Financial Services Regulation

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Unravelled: Life insurance, conflicted remuneration and commissions

3 November 2016

Written by Partner Michelle Levy and Managing Associate Simun Soljo

As you will know from our Client Updates, the Bill to amend the conflicted remuneration provisions in the Corporations Act 2001 (Cth) for life insurance has been introduced into Parliament a second time and draft regulations have been released for comment.

We struggle to know how to describe them because the changes seem to have conflicting purposes – on the one hand they are intended to limit conflicts for advisers who distribute life insurance by limiting the conflicted remuneration they are entitled to be paid, but on the other they provide a regime under which a life company can pay commission for the distribution of its life risk insurance. We think that there are some unintended consequences.  

What does the Bill say?

The Bill inserts a regulation making power into the Act. Under what will be a new section 963AA of the Corporations Act, the regulations may say that a benefit given in relation to a life risk insurance product is conflicted remuneration. This is a power to expand the class of benefits that are conflicted remuneration. And the regulations will do that.

And the Regulations?

The draft regulations say that a benefit given in relation to a life insurance product is conflicted remuneration if it relates to the distribution of life insurance, advice in relation to life insurance or information in relation to life insurance.

Until now, conflicted remuneration has been confined to benefits that could reasonably be expected to influence financial product advice given by a licensee or a representative. For example, an issuer of an investment product couldn't pay an adviser a percentage of its investment management fee if the adviser could reasonably be expected to recommend the product as a result of the payment. If the licensee or representative did not give financial product advice about the product, then the payment was and is not conflicted remuneration and they were and are free to accept the payment.

Under the proposed regulation, conflicted remuneration will no longer be linked to advice when it comes to life insurance. It is clear that this is intended – the Explanatory Memorandum says that the purpose of the new regulation making power is to ensure that commissions are banned irrespective of the 'channel' by which the product is distributed. The draft regulation says that a benefit is conflicted remuneration if it is given to a financial services licensee or a representative 'in relation to' a dealing in the product with a retail client or information given to a person (other than advice to a wholesale client). In short, the courts and a regulator will not have to worry about identifying any financial product advice.

But there are unintended consequences.

The relief

Section 963B currently provides a number of exceptions to the definition of conflicted remuneration, but only if the benefit is given to a licensee or representative who provides financial product advice to retail clients. The exceptions include, for example, a benefit given solely in relation to general insurance or a benefit given by a retail client in relation to the issue of a financial product or financial product advice given to the client.

The section also provides an exception for life insurance products other than group life policies issued to superannuation fund trustees or individual policies issued to a superannuation trustee for a MySuper member. The exception will continue to apply to benefits given to a licensee or representative who gives financial product advice if the benefit complies with the benefit ratio requirements and the claw back requirements. The benefit ratio requirements permit a flat commission for the life of the life risk insurance product (that is, each policy) or a stepped commission where the rate does not exceed the rate determined by ASIC. The clawback rules require commission to be paid back to the life company where a policy is cancelled early.

A problem with all of this is that the regulations expand the definition of conflicted remuneration to include benefits that have nothing to do with advice, but the exceptions will continue to apply only to benefits given to a licensee or representative who provides financial product advice. Therefore, once the Bill is passed, a life company could pay commission to an adviser who provides financial product advice to retail clients so long as the commission complies with the benefit ratio requirement and the claw back requirements, but it could not pay the same commission to a licensee or representative who does not provide financial product advice to retail clients. This seems a strange (and probably unintended) outcome.

It also seems that a life company could pay commission to any number of licensees and representatives in relation to the same life insurance product provided that each individual arrangement complied with the benefit ratio requirements and the claw back arrangements. The benefits paid to separate recipients would not need to be aggregated to work out whether the benefit ratio requirements have been complied with. For example, a life company could pay a commission to the dealer group and the adviser, provided they each provide financial product advice and that each commission does not exceed the ASIC-determined benefit ratio. Again, this is probably not intended.

What does it all mean?

The Wells Fargo story that broke a few weeks ago now, where 5000 or so employees were opening accounts for customers who had not asked them to, exposes a real weakness in the conflicted remuneration regime. In that case, employees were paid bonuses if they opened accounts. But it also appears to have been the case that they had to open a minimum number of accounts to keep their jobs. In other words, the bonus might have had very little effect on their conduct. They already had a strong incentive to open accounts – to keep their jobs. Similarly, conflicted remuneration might have a reasonably limited influence on the conduct of an employee whose continued employment depends on them selling financial products. Does this mean that even salaries should be banned? On their face, the new regulations could have that effect.

The definition of conflicted remuneration in the new regulations for life insurance does not depend on a benefit exerting any influence – it is enough that the benefit is given 'in relation to' a dealing or information given about the life insurance product. A lot of thought is going to be given to what 'in relation to' means and how far it goes. Is a salary paid to a call centre operator, whose job is to provide information about life products, a benefit that is given 'in relation to' that information? It is difficult to see how that would not be the case. Again, it seems that this is not intended – the legislation was probably not intended to stop product issuers and licensees paying salaries to employees providing information.

These examples highlight how difficult it is to design conflicted remuneration provisions that achieve their purpose without having unintended consequences. They also remind us that policy makers need to look beyond remuneration if they want to change industry behaviour.

Other articles in this edition of Unravelled

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