based bonus that is calculated by reference to the number of life
products sold by the licensee.
5.62 Table 5.2. below summarises the various payments identified in Figures
5.1, 5.2, and 5.3 and in the previous sections on remuneration in direct,
group and retail life insurance.
5.63 Table 5.2 is broken into three sections: direct, group, and retail. The
final column in Table 5.2 indicates the extent to which various payments—life
insurer to distributor; life insurer to employee; distributor to employee; life
insurer to trustee; trustee to life insurer; trustee to adviser / advice
licensee; life insurer to advice licensee; advice licensee to adviser—are
regulated. Unregulated payments in the final column are shaded in pale grey.
Table 5.2: Regulation of commissions, fees, and payments in the
life insurance industry
| |
Type
|
Payment From –
To
|
Regulation from 1 January 2018
|
|
Direct
|
|
1
|
Commission – upfront
|
Life insurer to
Distributor
|
From
1/1/18: Conflicted remuneration—banned, unless the commission complies with
the commission caps and clawback requirements.
|
|
2
|
Commission – ongoing
|
From
1/1/18: Conflicted remuneration—banned, unless the commission complies with
the commission caps and clawback requirements.
|
|
3
|
Commission – level
|
The
conflicted remuneration provisions do not apply to level commissions.
|
|
4
|
Performance pay
|
Life insurer to
Employee
|
A
performance benefit paid for the direct sale of life insurance will not be
conflicted remuneration if it complies with the commission caps and clawback
requirements.
|
|
5
|
Performance pay
|
Distributor to
Employee
|
|
6
|
Volume bonus
|
Life insurer to
Distributor
|
From
1/1/18: Presumed to be conflicted remuneration—banned unless it can be shown
that the benefit could not reasonably be expected to influence the sale of
the life insurance product.
|
|
Group
|
|
7
|
Profit sharing/Premium
adjustment
|
Life insurer to
Trustee
|
Not
regulated under the conflicted remuneration regime if there is no advice to a
retail client, although rules for profit sharing and premium adjustments are
proposed by the Insurance and Superannuation Working Group in the Insurance
in Superannuation Code of Practice.
|
|
8
|
Soft dollar benefits
|
|
9
|
Other payments
|
|
10
|
Other payments
|
Trustee to
Life insurer
|
Not
regulated under the conflicted remuneration regime if there is no advice to a
retail client.
|
|
11
|
Salary / fee for service
|
Trustee to
Adviser / Advice licensee
|
Regulated
by the conflicted remuneration regime, particularly in MySuper.
|
|
Retail
|
|
12
|
Commission upfront
|
Life insurer to
Advice licensee
|
From 1/1/18: Conflicted remuneration—banned, unless the
commission complies with the commission caps and clawback requirements.
|
|
13
|
Commission ongoing (trail)
|
From 1/1/18: Conflicted remuneration—banned, unless the
commission complies with the commission caps and clawback requirements.
|
|
14
|
Commission hybrid upfront and
ongoing
|
From
1/1/18: Conflicted remuneration—banned, unless the commission complies with
the commission caps and clawback requirements.
|
|
15
|
Commission – level
|
The conflicted remuneration provisions do not apply to level
commissions.
|
|
16
|
Volume bonus
|
From
1/1/18: Presumed to be conflicted remuneration—banned unless it can be shown
that the benefit could not reasonably be expected to influence the sale of
the life insurance product.
|
|
17
|
Shelf fees (not volume or
training based)
|
From 1/1/18: Conflicted remuneration—banned unless the fee
could not reasonably be expected to influence the choice of financial product
recommended or the advice or an exception applies.
|
|
18
|
Training fees
|
Limited
bans from 1/1/18. Non-monetary benefits such as training fees are exempt in
certain circumstances (e.g. if the training is relevant to the financial
services business and requirements such as time and cost are met).
|
|
19
|
Commission upfront
|
Advice licensee to
Adviser
|
From
1/1/18: Conflicted remuneration—banned, unless the commission complies with
the commission caps and clawback requirements.
|
|
20
|
Commission ongoing (trail)
|
From 1/1/18: Conflicted remuneration—banned, unless the
commission complies with the commission caps and clawback requirements.
|
|
21
|
Commission hybrid upfront and
ongoing
|
From
1/1/18: Conflicted remuneration—banned, unless it complies with the
commission caps and clawback requirements.
|
|
22
|
Commission – level
|
Advice licensee to
Adviser
|
The
conflicted remuneration provisions do not apply to level commissions.
|
|
23
|
Fee for service with rebated
commissions
|
Commission rebated to a consumer is less likely to be
conflicted remuneration as it is unlikely to influence the advice.
|
Source: Australian Securities
and Investments Commission, Additional information received 13 November 2017.
