Bills Digest no. 103 2015–16
PDF version [697KB]
WARNING: This Digest was prepared for debate. It reflects the legislation as introduced and does not canvass subsequent amendments. This Digest does not have any official legal status. Other sources should be consulted to determine the subsequent official status of the Bill.
Kai Swoboda
Economics Section
31 March 2016
Contents
Purpose
of the Bill
Background
Brief history of the future of financial advice changes
Policy development
Committee consideration
Statement of Compatibility with Human Rights
Policy position of non-government parties/independents
Position of major interest groups
Financial implications
Key issues and provisions
Date introduced: 11
February 2016
House: House of
Representatives
Portfolio: Treasury
Commencement: Sections
1–3 on Royal Assent; Schedule 1 on 1 July 2016.
Links: The links to the Bill,
its Explanatory Memorandum and second reading speech can be found on the
Bill’s home page, or through the Australian
Parliament website.
When Bills have been passed and have received Royal Assent, they
become Acts, which can be found at the Federal
Register of Legislation website.
All hyperlinks in this Bills Digest are correct as at
March 2016.
The purpose of the Corporations Amendment (Life Insurance
Remuneration Arrangements) Bill 2016 (the Bill) is to amend the Corporations
Act 2001 to:
- remove
the current exemption from the ban on conflicted remuneration for benefits paid
in relation to certain life risk insurance products and
- enable
the Australian Securities and Investments Commission (ASIC) to make a
legislative instrument to permit benefits in relation to life risk insurance
products to be paid—provided that certain requirements are met.
What is conflicted remuneration?
Division 4 in Part 7.7A of the Corporations Act sets
out a general ban on remuneration arrangements for financial advisors on the
sale of financial advice and financial products to certain consumers. The
rationale for the ban is that, because of the nature of the benefit or the
circumstances in which it is given, the remuneration arrangements could
reasonably be expected to influence the choice of product or advice given.[1] The general aim of these provisions—which were part of the ‘Future of Financial
Advice’ (FOFA) arrangements implemented by the Gillard Government—was to more
closely align the interests of those who provide financial product advice to
retail clients with the interests of their clients, and improve the quality of
advice these clients receive.[2]
Section 963B of the Corporations Act provides some exemptions
from the general ban on conflicted remuneration in certain circumstances. These
exemptions include, amongst other things, where the benefit relates solely to a
general insurance product[3] or where the benefit relates solely to a life risk insurance product, other
than a group life policy for members of a superannuation entity or default
superannuation fund.[4]
The exemption for life insurance outside of superannuation,
which was included as part of the FOFA changes, was based on concerns about
affordability of life insurance and the potential for under‑insurance.[5]
Life insurance industry, products
and remuneration arrangements
As at 30 June 2015 there were 28 registered life
insurers operating in Australia, with net premium income in 2014–15 of $60.9 billion.[6]
Life insurance generally covers a range of insurance
products including:
- life
cover—also known as term life insurance or death cover, pays a set amount of
money when the insured person dies
- total
and permanent disability (TPD) cover—covers the costs of rehabilitation, debt
repayments and the future cost of living if the insured person is totally and
permanently disabled. TPD cover is often bundled together with life cover
- trauma
cover—provides cover in the event of a diagnosis of a specified illness or
injury. These policies include the major illnesses or injuries that will make a
significant impact on a person's life, such as cancer or a stroke. It is also
referred to as ‘critical illness’ cover or ‘recovery’ insurance and
- income
protection—replaces the income lost through an inability to work due to injury
or sickness.[7]
Consumers generally purchase life insurance in one of three
ways: through an advice provider (adviser); directly from an insurer; or
through their superannuation fund and the group life cover offered by the fund.[8]
As at 30 June 2013 the Australian Securities and Investments
Commission (ASIC) found that, for 12 life insurers participating in an ASIC
survey, there were 2.6 million policies in force that were purchased
through an advice provider (adviser).[9] At this time, life only and income protection policies were the most common
policies in force, comprising 32 per cent and 21 per cent of the
total policies in force.[10]
For life insurance distributed under personal advice models,
advisers are typically paid under commission arrangements. In 2014 ASIC noted
that upfront commission models—in which advisers were paid an amount upon the
sale of a new premium—were the dominant remuneration arrangement by a
significant margin, with 82 per cent of the remuneration in the industry
in 2013 derived from these amounts (Figure 1).
Figure 1: Life insurance remuneration models, 2011–2013 averages
Source: ASIC, Review
of retail life insurance advice, op. cit., pp. 26–27.
