Learning to live with the LIF
Like them or not, financial advisers should already have begun making the adjustments necessary to operate within the new Life Insurance Framework, writes Catherine Evans.
Looming changes to life insurance remuneration arrangements are likely to test the business structures of financial advisers across Australia, with some ultimately set to fail.
The reform proposals have been designed to address concerns about the quality of advice provision within the industry, including the practice of policy "churning".
In many cases, planners face the prospect of significant loss of revenue when the new regime kicks in mid-year as new clawback periods take effect and upfront commissions are cut.
While the current proposals are not as extensive as initially flagged, the remuneration changes will challenge and re-shape the insurance advice industry as we know it and rock the viability of those advisers who have come to rely on income streams now likely to significantly diminish.
Some advisers may exit the industry and succession planning within the industry may also be affected as client book valuations need to be re-assessed in light of the new remuneration frameworks.
Background
In response to the Trowbridge report released in March 2015, which proposed a new reform model for adviser remuneration, the Federal Government announced changes to life insurance remuneration arrangements.
These changes support the Life Insurance Framework announced in June 2015 and will apply to personal and general advice, including direct sales.
On 3 December 2015, the Government released draft legislation containing its proposed amendments to the Corporations Act 2001. The Australian Securuties and Investments Commission (ASIC) subsequently released a consultation paper with comments due by 29 January 2016 and an expected introduction date of early 2016.
What's in store?
The key proposed changes include:
Decreases in Upfront Commissions
Upfront commissions on new business written will be capped at 80 per cent from 1 July 2016, 70 per cent from 1 July 2017 and 60 per cent from 1 July 2018. Together with this, ongoing commissions will be capped at 20 per cent from 1 July 2016.
In its 2014 retail life insurance advice report, ASIC found a "strong positive correlation between high upfront commissions and poor advice". According to ASIC's latest consultation paper, the reform package does not eliminate conflicts of interest in remuneration but is designed to balance the competing interests of advisers and clients.
These changes are significant and could impact quite heavily on revenue streams for financial advisers who rely on insurance commissions for a key source of profit. The big question facing advisers will be how to make up for this loss of revenue?
This will most likely require a complete review of the adviser's business model and may involve confronting some difficult home truths. While there is a staged transition period to encourage a smooth transition, fundamental changes to one's business model is not something that can be left to the last moment.
"Clawback" Periods
ASIC's industry review reported a spike in policy lapse rates for all policy and premium types in the second year of a life insurance policy when clawback arrangements no longer applied. Insurance sold with high upfront commissions also lapsed at a higher rate.
In light of this, a two-year clawback period will be introduced, with the clawback payable being tiered over the first two years of a policy. If a policy lapses in the first year, the clawback period will apply to 100 per cent of the commission on the first year's premium. If a policy lapses in the second year of the policy, the clawback period will apply to 60 per cent of the commission on the first year's premium.
Although the industry has welcomed the reduction from the proposed three-year clawback to two, this part of the reforms has attracted a lot of attention and debate, putting a spotlight on concerns over "churning" of insurance policies. Overall we expect the changes to have a positive impact for the industry.
Reviewing a client's policy every one to two years remains a prudent strategy for advisers but policies should only be renewed when to do so is in the client's best interests. The proposal aims to reduce the incentive for advisers to rewrite policies unnecessarily and reduces conflicts of interest. This change should not significantly affect the business of planners who are already doing the right thing.
Increased Industry Involvement
The Financial Services Council will have responsibility for implementing the Life Insurance Code of Practice, setting out best practice standards for insurers for matters including underwriting and claims management.
In addition, industry will need to work on expanding Approved Product Lists. There are no implementation dates as of yet, but the expansion will provide advisers with the ability to choose from a wider range of life insurance policies in the future which will also assist in improving the quality of advice given.
Increased Disclosure
Commencing in the second half of 2016, ASIC will review life insurance Statements of Advice, including prominent upfront statements about commissions.
ASIC's approach will be two-pronged: it will seek to make disclosure simpler and more effective for consumers, while also assisting advisers to make better use of disclosure documents. This may significantly impact existing business processes regarding disclosure for insurers and advisers.
ASIC will also require detailed information from life insurers on life insurance policies, remuneration data, lapse rates and clawback amounts. ASIC will use this information in a 2018 review to establish whether these reforms have been effective in producing better outcomes for consumers.
In Summary
The Government has indicated that the legislation supporting these changes may operate in a similar way to the "conflicted remuneration" provisions introduced under FOFA. However, it is expected that exemptions will apply for level commission arrangements and remuneration paid for advice on a "fee-for-service" basis.
The insurance remuneration changes are likely to alter the landscape of the industry if the experience of the FOFA reforms are anything to go by.
In anticipation for advice provided after 1 July 2016, it is advisable for businesses to start considering revenue models to minimise the impact of reduced upfront commissions on business operations and cash flow. Despite these changes, insurers and advisers will be able to grandfather existing remuneration arrangements entered into up until 30 June 2016.
But the clock is ticking.
Catherine Evans is a Partner at commercial law firm Cowell Clarke.
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