Key: Unregulated payments are shaded in pale grey.
5.64 The committee received a large body of evidence about the LIF reforms
and their impact on the retail-advised sector. There was, not surprisingly, a
substantial divergence in views. For example, consumer groups, while welcoming
the LIF reforms, argued that the reforms needed to go much further because, in
their view, a commission-based insurance sales model leads to poor consumer
outcomes. By contrast, many retail advice businesses were critical of the LIF
reforms because they felt the reforms would have a negative impact on their
businesses and their customers while, at the same time, failing to address
significant issues in other parts of the industry.
5.65 The Financial Rights Legal Centre (FRLC) acknowledged that the LIF reforms
were an important step in the right direction. However, the FRLC argued that,
given the harm caused by commissions and up-front commissions in particular,
the reforms needed to extend much further to include a clear phase-out date for
the removal of all commissions in the life insurance industry.
5.66 CHOICE had similar views, indicating that the LIF reforms are promising
first steps. But given the overwhelming evidence of consumer harm from
commission-based sales, CHOICE were firmly of the view that commissions needed
to be permanently banned, as they are for other types of financial advice:
We acknowledge that ASIC plans to review the impact of these
reforms to measure their effectiveness. As part of this review, ASIC should
introduce a glide path to zero for the removal of life insurance commissions,
with the aim of giving advisors a reasonable timeframe to develop new revenue
streams while protecting consumers from further exploitation.
5.67 Maurice Blackburn Lawyers argued that while the LIF reforms are a
welcome start, they do not address other systemic flaws in the life insurance
sales system that are a root cause of poor customer outcomes, namely:
- the pervasive vertically integrated cross selling practices by
large institutions through overly narrow Approved Product Lists (APLs); and
- the payment of shelf space fees by insurers to advisers to have
their product listed on the adviser's APL.
5.68 ClearView life insurance and advice group also welcomed the LIF reforms.
However, they argued that the reforms should be extended in two ways:
- the 'grandfathering' relief provided to existing conflicted
remuneration should be limited in time in order to avoid a perverse incentive
for advisers to keep clients in old products; and
- payments for 'education and training' should be subject to
limitations so that they cannot be used or abused in a way that limits market
access or competition.
5.69 The FSC supported the LIF reforms as set out in the bill. The FSC also
suggested that the life insurance industry had been proactive in supporting
reform to amend remuneration arrangements between life insurers and advisers to
minimise conflicts of interests.
5.70 By contrast, several advisers, adviser groups, and their representative
organisations expressed concern that the LIF reforms would have a negative
impact, particularly on smaller advice firms.
5.71 The FPA speculated that the LIF reforms may disproportionally affect
small advice firms because large firms may be able to cross subsidise any
associated costs by other business activities. The Life Insurance Customer Group also suggested that the LIF Reforms will
adversely impact small business and favour larger firms due to the potential
for cross-subsidies.
5.72 The Association of Financial Advisers indicated that while the measures that
have already started are welcome, without qualitative data analysing the
effects of existing levels of insurance and advice, government policy making on
life insurance will be piecemeal and may not be targeted where it is required
most.
5.73 Several advisers and adviser groups did not support the LIF Reforms for
various reasons, including concerns about the consultation process, the reforms may not address churn across the entire industry,or
other problems in the life insurance industry.
5.74 Bombora Advice also argued that under the reforms, insurers and
customers will pay more commissions overall in most circumstances. This is
because the higher permissible rates of ongoing commissions would add to a
greater overall cost than the pre-reform arrangements which had lower ongoing
commissions and higher up front commissions.
5.75 Finally, the committee notes that the Life Insurance Code of Practice
and the proposed Insurance in Superannuation Code of Practice do not appear to
place any significant controls on remuneration arrangements, except for premium
adjustments in group life insurance and some restriction on incentives for
declining claims.