The FOFA reforms were a package of amendments to change how
financial advice is delivered to clients including:
- how financial advisers behave in relation to providing advice
- how clients are charged for this advice and
- the disclosure of fees to clients.
The FOFA reforms constituted the Rudd and Gillard
Governments’ response to the 2009 report by the Parliamentary Joint Committee
on Corporations and Financial Services of its Inquiry into Financial
Products and Services (PJC report).[11] The impetus for the PJC inquiry was a number of significant corporate
collapses, including Storm Financial and Opes Prime.[12]
The FOFA reforms were introduced into the Parliament in late
2011 and implemented by two key pieces of legislation:
- the Corporations
Amendment (Future of Financial Advice) Act 2012 which:
- enhanced
the requirement for disclosure of fees and services associated with ongoing
fees[13] and
- enhanced
the ability of the Australian Securities and Investments Commission (ASIC) to
supervise the financial services industry, through changes to its licensing and
banning powers for financial advisers[14]and
- the Corporations
Amendment (Further Future of Financial Advice Measures) Act 2012 which
- required
those persons who are providing personal financial advice to retail clients to
act in the best interests of their clients, and to give priority to their
clients’ interests[15]
- imposed
a prospective ban on conflicted remuneration structures[16]
- applied
existing regulatory mechanisms under the Corporations Act more directly
to individual advisers as well as to licensees.[17]
The implementation date for most of the FOFA reforms was
originally 1 July 2012. However, Government amendments during the passage
of the legislation provided that the provisions would be voluntary until 1 July 2013,
after which time compliance with the relevant requirements was mandatory.[18]
Upon coming to office, the Abbott Government sought to
make a number of changes to some aspects of the FOFA arrangements through the Corporations
Amendment (Streamlining of Future of Financial Advice) Bill 2014, which was
introduced in the House of Representatives on 19 March 2014.[19] Some of the proposed changes included:
- removing
the need for clients to renew their ongoing fee arrangement with their adviser
every two years (also known as the ‘opt-in’ requirement)
- making
the requirement for advisers to provide a fee disclosure statement only
applicable to clients who entered into their arrangement after 1 July 2013
- removing
the ‘catch-all’ provision, from the list of steps an advice provider may take
in order to satisfy the best interests obligation
- better
facilitating the provision of scaled advice and
- providing
a targeted exemption for general advice from the ban on conflicted remuneration
in certain circumstances.[20]
Some of these proposals were controversial.
While the Bill was before the Parliament, the Government
announced that it would implement some of the changes by regulation.[21] These amendments were implemented through the Corporations Amendment
(Streamlining Future of Financial Advice) Regulation 2014, which commenced on 1
July 2014. [22] On 19 November 2014,
the Regulation was disallowed by the Senate.[23]
The Government then remade a number of time-sensitive
elements of the disallowed Regulation. These changes were implemented through
the Corporations Amendment (Revising Future of Financial Advice) Regulation
2014 (dated 11 December 2014) and the Corporations Amendment (Financial Advice)
Regulation 2015 (dated 25 June 2015).[24] The Regulations commenced on 16 December 2014 and 1 July 2015
respectively.
The Corporations Amendment (Streamlining of Future of
Financial Advice) Bill 2014, including amendments made by the Government, was
passed by the House of Representatives on 28 August 2014. The Bill, with
further Government amendments, was passed by the Senate on 24 November
2015 and agreed to by the House of Representatives on 1 March 2016.[25] The key changes that were proposed in the Bill as introduced but not included
in the Bill as finally passed by the Parliament were:
- changes
to the Statements of Advice requirements
- repeal
of the requirement that licensees send fee disclosure statements to pre-1 July
2013 clients
- repeal
of the opt-in requirement for continuing an ongoing fee arrangement between a
fee recipient and a client
- changes
to the best interests duty and scaled advice and
- the
general advice exemption from conflicted remuneration.[26]
The arrangements proposed by the Bill are a response to
concerns held over a number of years about remuneration arrangements in the
life insurance industry. These concerns were considered as part of the FOFA
reform process.
While self-regulation was first proposed by the financial
services industry in 2011, the idea did not receive universal industry support.
This then led to a life insurance industry-commissioned review, which
overlapped with the Government’s financial system review and ASIC research.
Further consultation by the Government after these processes
concluded then contributed to the design of the measures included in the Bill.
