What the Life Insurance Framework means for your advice business and compliance arrangements.
The government announced its intended approach to LIF. In this article imac legal & compliance identifies some of the things you’ll need to review and/or address in your business’s compliance arrangements. But first, let’s recap on what the proposed changes are.
Proposed LIF Changes
The changes will start on 1 July 2016 and apply to personal and general advice. The changes (which will be confirmed in draft legislation) are:
- Maximum total upfront commission of 60 per cent of the premium in the first year of the policy, from 1 July 2018.
- Maximum ongoing commission of 20 per cent of the premium in all subsequent years from 1 July 2016.
- Two year retention (‘clawback’) period, to commence from 1 July 2016 to apply as follows:
- when a policy lapses or the premium decreases in the first year of the policy, to 100 per cent of the commission on the first year’s premium; and
- when a policy lapses or the premium decreases in the second year of the policy, to 60 per cent of the commission on the first year’s premium.
(Note: the premium on which the commission caps are calculated can include the base premium, frequency loading and policy fee but not stamp duty or GST. Policies will not be deemed to have lapsed in case of a claim or suicide/self-harm)
- Ban on other volume-based payments from 1 July 2016, with appropriate grandfathering arrangements, consistent with the Future of Financial Advice laws.
- Life insurance companies to offer fee-for-service insurance products to support advisers who wish to operate on a fee-for-service basis.
- Maximum total upfront commission of 80 per cent of the premium in the first year of the policy from 1 July 2016.
- Maximum total upfront commission of 70 per cent of the premium in the first year of the policy from 1 July 2017.
- Maximum total upfront commission of 60 per cent of the premium in the first year of the policy from 1 July 2018.
Quality of advice and insurer practices
- Life Insurance Code of Conduct to be developed by the FSC by 1 July 2016. Similar to existing codes for Banking and General Insurance, the Code would set out best practice standards for insurers, including in relation to underwriting and claims management.
- Industry will have responsibility for widening Approved Product Lists through the development of a new industry standard. It is envisaged that this industry standard will be a joint effort of all industry participants, led by the FSC.
Better enforcement and monitoring
- Ongoing reporting by life insurance companies of policy replacement data to ASIC to commence from 1 July 2016.
- ASIC to complete a review of the impact of the life insurance reforms by the end of 2018.
- 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.
- The Government will amend the Corporations Act 2001 in order 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.
Some practical legal and compliance considerations for your business
1. Review your AR agreements
As licensees and not authorised representatives typically have contractual relationships with insurers (e.g. by way of a distribution agreement or similar), any clawback claims are likely to be made against the licensee. The licensee would then need to claim that back from the relevant adviser. But to do that, the licensee needs to have a contractual right to do so. In my experience, not all AR agreements expressly allow for clawing back commissions.
TIP: review your AR agreements to ensure you have clear rights of indemnity/clawback provisions. These provisions need to be effective even if the adviser has moved on from your licence.
2. Do your due diligence when purchasing a risk book
If you are looking at purchasing a risk book of business, you should ensure you do your due diligence and get appropriate warranties around the policy age. It may also be worthwhile considering structuring the purchase so that final payment is not made until any policy lapses/clawbacks will have come to fruition and can be factored into the final price.
3. Consider revaluing risk book purchases
It looks like risk insurance will not be as profitable as it has been in the past. You may wish to review your valuations for risk insurance purchases.
4. Uncertainty where more than one adviser involved over the life of a policy
The proposed framework contains no detail at this stage on how insurers are to deal with clawbacks if commissions are paid to more than one adviser/licensee during the clawback period (e.g. because an adviser exists or a client moves to another adviser). We suggest that logic and fairness dictate that each adviser should only be responsible for any clawback during the period they serviced the client.
But even this will likely be problematic. Let’s say a policy cancels during its second year where Adviser A was entitled to commissions for 15 months and Adviser B was entitled to commissions for a four month period. The rules as described at this stage suggest that the clawback will be 60% pf the commission on the first year’s premium. Who is to pay what back? The policy cancelled when Adviser B was looking after the client so Adviser A will undoubtedly be upset about having to repay anything. “But I wasn’t responsible for the client cancelling the policy. Adviser B should have kept the client in the policy” they will say. And Adviser B will say “I don’t want to refund any commission because the rules require 60% of the first year’s commission to be refunded but I never received any of the first year’s commission. And the second year’s commission is only a fraction of the first year’s, so even pro rating the clawback won’t be fair.”
You will need to check the details of the rules when they are released to check that such issues are adequately addressed. Licensees will need to ensure they have checks and balances in place to reconcile insurer clawback claims against commissions received, as well as being able to determine when the policy anniversary is so you can determine that the appropriate percentage is claimed in the clawback.
5. Monitoring and training will need to be reviewed and revised
Of course, situations will arise where a client’s circumstances dictate that the best thing for them to do is to cancel a policy before the end of the clawback period (e.g. a client who receives a significant inheritance could be in a position to cancel their life insurance). If and when the adviser next meets with the client, to act in their best interests means that the adviser should recommend cancelling the policy even if it means having to refund commissions to the insurer, as they have a duty to prioritise the client’s interest to their own.
Also, perhaps your business will decide to implement certain advice rules around dealing with client policies that are less than two years old and those which are greater than two years old. Compliance managers will need to provide guidance and training on these sorts of issues and ensure ongoing monitoring and supervision arrangements are able to pick them up.
6. Review your fee charging models
As commissions are crimped, many licensees will review their fee charging models. At the very least many will consider whether fee for service is viable for their business or hybrid commission and fee for service models. Maybe you will decide to shift focus and get involved only in higher value insurance work. Whatever way your business decides to go it’ll require a strategic re-think first.
7. Check your disclosures
Consider whether your fact finds will need to be updated, for example to expressly record how long existing policies have been in place. Does any of your templated SOA text refer to upfront and ongoing commission ranges which will need to be changed? Also, Minister O’Dwyer indicated that the government will also seek to “strengthen remuneration disclosure” in SOAs, “including prominent upfront statements about commissions. While no detail has been provided, it appears clear that particular new disclosures will be required and are likely to be required at the start of an SOA.
8. Recording lapse rates
Will your business have any processes to record lapse rates so you can identify trends with particular advisers? Such data will be crucial to running an effective compliance regime.
9. Have processes to identify and deal with churn
If you’re not doing it already, you should look at ways to identify possible churn (regardless of whether a policy is in clawback phase or not) within your business and ensure you regularly run reports and act on them to ensure churn doesn’t infect your advice practices.
10. Review your volume-related payments (if any)
The government has said that such payments will not be allowed and that grandfathering rules similar to FOFA will be introduced (i.e. existing arrangements will be honoured but new clients are unlikely to be covered). Your business will need to properly identify such arrangements (i.e. whether the licensee or individual advisers receive such payments) and develop rules to ensure you comply with the new restrictions.
11. Review your risk APL
If you currently have a restricted risk APL, you will need to review it to ensure it meets the new requirements to have a broad risk APL. We do not think either the government, regulators, or industry associations are able to mandate that an advice practice must include ALL insurers on their APL. If you don’t already do so, you should develop a formal process for inclusion/exclusion on your risk APL.
12. Identify any legacy risk products
As the government has said they intend to facilitate rationalisation of legacy products, it will be necessary to identify any such products amongst your adviser/client base so that you can pro-actively manage these clients to get the best outcome possible for them.
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