Shelf space fees and training fees
5.76 Further flows of money not specifically identified in Figure 5.3 are
shelf space fees and training fees. A shelf space fee is a fee paid by an
insurance company to an advice licensee in order to ensure the licensee
includes certain products from that insurance company on the licensees' APL.
5.77 Evidence to this inquiry identified a range of concerns with shelf space
and training fees, some of which are set out below.
5.78 Clearview argued that shelf space fees are an arbitrary and prohibitive
cost charged by large licensees (often institutional) to external product
manufacturers to get on their APLs. ClearView estimated that insurers currently
pay $10–15 million per year in shelf space fees. Individual shelf space fees
range from $80 000 to $500 000.
5.79 Furthermore, ClearView recommended that, in order to be able to provide
a service in the best interest of clients, advisers should be able to recommend
any APRA-regulated retail insurer in the market.
5.80 Maurice Blackburn Lawyers argued that shelf space fees are a systemic
flaw in the life insurance sales system because shelf space fees cause a
conflict of interest. This conflict of interest between the licensee/adviser and the best interests
of the client arises because the adviser is restricted to recommending the
products that are on the licensee's shelf. As a consequence, the adviser may
recommend a product that is not necessarily in the client's best interests.
This results in a poor outcome for the customer.
5.81 Maurice Blackburn therefore suggested that the use of shelf space fees
should be either banned, or properly regulated by ASIC to ensure robust
disclosure obligations.
5.82 ASIC indicated that it has not conducted reviews of shelf space fees.
However, ASIC noted that while volume-based shelf space fees are banned under
section 964A of the Corporations Act, other shelf space fees are not
specifically banned. Whether a shelf-space fee will be conflicted remuneration
will depend on the circumstances in each case. Relevant circumstances include:
- the size of the fee;
- how the fee is calculated (for example, is it linked to the sale
of the insurer's products);
- how the licensee uses the fee;
- whether the fee is passed onto advisers, and in what form; and
- how the insurer's products are presented on the APL and to the
advisers.
5.83 The committee heard evidence that certain non-monetary benefits have the
potential to function as de-facto shelf space fees. For example, Mr William
Crawford informed the committee that the life insurance industry may be finding
loopholes that allow other fees with similar conflict of interest risks to
shelf space fees to continue to be paid. He noted that, in order to avoid the
conflicted remuneration laws, the way shelf space fees operate has changed from
a direct payment from the life insurer to the AFS licensee, to a more discrete
method through the use of education and training funds. In this regard, Mr
Crawford explained that not only do life insurance companies pay training money
to dealer groups and advice licensees, but the life insurance companies also
provide the training from their own resources.
5.84 The committee received confirmation of this arrangement when Zurich
revealed that it would not only pay for the training provided to a licensee,
but Zurich would also provide that training as well:
Senator O'NEILL: And they think you are pretty good to put
you on, and then they say, 'We think you're really good, but you'll have to pay
us some money as well,' and they then use the money that you pay to them to do
what?
Mr Bailey: Predominantly education and training of their
advisers.
Senator O'NEILL: Which is provided by you, or provided by
somebody else. Do you pay them to let you train their people?
Mr Bailey: It supports the cost of training on the Zurich
proposition.
Senator O'NEILL: So you pay them, but you do the training as
well. You pay them twice: you pay them money and you also pay them with your
expertise.
Mr Bailey: We need to contribute some of the expertise,
clearly, yes.
Senator O'NEILL: But you pay them money as well?
Mr Bailey: To support their costs associated with that education
and training.
Senator O'NEILL: Which you provide.
Committee view
5.85 Evidence to the committee, particularly from ASIC, indicates that a
plethora of hidden payments including commissions, fees, performance-related
payments, soft dollar benefits, and non-financial benefits exist within the
various structures of the life insurance industry. These money flows exist to
varying degrees across all three sectors: retail, direct, and group.
5.86 The committee also received evidence about a vast range of hidden remuneration
that does not even appear in Figure 5.3 in relation to remuneration within
retail life insurance. These money flows constitute what used to be termed
shelf space fees. These are fees paid by a life insurer to an advice licensee
in order to ensure the licensee includes certain products from that insurance
company on the licensees' APL.