Industry attempts at self-regulation
At the same time as the development of the FOFA package of
measures in 2010 and 2011, the financial services industry was examining
remuneration arrangements in life insurance to address issues associated with
‘churning’—whereby consumers with an existing life insurance policy are sold a
new policy by a financial adviser that has no net benefit for the consumer.[27] While churn can be a measure of competition within an industry and indicate
that choice is exercised by consumers, relatively high levels of churn in some
industries may also be associated with concerns about inappropriate marketing
strategies or customer dissatisfaction with a supplier.
In August 2011, the Financial Services Council (FSC)
recognised that churning impacted on both the quality and cost of life
insurance products for consumers and on the profitability of the industry, with
the CEO of the FSC noting:
Advisers that engage in churning do so to access the upfront
commission on the sale, in the knowledge that the new policy provides
essentially equivalent cover and benefits for the client, to the policy that
has been replaced.
The practice also creates cost pressures for life insurance
premiums that are simply wasteful and unnecessary.
This practice is not in the interests of consumers and the
FSC has taken the clear view that it is inconsistent with the statutory
requirement for financial advisers to act in their clients ‘best interests’.
While this practice is not widespread, it is significant
enough an issue to warrant industry action.[28]
At this time, the FSC proposed the development of a
voluntary industry standard (which would apply to members of the FSC) to
address the practice of ‘churning’.[29] The FSC proposal included:
- the
removal of ‘takeover terms’ (that is, banning the practice of the relaxation of
the standard underwriting process for replacement business) for a policy or a
group of policies that are transferred by an adviser between insurers and
- the
establishment of a consistent adviser responsibility period across the industry
of two years—with 100 per cent commission clawback if the policy lapses with an
insurer within one year, and 50 per cent commission clawback if the policy
lapses with an insurer during the second year.[30]
When this proposal was announced, the FSC intended that it
would be finalised in 2012 ‘with an implementation date that would be
consistent with the FOFA reforms’.[31]
One year later, in August 2012, the FSC finalised its
proposed industry standard, which was to be effective from 1 July 2013.[32] Key elements of the proposed standard included:
- Where
an advised policy lapses within three years of commencement, a three year
adviser responsibility period will apply;
- A
tiered commission claw-back provision will be introduced as follows:
– 100% of remuneration paid
by an insurer to an adviser if the policy lapses within the first year;
– 75% of remuneration paid
by an insurer if the policy lapses within the second year; and
– 50% of remuneration paid
by an insurer if the policy lapses within the third year.[33]
By February 2013 however, the implementation of the
standard had been abandoned by the FSC.[34] The CEO of the FSC was reported to have attributed the decision to ‘no longer
having the unanimity on this approach’ and that ‘the proposed framework raised
a complex set of factual, legal and economic issues from a competition
perspective, which meant that it would have required regulatory approval in
order to be implemented’.[35] The CEO of the FSC noted that the FSC ‘remains committed to ensuring a sustainable
life insurance sector which will deliver outcomes for the community and the
industry participants’.[36]
ASIC review
On 9 October 2014, ASIC published a review of retail
life insurance.[37] The review, conducted between September 2013 and July 2014, examined:
- how
life insurance is sold by advisers
- how
advisers are remunerated for that advice
- the
drivers behind product replacement advice to consumers and
- the
quality of the personal advice consumers receive.[38]
The purpose of the review, described as a ‘proactive
surveillance of life insurance advice’ in the 2014–15 ASIC annual report, was
‘to better understand the quality of advice consumers receive’.[39]
The ASIC review noted that life insurance policies are
lapsing—when a policy ceases due to non-payment or cancellation by the client—at
high rates, with policy lapses doubling from approximately seven per cent in
the first year to 14 per cent in the second year.[40] After the initial spike, lapse rates remain high (above 14 per cent) for
the next three years before tapering.[41] The factors for these higher lapse rates included:
- product
innovation by insurers, such as changing actuarial assumptions at underwriting
or the redesign of key policy features such as definitions and exclusions,
which leads to the repricing of policies
- age-based
premium increases affecting affordability, and
- incentives
for advisers to write new business or rewrite existing business to increase
commission income.[42]
The ASIC review also found a correlation between high lapse
rates and upfront commission models.[43]
The main recommendations of the review did not necessarily
advocate a stronger role for government in regulating remuneration
arrangements. Instead, the recommendations were for insurers and financial
advisers to examine, individually or as an industry, the business models and
remuneration arrangements:
We recommend that insurers:
(a) address misaligned incentives in their distribution
channels;
(b) address
lapse rates on an industry-wide and insurer-by-insurer basis (e.g. by considering
measures to encourage product retention); and
(c) review
their remuneration arrangements to ensure that they support good-quality
outcomes for consumers and better manage the conflicts of interest within those
arrangements.
