Update on the FMA’s ongoing review of insurance replacement business and conflicted conduct
In our article “Top predictions for 2018”, we referred to the Financial Market Authority (FMA)’s June 2016 report “Replacing Life Insurance – who benefits?”. The FMA identified a small number of financial advisers with potential indicators of churn, including: (a) a high volume of life insurance policies on their books; and (b) a high rate of replacement of that business.
The FMA has now published its “Update on the FMA’s ongoing review of insurance replacement business and conflicted conduct”. In preparation of this report, the FMA considered the business practices of 24 insurance intermediaries it selected for review. The full report can be accessed here.
Of the 24 insurance intermediaries the FMA reviewed: 17 were Registered Financial Advisers (RFAs) and seven were Authorised Financial Advisers (AFAs). Unlike AFAs, RFAs are not subject to a code of conduct and are not obliged to actively disclose how they are remunerated, including whether they receive commission or other incentives from financial service providers. RFAs were involved in the vast majority of high replacement activity identified in the FMA’s June 2016 report.
The report outlined the following key drivers of poor conduct:
- Half of the advisers reviewed were either not aware of the obligation under section 33 of the Financial Advisers Act 2008 (FAA) to exercise care, diligence and skill, or they were in breach of that obligation;
- The advisers were poor at keeping records for the benefit of clients (a key element of exercising care, diligence and skill which helps clients make informed decisions and to understand the advice they are getting); and
- Strikingly, most of the advisers reviewed and interviewed failed to recognise that incentives create a conflict with the interests of their clients.
While the advisers are not representative of the wider adviser community (they were selected due to concerns about potentially high levels of replacement business activity connected to incentives offered by insurance providers), the review emphasises a requirement by:
- advisers to (among other things) demonstrate how they have met their care, diligence and skill obligations, keep appropriate records of client communications (and provide those to clients in a way that can assist them with their decision-making), and explain to clients the costs, benefits and consequences of replacing insurance policies; and
- insurance providers to determine how best to ensure the current distribution model for insurance policies – which is based on the payment of commissions and incentives by providers to advisers selling their products – does not encourage the patterns of behaviour outlined in the FMA’s report. In this respect, the FMA’s analysis of providers’ data showed a clear connection between the timing of replacement policies being sold and the incentives being offered.
FMA takes action
As a result of the review, the FMA issued warnings to four registered financial advisers (RFAs) for breaching their obligation under section 33 in respect of advice provided on replacement insurance policies. It also issued compliance letters to six RFAs and one authorised financial adviser (AFA).
Under the current FAA regime the powers of the FMA are limited. A breach of section 33 is not an offence and the FMA has administrative powers only in this respect (such as warnings and directions in writing).
RFAs also have fewer duties than AFAs (beyond the basic requirements to exercise care, diligence and skill, and avoid misleading or deceptive behaviour). RFAs are not held to minimum specified competence standards or a code of conduct. They have no direct regulatory obligation to put their clients first (as is required under the Code of Conduct for AFAs), and as a result, there is no legal basis for determining whose interests were being prioritised when the RFAs the subject of the review recommended replacing insurance policies.
The FMA’s expectations
The FMA used its report to make clear that it expects insurance intermediaries:
- to be aware of and adhere to the FMA’s guidance on care, diligence and skill;
- explain to clients the costs, benefits and consequences of replacing insurance policies;
- to demonstrate how they have met their care, diligence and skill obligations;
- meet their compliance obligations by ensuring appropriate records are kept; and
- Read the guide to the FMA’s view of conduct. While this does not strictly apply to RFAs, the FMA considers they should be aware of its contents.
In order to comply with its expectations, the FMA recommends that insurance intermediaries observe the following:
- insurance intermediaries should ensure that they retain detailed and accurate records of the advice given to clients: Keeping records is an integral part of the advice service … Care, diligence and skill means documenting advice services and providing these records to clients in a way that will help them make decisions.
- when providing personalised advice on the replacement of insurance products an insurance intermediary should make an appropriate comparison of the client’s existing insurance policy and the new, recommended one; and
- if no comparison is being made:
- this should be made clear to the client; and
- the insurance intermediary should explain the general types of adverse consequences that may occur if the new, recommended insurance policy is taken up e.g. the client could lose benefits they may have received under the original policy.
Legislative reform and the FMA’s future focus
The Financial Services Legislation Amendment Bill is currently before parliament, having had its first reading in December 2017. As currently drafted the Bill will remove the distinction between RFAs and AFAs, meaning all financial advisers will be required to give priority to the client’s interest and will be subject to a new Code of Conduct. The FMA notes that the new regime will help address some of the issues highlighted in their report.
While the report focuses on intermediaries, the FMA states that insurance providers need to take responsibility for mitigating areas of poor and conflicted conduct as it is their incentive and commission structures which have created the conflicts.
The FMA outlines future work to be completed or commenced in 2018:
- Further thematic reviews into conflicted conduct and commission structures;
- Engaging with other agencies and industry bodies;
- Developing supervision and licensing frameworks; and
- Updating the examples on care, diligence and skill on the FMA website.
As we predicted in Issue 13, this report demonstrates that there is, and will continue to be, greater regulatory involvement in the insurance intermediary market going forward.
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