Born again

Financial Advisers and life insurers alike have been working hard over many decades to address the growing problem of underinsurance in Australia.

It is a problem TAL chief executive Jim Minto says the industry acknowledges and has been preoccupied with since it was raised at the Financial Services Council conference back in 2005.

But while it has been focused on trying to get more Australians to sign up to risk insurance, the industry has also been working to address issues of its own.

Along with the wider advice industry, risk specialists and life insurers have been thrown under the regulatory microscope to ensure clients are receiving quality advice.

The Ripoll Inquiry, Financial System Inquiry and the Senate’s recent inquiry into the ‘scrutiny of financial advice’ have all assessed the life insurance industry and brought many issues to the surface.

Although none have brought more heat than ASIC’s assessment, which led to the release of its Review of retail life insurance advice report.

Grabbing the attention of both advisers and insurers the report was, arguably, the most scathing review the industry received to date.

It found that a significant number of advice cases reviewed had breached legal and best-practice requirements, heralding “unacceptable” levels of failure in the risk advice space.

In handing down its report card, ASIC deputy chairman Peter Kell said it was a wake-up call that should put both insurers and advisers on notice.

“Both insurers and advice firms need to work on delivering a consistently better service for consumers,” Mr Kell said at the time.

Having the proverbial ball slammed in the industry’s court, the relevant lobby groups weren’t slow to act.

The Association of Financial Advisers (AFA) – which has long represented risk advisers – and the FSC – which counts all of the major life companies among its members – paired up to create the somewhat awkwardly named Life Insurance and Advice Working Group (LIAWG) to be led by former APRA official John Trowbridge.

This cover story examines the regulator’s findings in detail as well as the industry response and emergence of a specialised sector committed to addressing these issues.

A bad report card

On 9 October 2014, ASIC handed down the findings of its review of retail life insurance advice, conducted between September 2013 and July 2014.

In its findings, ASIC found of the 202 cases it examined in total, 37 per cent failed to comply with the law.

Describing this as an “unacceptable level of failure”, ASIC says given the importance of dispensing quality advice to consumers, it was of major concern that more than one-third failed to meet legal standards.

The regulator also split its sample between advice given before the introduction of the FOFA legislation and advice given after its introduction.

Of the 94 pieces of advice given before the introduction of FOFA, 41 per cent failed to meet legal requirements, while of 108 pieces of advice given after the introduction of FOFA, 33 per cent failed.

ASIC says the factors which contributed to this poor quality of advice included adviser incentives, inappropriate scaling of advice and a lack of strategic advice.

Insurance incentives
In assessing the quality of advice, the regulator notes the continual occurrence of upfront commissions and advice that failed to comply with the law.

In fact ASIC notes a common theme between high upfront commissions and advice, with 96 per cent of the poor advice found to have involved high upfront commissions.

Despite acknowledging that 80 per cent of the 202 files it reviewed consisted of upfront commissions, the regulator says this finding suggests where an adviser is paid under an upfront commission model there was a “statistically significant” likelihood that the advice would not comply with the law.

“The chance of getting advice that rated a pass was significantly higher where the adviser was paid under a commission structure other than upfront commissions”, the regulator says in its report.

ASIC points out upfront commissions have a “material effect” on the type of advice a licensee will give and an adviser will be more focused on their monetary gain as opposed to providing advice that is in a client’s best interests.

“High upfront commissions give advisers an incentive to write new business. The more premiums they write, the more they earn,” the report says.

Appropriate scaling

The regulator found that some of the failed advice to clients was not appropriately scaled, ie. advice was either too comprehensive or not comprehensive enough based on a client’s needs.

ASIC says advisers were failing to exercise “sufficient prudence and judgement” in finding out a client’s circumstances, including adequate reasons within a client’s statement of advice (SOA) for the insurance they had been recommended.

Advisers were not asking relevant questions or properly assessing a client’s situation before recommending an insurance policy. And, when an insurance policy was recommended, ASIC found the policy to be far greater than the client actually needed.

By increasing the overall package of the insurance cover, the client was found to be paying a higher premium, which in turn increased the commission income for the adviser.

This then led the regulator to draw the parallel that remuneration models were influencing the quantity of insurance they would recommend to a client to increase the premium and their total pay package.

Strategic advice
Another finding was the “failure of advisers to give strategic risk advice” to their clients.

Advisers failed to provide strategic direction for their clients, ie. risk advice that would adequately look at a client’s cash flow position and their priorities and be of meaningful value to their clients.

“In our file reviews, we found that the complexity of the client’s personal circumstances was not taken into account and that many advisers responded with generic advice,” the report says.

“We found a number of cases where the advice recommended a sum insured and therefore a premium that seemed significantly in excess of the client’s ability to afford or retain the insurance over a period of time.