5.87 Evidence to the committee indicated that insurers currently
pay $10–15 million per year in shelf space fees and that
individual shelf space fees range from $80 000 to $500 000. These are
substantial sums of money in anyone's language.
5.88 The committee endorses the view expressed by the Trowbridge review that
the incentives embedded in non-commission remuneration and benefits has the
potential to create conflicts of interest for advice licensees and advisers.
5.89 The committee also supports the Trowbridge review recommendation that
licensees be prohibited from receiving benefits from life insurers that might
influence recommended product choices or the advice given by the licensees'
advisers.
5.90 In light of the recommendations made in the Trowbridge review, the
committee was particularly disconcerted by the evidence it received that life
insurers and advice licensees are finding ways to work around the conflicted
remuneration restrictions that commenced on 1 January 2018 regarding shelf
space fees.
5.91 While the committee recognises that each case will be assessed on its
individual circumstances, the committee is concerned that life insurers are
continuing to pay, and advice licensees continuing to receive, shelf space fees
by disguising the payments as education and training fees.
5.92 The committee was disturbed to receive confirmation from Zurich, a major
life insurer, that it would both provide training to an advice licensee and pay
the advice licensee for that training. This appears to be nothing more than a
re-badging exercise. That is, what used to be referred to as shelf space fees
are now rebadged as training fees merely in order to circumvent the new rules
on conflicted remuneration.
5.93 The committee emphasises that the rules banning conflicted remuneration
have been introduced specifically in order to mitigate some of the risks around
conflicts of interest in the life insurance industry. It bears repeating that
the wrong type of financial incentives have contributed significantly to a
range of poor practices and misconduct in the financial services industry
including misleading advice and mis-selling with poor outcomes for customers.
5.94 The committee reiterates its finding from its 2009 inquiry into
financial products and services in Australia, namely that commissions (both
up-front and trailing), volume bonuses, sales target rewards, and soft-dollar
incentives place financial advisers in the role of both broker (that is, seller)
and expert adviser. As the committee stated in 2009, a significant conflict of
interest for financial advisers arises when they are remunerated by product
manufacturers because these payments place financial advisers in the role of
both broker and expert adviser, with the potentially competing objectives of
maximising remuneration via product sales and providing professional, strategic
financial advice that serves clients' interests.
5.95 In this regard, the committee is of the view that shelf space, education,
and training fees should also be treated as remuneration and benefits. The
committee struggles to see how the continued existence of these payments and
benefits has any benefit for the consumer.
5.96 As such, the committee considers that the current remuneration
arrangements in the life insurance industry lack transparency and create
conflicts of interest that could continue to have detrimental outcomes for
consumers. Furthermore, the lack of transparency surrounding many of these
payments makes it difficult for policy makers, regulators and consumers to make
informed decisions.
5.97 The committee recognises that action has been taken to address
conflicted remuneration through ASIC reviews, the introduction of Future of
Financial Advice reforms, and the Corporations Amendment (Life Insurance
Remuneration Arrangements) Act 2017. The committee notes these latest
reforms.
5.98 The committee also acknowledges the concerns raised by retail advisers
regarding the impact of the LIF reforms on their businesses. In this regard,
the committee notes that while commission caps and clawback requirements will
apply to upfront and hybrid commission structures, the cap on ongoing
(trailing) commissions has been increased from 10 per cent to 20 per cent and
there is no anticipated cut-off period for ongoing commissions. Furthermore, for
level commission structures, the commission caps and clawback requirements will
not apply, meaning that the life insurer will continue to be able to pay the
advice licensee a flat rate commission of around 30 per cent of the first
year's premium and for every year of the life of the policy.
5.99 An approximate calculation of the commission payments on a hypothetical
life insurance policy with a $1000 premium indicates that after six years,
under the old regime, the commission payments would amount to about $1800
($1300 first year commission plus five years of ongoing commissions at $100
each). Under the LIF reforms, the commission payments would still amount to
about $1800 ($800 first year commission plus five years of ongoing commissions
at $200 each). Finally, under a level commission structure, the commission
payments would also amount to about $1800 ($300 first year commission plus five
years of ongoing commissions at $300 each). In other words, the quantum of the
commission stream has not necessarily decreased. Indeed, for any policy held
for more than six years, the LIF reforms allow a higher level of commissions to
accrue to an advice licensee.
