Chapter 5

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.[1]

5.3                  In terms of conduct and disclosure, the Wallis inquiry identified the need for:

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.[3]

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.[4]

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]

5.8                  The 2009 inquiry made recommendations to address these conflicts of interests including:

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.[7]

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:

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:

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.[8]

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.[9] 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.[10]

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.[11]

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:

5.33             Up until 31 December 2017, the following arrangements operated in the three commission-based systems:

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:

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.[13]

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.[14]

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.[15]

5.41             The commission caps should not have any effect on fee-for-service arrangements.[16]

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.[17]

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:

  1. could reasonably be expected to influence the choice of financial product recommended by the licensee or representative to retail clients; or
  2. could reasonably be expected to influence the financial product advice given to retail clients by the licensee or representative.[18]

5.45             However, the FOFA reforms contain provisions that exclude most forms of life insurance from the bans on conflicted remuneration:

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.[20]

5.47             Some examples of poor advice reported on in Report 413 included:

5.48             ASIC also found evidence of poor life insurance advice that resulted in considerable detriment to consumers, including:

  1. 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
  2. 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.[22]

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:

  1. ensure that remuneration structures support good-quality advice that prioritises the needs of the client;
  2. review their business models to provide incentives for strategic life insurance advice;
  3. review the training and competency of advisers giving life insurance advice; and
  4. 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.[23]

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.[24]

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.[25]

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.[26]

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.[27]

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.[28]

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.[29]

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'.[30]

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.[31]

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.[32]

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.[33]

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.[34]

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.[35]

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:

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:

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.[38]

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.[39] 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.[40]

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.[41]

5.73             Several advisers and adviser groups did not support the LIF Reforms for various reasons, including concerns about the consultation process,[42] the reforms may not address churn across the entire industry,[43]or other problems in the life insurance industry.[44]

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.[45]

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.[46]

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.[47]

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.[48]

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.[49] 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.[50]

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:

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.[52]

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.[53]

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:

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:

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.

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