We recommend that AFS licensees:
(a) ensure that remuneration structures support
good-quality advice that prioritises the needs of the client ;
(b) review their business models to provide incentives for
strategic life insurance advice;
(c) review the training and competency of advisers giving
life insurance advice; and
(d) 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.[44]
Trowbridge Review
Following the release of the ASIC review, in December 2014, the
Association of Financial Advisers (AFA) and the FSC established a Life
Insurance and Advice Working Group headed by former APRA member John
Trowbridge, to review the ASIC report.[45]
Interim report
An interim report was published by the FSC on 17 December
2014.[46] The interim report put forward five models to be considered for direct adviser
remuneration:
- level
commissions only (no extra commission in Year 1) and no other direct
remuneration
- hybrid
commissions as currently understood as the maximum commissions (for example,
dictating a maximum upfront commission of 80 per cent and level commission
thereafter)
- modified
hybrid comprising initial remuneration of a combination of commission at a
level less than the current hybrid plus a fixed dollar payment. Renewal
commissions could be as per current hybrid arrangements
- level
plus fees comprising level commissions, at a rate to be considered,
supplemented by an initial payment in the nature of a fee from the insurer to
the adviser. Such a payment would not be a commission but a fee in the nature
of cost recovery or expense reimbursement and
- level
funded as a variation on ‘level’ where the commissions are level but to offset
initial costs, on each policy inception the insurer lends the adviser funds
that are repayable over say three to five years from renewal commissions.[47]
Final report
The final report was released on 26 March 2015.[48] In relation to remuneration arrangements, the final report proposed a
remuneration model that was based on a fixed level of commission (maximum
20 per cent of premiums) supplemented by an ‘initial advice payment’.[49] The recommendations were in two parts, with a ‘reform model’ (commencing from a
date in 2018) supported by a three-year transition plan:
The Reform Model can be described as level commissions
supplemented by an Initial Advice Payment available at a client’s first policy
inception and then no more often than once every five years, where:
- the
level commission is a maximum of 20% of premiums;
- the
Initial Advice Payment (IAP) is paid by the insurer to the adviser on a per
client basis (which would generally mean the insured life);
- the
IAP is available to the adviser when a client first takes out a life insurance
policy and subsequently no more often than once every five years and then only
when a new policy is being taken out (the “five year rule”); and
- the
IAP is a maximum of $1,200 or, for customers with annual premiums below $2,000,
no more than 60% of the first year’s premiums.
…
The Transition Plan has two phases
–
The first phase is where the five
year rule is to apply on a best endeavours basis by insurers and licensees. It
is recommended to commence as soon as possible, say 30 June 2015. In all other
respects current arrangements would remain in place pending the second phase.
The second phase will require some
form of regulation, to begin from a suitable date in 2016 and is where –
- the
maximum commissions are to be on the current hybrid basis with a cap, so that
the maximum initial commission is 80% of premiums capped at $8,000 and maximum
renewal commission is 20%;
- for
the purposes of the five year rule, the initial commission is to be treated as
a recurring component of 20% and an IAP of 60% of premiums;
- this
arrangement is to continue for two years pending full introduction of the
Reform Model.[50]
On 25 June 2015, the then Assistant Treasurer welcomed the
release of the Trowbridge Review and noted that the Government would consider
the proposals in the context of its response to the Financial System Inquiry.[51]
Financial System Inquiry
The Financial System Inquiry (also referred to as the
‘Murray Inquiry’ after its chair Mr David Murray AO), conducted over the period
late 2013 to late 2014, included some consideration of remuneration
arrangements in the financial services industry.
Interim report
In its interim report, released on 15 July 2014, the
Murray Inquiry noted that ‘the principle of consumers being able to access
advice that helps them meet their financial needs is undermined by the
existence of conflicted remuneration structures in financial advice’.[52] The interim report also sought some additional information about the extent of
underinsurance.[53]
Final report
In its final report, released on 7 December 2014, the
Murray Inquiry made some specific recommendations about remuneration
arrangements in the life insurance industry.[54] The final report states:
With the exception of group life insurance policies inside
superannuation and an individual life insurance policy for a member of a
default fund, life insurance products are exempt from the [future of financial
advice] ban on commissions. This allows individual life policies to be sold
with high upfront commissions, creating an incentive for advisers to make a sale,
rather than provide strategic advice. For example, these policies can have
100–130 per cent of the first year’s premium payable as upfront commissions,
with an ongoing trail commission of around 10 per cent.