5.100 Nevertheless, in light of the substantial commission flows that appear
likely to continue within the life insurance industry, as well as the
substantial monetary and non-monetary flows associated with various fees (shelf
space, training, and education), the committee considers that further
transparency around the remuneration arrangements in the life insurance
industry is required in order to mitigate any risks of corruption that may arise
from conflicts of interest.
5.101 During the inquiry, the committee asked life insurers to provide data on
remuneration, commission, payment and fee flows within the life insurance
industry. The committee then provided the data to ASIC and asked ASIC to
analyse it in a series of written questions on notice. As at 22 March 2018,
ASIC had not responded to the committee's questions. The committee will make
ASIC's responses available when they are received.
5.102 The committee regards a thorough and comprehensive review as
particularly important because of the potential linkages between commissions
and shelf space fees (or their equivalent). For example, the committee can
envision a situation arising where a life insurer agrees to pay an advice
licensee a higher rate of commission up to the legal maximum as part of a deal
to secure space for that life insurer's product on that advice licensee's shelf.
It is partly out of an awareness of these potential linkages that the committee
has considered shelf space fees in this chapter on remuneration, although the
committee recognises that shelf space fees are intimately linked to approved
product lists (APLs) which are the topic of the next chapter.
5.103 The committee therefore recommends that ASIC conduct a systematic review
and risk assessment of all payments and benefits (monetary and non-monetary) between
participants in each sector of the life insurance industry with a view to
advising the government of any outstanding risks and regulatory gaps. To spell
this out, the committee expects that this would include, but not be restricted
to, all commissions and fees including training and education fees and the like.
5.104 In addition, the committee considers that it is particularly important
that reforms resulting from the ASIC review are progressed in parallel for the
direct, group and retail sectors in order to avoid any inappropriate regulatory
induced flow of customers between the sectors.
Recommendation 5.2
5.105 The committee recommends that:
- ASIC conduct a systematic review and risk assessment of all
payments and benefits flowing between participants in each sector of the life
insurance industry—direct, group, and retail—and inform the government of any
regulatory gaps; and
- the government consider further regulation of payments between
life insurance industry participants following the ASIC review.
5.106 The committee notes that the life insurance industry may argue that some
of these matters will be addressed in future iterations of its code of
practice. However, the committee is not convinced. Apart from a reference to
profit sharing payments in the draft Insurance in Superannuation Code of
Practice, the industry's code of practice has not addressed the lack of
transparency and conflict-of-interest risks with the payments described in this
chapter and set out in Figures 5.1, 5.2, and 5.3 and Table 5.2.
5.107 The committee also notes that payments made from life insurers to trustees
remain unregulated by conflicted remuneration provisions and can include
payments arising from profit sharing arrangements that exist between trustees
and life insurers in the provision of default insurance funded by
superannuation guarantee contributions. The committee also notes that there is
no transparency around other payments that may exist between life insurers and
trustees including soft dollar benefits. The committee believes that given the
compulsory nature of superannuation and the automatic provision of insurance,
transparency around the exact nature of the value of these arrangements is
critical for confidence in the superannuation system.
Recommendation 5.3
5.108 The committee recommends that ASIC and APRA immediately undertake an audit
of all superannuation trustees to identify the nature, purpose and value of all
payments, including any 'soft-dollar' benefits that occur between life insurers
and trustees or any related parties in connection with the provision of default
insurance to members of MySuper and choice superannuation products, including:
- current and historical payments made by life insurers to trustees
or any related parties and/or by trustees to life insurers under
profit-sharing, premium adjustment models, experience share arrangements or any
arrangement of a similar nature;
- the total premium value attributable to the existence of
profit-sharing, premium adjustment models, experience share arrangements or any
arrangement of a similar nature between a trustee and a life insurer; and
- payments, including any 'soft-dollar' benefits made or that may
become payable by life insurers to trustees or any related parties of trustees
for any purpose, for example, subsidisation of administration costs,
technology, marketing, sponsorship, hospitality, staff expenses etc.
5.109 The committee also recommends that the report be published by ASIC and
APRA as soon as practical to ensure confidence in the compulsory superannuation
system.