“There was no evidence of any evaluation of the client’s other priorities to found a reasonable basis for the advice,” it says.

ASIC adds that its concerns about the lack of strategic advice were amplified when it saw advisers were addressing affordability issues by writing new cover with a different insurer at the same level or writing the same level of cover but changing the source of payments.

This led the regulator to examine the rate at which policies lapsed.

Looking at lapses

In reviewing the length of active insurance policies, ASIC found a high rate of cancellation by clients within the first two years of entering a policy.

ASIC points out there was a “sharp increase” in lapse rates after policies had been in force more than 12 months and then continued to remain “persistently high” over time.

Insurance policies were lapsing for a number of reasons including increases in aged-based premiums where clients could no longer afford to continue paying.

ASIC says in instances where this occurred, advisers were paid under a high upfront commission model.

In fact, the regulator says policies lapsed at a much higher rate when upfront commissions were involved than any other model of remuneration.

High upfront commissions also encouraged advisers to rewrite clients into new policies after a one- or two-year period to increase their income.

The regulator says advisers driven by incentives to recommend a high-value policy to a client that they could afford to pay over the long term was leading to poor commercial outcomes for insurers.

“Insurers are losing existing business at a point in the policy life cycle where they have no prospect of recovering high upfront costs.

“At the same time, insurers are incurring new upfront costs to win new business to replace the business lost to competitors,” the report says.

Investigating the investigators

ASIC’s findings fell hard on the life insurance industry, with many acknowledging the need to improve the industry.

But many stakeholders have also questioned the small sample the regulator decided to review the industry on, with some advisers calling the review a targeted piece of research.

The regulator was spurred to conduct the review when recommendations were made by the Parliamentary Joint Committee (PJC) on Corporations and Financial Services in its inquiry into the Future of Financial Advice Bill, which said the quality of advice in risk insurance needed to be monitored.

Undertaking the recommendation of the PJC, the regulator asked 12 life insurers to provide three licensees or authorised representatives that had the highest number of active policies and policy lapses during the 2012 and 2013 financial years.

ASIC then chose a total of 202 advice files to assess. But for some, including AFA chief executive Brad Fox, the sample size was too small.

“It certainly has been a targeted piece of research to the extent that they defined very tightly where to look.

“There are some question marks around how representative this sample is – and I think any time you are only looking at 70-odd advisers, it’s not enough to be fully representative – but to have found the levels of failure, especially on upfront commissions suggests we do need to look at this,” Mr Fox says.

Echoing Mr Fox’s comments, Mr Minto says the “edges of the methodology” could be argued but the reality is poor advice was found and needs to be addressed.

“I think that [ASIC] calling out that the game needs to lift in terms of quality of advice – I don’t think anybody would argue with that,” Mr Minto says.

Although for Synchron director Don Trapnell drawing conclusions from a review of 202 advice files was not comprehensive enough to make proper conclusions on high upfront commissions.

“I believe [the regulator] genuinely felt that the space needed an investigation and therefore targeted the leading risk licensees in Australia to get that review.

“A study has to be done to find what is [the] driver [of poor advice] rather than drawing conclusions based on a survey of 202 policyholders,” Mr Trapnell says.

Despite many pointing out the regulator’s selective sample advisers, insurers have acknowledged they need to act and start implementing changes to improve the industry – something which Mr Trowbridge and the LIAWG are aiming to do.

The industry fights back

The formation of the LIAWG by the AFA and the FSC represented different sides of the life insurance industry coming together under a single banner.

Led by Mr Trowbridge the working group’s goal is to find a way to address the issues raised by the regulator.

On 17 December 2014 Mr Trowbridge handed down his interim report outlining four key areas he believed needed to be discussed to achieve a more professional industry.

These areas included addressing the quality of advice, assessing adviser remuneration and incentives, insurer practices and product offerings.

Across these four points, Mr Trowbridge brought new and old ideas to the table for the industry to consult on.
While careful not to make any specific recommendations before the release of the final report he did make one exception.

“I am offering a view [that] nil commissions won’t work and the other is that the high upfront commissions of more than 100 per cent on the first year’s premium – we are ruling that one out too,” Mr Trowbridge said when he handed down the report.

This view also aligned with David Murray’s recommendation within the FSI that high upfront commissions should be replaced with a level commission model.

“This would provide a balanced and cost-effective approach to better align the interests of advisers and consumers,” the FSI report says.

“The remuneration model needs to be sustainable; otherwise there is a risk that providers may exit the market, making it more difficult for consumers to obtain life insurance advice.”

The interim report introduced five possible replacements to high upfront commissions, which included hybrid commissions, modified hybrid, level plus fees and level funded commissions.