… 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.[55]
The Murray Inquiry recommended that a level commission
structure be implemented through legislation requiring that an upfront
commission is not greater than the ongoing commission.[56] The final report also noted:
Alternative models of remuneration, such as delayed vesting
of commissions and clawback arrangements, may simply delay the issue of churn
and are complex. 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 structures do not address
the issues in life insurance, Government should revisit banning commissions.
The Inquiry has not determined the percentage amount of the
level commissions that should apply in the life insurance sector. This should
be left to the market and industry.[57]
Government response to Financial
System Inquiry
The Government response to the Murray Inquiry was released
on 20 October 2015.[58] The Government response noted the release of the Trowbridge final report which
had been delivered during the Murray Inquiry and proposed to proceed with the
life insurance industry’s proposed reforms:
The Government agrees more can be done to better align the
interests of financial firms and consumers. However, we intend to take a
different approach to that recommended by the Inquiry for retail life
insurance.
We support the retail life insurance industry’s proposed
reforms as announced by the then Assistant Treasurer on 25 June 2015. The
Government will consider the extent to which legislation and/or action by ASIC
may be necessary to implement the industry agreement.
A Government review in 2018 will consider whether the new
industry arrangements for life insurance advice have better aligned the
interests of firms and consumers. If the review suggests further reform,
consideration would be given to the Inquiry’s recommendation for a level
commission structure or further extending the existing Future of Financial
Advice provisions on conflicted remuneration to life insurance advice.[59]
Final policy decision and draft
legislation
On 6 November 2015 the Assistant Treasurer announced that
the Government had reached agreement with the life insurance industry about
remuneration arrangements.[60] Key elements of the announced package included:
- phasing
down upfront commissions to a maximum of 80 per cent from 1 July 2016; 70 per
cent from 1 July 2017 and then 60 per cent from 1 July 2018, together
with a maximum 20 per cent ongoing commission and
- introducing
a two year retention (‘clawback’) period as follows:
- in
the first year of the policy, to 100 per cent of the commission on the first
year’s premium and
- in
the second year of the policy, to 60 per cent of the commission on the first
year’s premium.[61]
Treasury released draft legislation for consultation on
3 December 2015, with submissions due by 4 January 2016.[62] The Assistant Treasurer noted in her second reading speech that over
20 submissions to the draft legislation had been received.[63] At the date of publication of this Bills Digest, submissions to the draft
legislation had not been published by Treasury.
On 15 December 2015 ASIC released a consultation
paper seeking feedback on aspects of the proposed legislative instrument that
would underpin much of the detailed arrangements that would be facilitated by
the Bill.[64] Comments on the consultation paper closed on 29 January 2016.[65] Included in the consultation paper were the following proposed key thresholds
in relation to maximum commissions and clawback arrangements:
- transitional
arrangements for the setting of the maximum level of commissions at 80 per
cent of the premium in the first year of the policy from July 2016, reducing to
70 per cent from 1 July 2017 and then to 60 per cent from 1 July 2018
- an
ongoing commission for policy renewals will be set at a maximum of 20 per
cent of the total of the premium paid for the renewal and
- a
two-year clawback period for policies that have lapsed, with 100 per cent
of the commission repaid if the policy lapses in the first year and 60 per
cent of the commission repaid if the policy lapses in the second year.[66]