Risk remuneration

However, Shartru Wealth Management chief executive Rob Coyte explains the focus should not be on what remuneration models advisers are paid under, but making sure they adhere to the law.

“Given the current law effectively protects consumers against unscrupulous conduct by the few ‘bad eggs’ what is imperative now is that this law is enforced,” Mr Coyte says.

“There is no need to continue to look for magic bullets to problems like churning as the solutions are already present in the existing law.

“The only thing that matters is if the advice is appropriate and the client receives value for such advice,” he says.
Mr Trapnell says if high upfront commissions were to be removed from risk advice it will spark a huge exit of advisers from the industry and make advice more expensive for clients.

“The remuneration components of the sale of a life insurance product should adequately reflect the effort undertaken by the adviser to do that sale,” Mr Trapnell says.

“If the remuneration does not adequately reflect that, there will be people who will leave this industry.

“There will be people who will leave this industry [because they] cannot afford to stay in it and [as a result this will] exacerbate any underinsurance problems we may be perceived to have,” he says.

Mr Trapnell also explains that introducing a level funded commission model, as recommended by the FSI, would make it incredibly difficult for new advisers to start a risk practice.

“The reason anyone goes into business is to make money, to be able to put bread on their table,” he says.
“If the cost of running their business is outweighed, or is not outweighed by the revenue being received you are going to go broke, so why would you go into that business?

“The only way a flat commission model would work is if you have a very mature business over many years.
“So that means zero new entrants, and we will have people leaving the industry,” Mr Trapnell explains.

Mr Minto says if the industry were to implement a new remuneration model it will need to be something that will work effectively without impacting clients or advisers.

“For many customers the cost of providing insurance is a front-ended cost; it is a significant cost. So how do you make the required change without leaving advisers unable to service new customers?” Mr Minto says.

“We still want customers to receive advice and as much advice as possible, so how do we make a change that enables this to happen?

“TAL wants advice to survive for many days to come as people will need it – so how can we come up with something that works well for the future?” he says.

Affinia general manager Craig Parker says many advisers within his network have already acknowledged the need for the industry to turn to another remuneration model.

“The conversations we have with our advisers, that if you have your businesses on an upfront basis today you need to consider moving to the hybrid or the level commissions,” Mr Parker says.

Bombora Advice managing director Wayne Handley echoes Mr Parker’s comments and adds that it was time for a “healthy debate” around the issue.

“We need to look at the various solutions that are available to us,” Mr Handley says.

“The Trowbridge report is very good; it throws up five considered remuneration models and I think that is a good thing because that gets people’s juices flowing.

“You can’t deny ASIC’s report with the parallel between upfront commissions and poor quality of advice,” he says.
While discussion is being generated Mr Handley also says many advisers have not been engaged enough or wanting to get involved in the conversation.

Emerging from the cocoon

In fact Mr Handley says not getting involved is a “dangerous position” to have.

“One thing the Trowbridge [report] does, is it provides an opportunity for the most important people in the profession – that is the advisers, the ones who are delivering advice to clients day in and day out, every day – to have a say,” he says.

“[Advisers] should take the opportunity to have a say and in a constructive way because they are the ones delivering the advice to the consumer.

“We would learn a lot more from the professional practitioner and what actually takes place in a professional risk practice,” Mr Handley says.

Along with this need for advisers to be more engaged, Mr Parker adds that he believes a stronger sense of community is also needed amongst advisers and that they should learn from one another.

“Advisers want to share their best practices, they want to share challenges and they want to be able to have a conversation with other professionals to actually drive the outcome, which will be for their business [and] their clients.

“It is up to that community, to actually make sure you are promoting the services you are delivering, the good news stories, and then working together to actually [make] sure you are putting processes in place to improve,” Mr Parker says.

As these issues are addressed and debated, Mr Parker says it will create a strong sense of community amongst risk advisers, and that is something that will only continue to grow in the future.

“Businesses need to work together,” he suggests. “We have enough clients in Australia to service them, we have enough clients to actually assist them with their risk advice.

“Advisers that I speak to don’t talk about the lack of opportunity, advisers want to share their best practices, they want to share challenges, and they want to be able to have a conversation with other professionals,” he says.

Mr Parker also believes while a sense of community is important, it is also just as equally important to ensure advisers are doing the best for their business and clients.

The important of risk advice is something everyone within the industry acknowledges should be a core component of every adviser’s business.

Mr Coyte says it is the primary role for every adviser to identify risks and have their clients looking at solutions to protect themselves against those risks.

“Risk advice should be offered to all clients,” Mr Coyte says. “Those advisers that don’t facilitate [that] should make sure they have referral arrangements in place with appropriate professionals so as to assess their clients’ needs.”