These key thresholds are consistent with the Government’s
6 November 2015 announcement.
Broader policy considerations
The Government’s 6 November 2015 announcement made
reference to several other policies that were part of a broader approach to
improving the quality of financial advice for life insurance and the efficiency
of the life insurance industry. These included:
- a
Life Insurance Code of Conduct to be developed by the FSC by 1 July 2016. The
Code would set out best practice standards for insurers, including in relation
to underwriting and claims management
- financial
services industry to have responsibility for widening Approved Product Lists
through the development of a new industry standard.[67] This industry standard will be a joint effort of all industry participants, led
by the FSC
- ASIC
to commence a review of Statements of Advice from the second half of 2016, with
a view to making disclosure simpler and more effective for consumers as well as
assisting advisers to make better use of these documents. The review of
Statements of Advice will also consider whether the disclosure of adviser
remuneration could be more effective, including prominent upfront disclosure of
commissions and
- amendments
to the Corporations Act to facilitate the rationalisation of legacy
products in the life insurance and managed investment sectors, with further
analysis of the taxation implications explored in the context of the
Government’s Taxation White Paper process.[68]
A broader range of measures to improve the standard and
quality of financial advice, through mandating educational standards and
professional development standards, is also being pursued by the Government as
part of its response to the Financial System Inquiry.[69]
Senate Economics Legislation
Committee
The Bill was referred to the Senate Economics Legislation
Committee (Economics Committee) for inquiry and report by 15 March 2016.[70] The Economics Committee received a similar form letter from 209 stakeholders
and 56 other submissions.[71] Most submissions originated from persons working in the life insurance industry
as advisers. They expressed a number of concerns, for instance:
- he
legislation would have the effect of exacerbating Australia’s ‘chronic
under-insurance crisis’[72]
- the
amendments would create ‘barriers and impediments’ to those financial advisers
who seek to improve education, operate honestly and in a trustworthy manner for
the benefit of consumers[73] so that the industry will see a reduction in adviser numbers[74] and the Bill will not provide any identifiable benefits for consumers.[75]
The Economics Committee recommended that the Bill be
passed.[76] In additional comments, Labor members of the Committee noted the following
concerns raised in submissions to the inquiry:
- the
reviews preceding the reform focused on churning, and not appropriate methods
of dealing with rogue advisers; the data sample used in ASIC's review was
inadequate; and not all stakeholders were consulted
- the
reform will adversely affect consumer choice and competition, and will see an
increase in the cost of life insurance, coupled with the implementation of fees
for advice and
- the
life insurance advice industry will see a decline in adviser numbers and an
increase in the market share of large institutions like banks.[77]
Senate Standing Committee for the
Scrutiny of Bills
The Senate Standing Committee for the Scrutiny of Bills made
no comment on the Bill.[78]
As required under Part 3 of the Human Rights
(Parliamentary Scrutiny) Act 2011 (Cth), the Government has assessed
the Bill’s compatibility with the human rights and freedoms recognised or
declared in the international instruments listed in section 3 of that Act. The
Government considers that the Bill is compatible.[79]
Parliamentary
Joint Committee on Human Rights
The Parliamentary Joint Committee on Human Rights has
considered the Bill and concluded that it does not raise human rights concerns.[80]
When the Bill was debated in the House of Representatives
on 3 March 2016, the Australian Labor Party (ALP) indicated that it would
support the Bill.[81] While the ALP noted some issues of concern (such as separating out the cost of
stamp duty and other government taxes in life insurance products), the overall
position of the ALP was:
… [it] will make incremental improvement to the life
insurance remuneration structures. We know that that view is not universal in
the sector or in the community but we think all of these Bills are, on-balance
calls and we think, on balance, this Bill is worth supporting.[82]
As noted previously, while ALP Senators made some
additional comments in the Senate Economics Legislation Committee inquiry into
the Bill, the ALP Senators did not propose to oppose the Bill.[83]
At the time of writing this Bills Digest, no other
non-government parties or independent Senators or Members had publicly expressed
a position on the Bill.
In her second reading speech, the Assistant Treasurer specifically
acknowledged the work of the AFA, the Financial Planners Association (FPA) and
the FSC ‘in working together to achieve sensible reforms for the sector which
will benefit consumers through the provision of more appropriate advice and the
long-term sustainability of the industry’.[84]
The AFA has generally supported the development of the
regulatory package. On 6 November 2015 the AFA welcomed a reduction in the
clawback period from three years to two years, noting that this ‘brings greater
fairness to the [Life Insurance Framework] and that ‘[t]o succeed in having
this reduced to two years is a great relief for our members, particularly those
that own and operate small businesses’.[85]
The FSC comments on 6 November 2015 also supported the
proposed arrangements, noting that the proposed changes were ‘a positive first
step in lifting industry practices to improve consumer outcomes’.[86]
The FPA also welcomed the proposed arrangements, noting that
they were ‘a sensible outcome that will ensure the sustainability of the
industry’.[87] The FPA noted that the setting of the clawback period of two years was ‘a
result of combined representation by the AFA and FPA’.[88]
National Seniors Australia (NSA) supports the intent of
the regulatory package.[89] However, while recognising that the package was a compromise solution, NSA
considered that ASIC should be given the power to set level commissions and
zero commissions and also that the clawback provisions should be strengthened
to specify a minimum three-year period.[90]
Consumer organisation Choice, also commenting on the
6 November 2015 announcement, was generally supportive of the regulatory
package but was ‘disappointed that the reforms have been watered down since
they were announced in June’.[91] Choice considered that the change from a three year clawback period was ‘the
result of an aggressive lobbying campaign by financial advisers seeking to
protect the conflicted remuneration models upon which their industry is built’.[92]
The Explanatory Memorandum notes that the financial impact
on the Commonwealth of the measures proposed by the Bill is ‘nil’.[93]
However, the Regulation Impact Statement acknowledges:
For large and medium sized licensees, there will be
implementation costs associated with updating IT and other systems. It is
assumed that small licensees do not have advanced IT systems and so the IT
costs are not likely to be material. All licensees will have additional costs
associated with monitoring compliance with the new regulations.
Individual financial advisers will incur a small cost
associated with updating their knowledge of the remuneration arrangements,
including clawback.
It is estimated that the increase in annual compliance costs
for the industry as a whole will amount to $27.8 million.[94]
Why regulate life insurance
remuneration arrangements?
In her second reading speech, the Assistant Treasurer noted
that the proposed changes ‘strike the right balance between protecting
consumers and recognising the need for ongoing viability and industry
stability’.[95]
The balance needs to be struck in respect of two matters:
- first,
balancing the objective for more people to take out life insurance and the
remuneration arrangements that may contribute to inappropriate advice and life
insurance products being chosen by a consumer and
- second,
the form of regulation and the extent of government intervention required to
achieve the desired outcomes.
Consumer interests
As noted previously, the exemption for life insurance
outside of superannuation from the conflicted remuneration arrangements under
FOFA was largely based on concerns about affordability and the potential for
under-insurance.[96]
Commission-based arrangements for the sale of life
insurance, where products can be complex and there exists asymmetric
information between buyer and seller about remuneration arrangements, can lead
to greater incentives to provide biased advice to unsophisticated potential
consumers.[97] Economic analyses suggest that a commission-based model can be superior to the
alternative upfront fee-for-service approach, although this result can depend
on the extent to which different consumers are prepared to directly pay for
advice and the value they attach to the advice.[98]
The approach proposed by the Bill dilutes, but does not
remove, the influence of commission-based remuneration arrangements in part of
the life insurance industry. It also steers a middle course through the
proposals of the Trowbridge final report for a fixed level of commission
(maximum 20 per cent of premiums) supplemented by an ‘initial advice
payment’ and the recommendations of the Murray Inquiry which were for a level
commission structure requiring that an upfront commission is not greater than
the ongoing commission.[99]
Form of regulation
There has been some history of self-regulation in parts of
the financial services industry through the development of industry codes of
practice or codes of conduct. The first such financial services code was adopted
in 1989 whilst a code covering life insurance was developed in 1995.[100] Initially, such codes were viewed largely as part of an ‘enrolment’ process to
draw industry into the regulatory system.[101] While such codes are sometimes viewed as a defensive mechanism by industry, it
is also arguable that they have become more forward-looking initiatives, ‘focusing
on improving standards and providing genuine consumer protection.[102]
As noted previously the life insurance industry, through the
FSC, had attempted to develop an industry standard to address issues related to
churning and inappropriate advice. However, the failure of the industry to self‑regulate
has arguably necessitated the government stepping in to regulate remuneration
arrangements.
The Trowbridge final report supported government
intervention, noting:
It is essential for the integrity of the recommendations on
adviser remuneration and licensee remuneration that there be some kind of
externally imposed regulation on the industry. An effective form of this
regulation, given the nature of the regulation required and the ability of ASIC
to maintain an associated compliance regime, is likely to be the imposition by
ASIC of licensing conditions on life insurers. These conditions would oblige
all life insurers, and through them all licensed adviser groups (generally
referred to as licensees in this report) by means of the contractual
relationships between insurers and licensees, to conform to the Reform Model,
the Transition Plan and the avoidance of conflicts of interest by licensees.[103]
The Murray Inquiry also backed implementing its
recommendations for a level commission structure through legislation.[104]
A wait and see approach?
To some extent the regulatory model adopted by the
Government adopts a ‘wait and see’ approach, with the success of the regulatory
measures to be assessed by an announced ASIC review in 2018.[105]
The Assistant Minister indicated that further regulation
may be required, noting in her second reading speech that ‘[i]f this 2018
Review does not identify significant improvement in product churn and the
quality of advice, the Government will move to mandate level commissions, as
was recommended by the Financial System Inquiry’.[106]
Facilitative provisions
The main elements of the Bill amend the conflicted
remuneration framework in Part 7.7A of the Corporations Act to empower
ASIC to make a legislative instrument which will regulate benefits paid to life
insurance brokers and advisers on the sale of life insurance products. These
include some key concepts and definitions.
Allowable commissions and clawbacks
Existing section 963E of the Corporations Act bans
a financial services licensee from accepting conflicted remuneration.
The term conflicted remuneration is defined as any benefit,
whether monetary or non-monetary, given to a financial services licensee (or
their representative) 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.[107]
However, certain benefits are exempted from the definition
of conflicted remuneration. In particular, paragraph 963B(1)(b)
of the Corporations Act provides that a benefit in relation to life
products other than a group life policy for members of a superannuation entity
or a life policy for a member of a default superannuation fund is not conflicted
remuneration. Item 3 repeals and replaces paragraph 963B(1)(b)
to limit the extent of the exemption. Proposed paragraph 963B(1)(b) provides for a similar exemption for life insurance products outside of
superannuation to that which currently exists—subject to either the benefit
ratio for the benefit being the same for each year in which the product is
continued or satisfying the benefit ratio requirements and the clawback
requirements.
Benefit ratio requirements
Item 4 inserts proposed subsections 963B(3A)–(3C) into the Corporations Act. The benefit ratio is the ratio
between the benefit (that is, the benefit paid to an adviser or broker) and the policy cost payable for the product for the year. The policy
cost is the total of:
- the
premiums payable for the product, or products, for that year
- any
fees payable for that year to the issuer of the product
- any
additional fees payable because the premium for the product is paid
periodically rather than in a lump sum and
- any
other amount prescribed by the regulations.[108]
The benefit ratio requirements are satisfied
in relation to a benefit for a life risk insurance product if the benefit
ratio for the benefit for the year in which the product is issued and
for each year that the product is continued is equal to or less than that
determined by ASIC, by legislative instrument, as an acceptable benefit ratio
for that year.[109]
Clawback requirements
The clawback requirements are satisfied if:
- the
arrangement under which the benefit is payable includes an obligation to repay
all or part of the benefit if within two years after it is first issued to a
retail client either:
- the
product is cancelled or is not continued within two years after it is first
issued to a retail client, other than because a claim is made under the
insurance policy or because other prescribed circumstances
exist or
- the
policy cost for the product during a year or across two years is reduced within
two years after it is first issued to a retail client and
- the
amount to be repaid under the obligation is equal to or greater than the amount
determined by ASIC, by legislative instrument to be an acceptable repayment.[110]
Although the contents of the legislative instruments is
not known, by way of guidance, ASIC’s December 2015 consultation paper proposed
the following key thresholds in relation to maximum commissions and clawback
arrangements:
- transitional
arrangements for the setting of the maximum level of commissions at 80 per
cent of the premium in the first year of the policy from July 2016, reducing to
70 per cent from 1 July 2017 and then to 60 per cent from 1 July 2018
- an
ongoing commission for policy renewals will be set at a maximum of 20 per
cent of the total of the premium paid for the renewal
- a
two-year clawback period for policies that have lapsed, with 100 per cent
of the commission repaid if the policy lapses in the first year and 60 per
cent of the commission repaid if the policy lapses in the second year.[111]
Transitional arrangements
Item 6 inserts transitional arrangements into the Corporations
Act. Proposed section 1549A inserts the meaning of the term commencement
day. This will be 1 July 2016.
The amendments in the Bill apply to benefits given under an
arrangement that is entered into after 1 July 2016.[112] They do not apply to benefits given under an arrangement that is entered into
before 1 July 2016—provided that the life product is issued within three months
of 1 July 2016.[113]
Further flexibility in implementation is provided through a
regulation making power to prescribe circumstances in which the arrangements
do, or do not apply.[114]
2018 Review
As noted above the success or otherwise of the proposed
remuneration arrangements will be examined as part of a review by ASIC in 2018.[115] The requirement for ASIC to undertake this review is not part of the Bill.
ASIC has existing powers under section 912C of the Corporations
Act to facilitate the collection of relevant information from financial
services licensees. Item 1 inserts new proposed paragraph 912C(1A)(e) so that such information may be collected in a specified manner (including in
electronic form).
Members, Senators and Parliamentary staff can obtain
further information from the Parliamentary Library on (02) 6277 2500.
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