Align the interests of financial firms and consumers
Better align the interests of financial firms with those of consumers by raising industry standards, enhancing the power to ban individuals from management and ensuring remuneration structures in life insurance and stockbroking do not affect the quality of financial advice.
Better align the interests of financial firms with those of consumers by:
- Industry raising standards of conduct and levels of professionalism to build confidence and trust in the financial system.
- Government amending the law to provide ASIC with an enhanced power to ban individuals, including officers and those involved in managing financial firms, from managing a financial firm. This would enhance adviser and management accountability.
- Government amending the law to require that an upfront commission for life insurance advice is not greater than ongoing commissions. This would reduce incentives for churning and improve the quality of advice on life insurance.
- ASIC reviewing the effect of current stockbroking remuneration structures on the quality of consumer outcomes. If this review raises significant concerns, ASIC should advise Government on the need to remove the sector’s exemption from the ban on conflicted remuneration.
- Improve the culture of financial firms and build consumer trust in those firms.
- Align remuneration structures with a customer-focused culture.
- Promote efficiency in the financial advice sector through increased consumer participation and engagement.
Problems the recommendation seeks to address
Poor standards of conduct and professionalism
Recent cases of poor financial services provision raise serious concerns with the culture of firms and their apparent lack of customer focus. Research in 2009 suggested that financial firms may not be implementing systems and procedures within their organisations that promote ethical culture and integrate governance, risk management and compliance frameworks.42 In 2011–12, approximately 94 per cent of ASIC’s banning orders involved significant integrity issues, where the alleged conduct would breach professional and ethical standards and/or the conduct provisions in the Corporations Act 2001.43 The remaining 6 per cent of cases involved competency issues.
The Inquiry considers that cases of consumer detriment and poor advice reflect organisational cultures that do not focus on consumer interests. Such cultures promote short-term commercial outcomes over longer-term customer relationships. This has contributed to a lack of consumer confidence and trust in the system. In research undertaken by Roy Morgan, only 28 per cent of participants gave financial planners ‘high’ or ‘very high’ ratings for ethics and honesty, and trust in bank managers was held by just 43 per cent of participants.44 In addition, ASIC found only 33 per cent of stakeholders agreed that financial firms operate with integrity.45
ASIC has observed phoenix activity in financial firms, where senior people from a financial firm with poor operating practices may establish a new business or move to an alternative firm.46 Currently, ASIC can prevent a person from providing financial services, but cannot prevent them from managing a financial firm. Nor can ASIC remove individuals involved in managing a firm that may have a culture of non-compliance.
In light of recent evidence, the Inquiry is concerned about high upfront commissions for life insurance advisers. This has been a longstanding industry practice reflecting that life insurance has higher arranging costs, such as managing the underwriting process, and that consumers are often not independently motivated to purchase life insurance. With the exception of group life insurance policies inside superannuation and an individual life insurance policy for a member of a default fund, life insurance products are exempt from the FOFA ban on commissions. This allows individual life policies to be sold with high upfront commissions, creating an incentive for advisers to make a sale, rather than provide strategic advice. For example, these policies can have 100–130 per cent of the first year’s premium payable as upfront commissions, with an ongoing trail commission of around 10 per cent. A recent ASIC report on life insurance revealed significant problems with both compliance and the consequences for consumers.47 More than a third of the personal advice reviewed failed to comply with the laws relating to appropriate advice and prioritising the needs of the consumer.
Upfront commissions can affect the quality of advice. ASIC found that 96 per cent of advice rated as a ‘fail’ was given by advisers paid under an upfront commission model. ASIC also found high upfront commissions encourage advisers to replace a consumer’s policy rather than retain it.48 In some cases, this may result in inferior policy terms. To date, industry approaches to address the issues in life insurance have not worked.49
In recent years, ASIC has identified compliance issues in the stockbroking industry.50 The Inquiry is aware of concerns with the prevalence of ‘grid’ commissions for advisers, where commission-based remuneration is received soon after advice is given, with the potential to create a conflict of interest between the adviser and the consumer. Australia and the United States are the only jurisdictions that use a grid commission structure. In most other major financial centres, stockbrokers are paid a salary and discretionary bonus. The Inquiry recognises it may be difficult for individual firms to change remuneration models without policy intervention because stockbrokers would move firms.
To build confidence and trust in the financial system, financial firms need to be seen to act with greater integrity and accountability. The Inquiry believes changes are required not only to the regulatory regime and supervisory approach, but also to the culture and conduct of financial firms’ management, which needs to focus on consumer interests and outcomes. A change in culture in line with community expectations should promote confidence and trust in the financial system and limit the need for more significant regulation.
Raising standards of conduct and levels of professionalism would require both a coordinated industry approach and focus of attention by individual firms. Industry associations could lead this initiative, with stakeholder input from ASIC and consumer organisations. Introducing or enhancing individual firm or industry codes of conduct is one way in which industry could set raised standards and hold themselves accountable.
An enhanced banning power should improve professional behaviour, management accountability and the culture of firms, by removing certain individuals from the industry and preventing them from managing a financial firm. This should also include individuals who are licence holders or authorised representatives, or managers of a credit licensee. It should prevent those operating under an Australian Financial Services Licence from moving to operate under a credit licence and vice versa.
For life insurance, the Inquiry recommends a level commission structure implemented through legislation requiring that an upfront commission is not greater than the ongoing commission. This would provide a balanced and cost effective approach to better align the interests of advisers and consumers. 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 findings of the Financial Services Council and the Association of Financial Advisers working group should also be considered during the development and implementation phases.
Alternative models of remuneration, such as delayed vesting of commissions and clawback arrangements, may simply delay the issue of churn and are complex. At this stage, the Inquiry does not recommend removing all commissions, as some consumers may not purchase life insurance if the advice involves an upfront fee. However, if level commission structures do not address the issues in life insurance, Government should revisit banning commissions.
The Inquiry has not determined the percentage amount of the level commissions that should apply in the life insurance sector. This should be left to the market and industry.
The Inquiry notes the FOFA ban on conflicted remuneration and associated measures are relatively new and should bring significant change to the industry and benefits for consumers. However, some incentive-based remuneration models remain, including grandfathered arrangements and other specific exclusions. The Inquiry believes that these instances of conflicted remuneration should be monitored, and Government should intervene if further significant issues are observed.
Specific attention is required in the stockbroking sector in the immediate future. Unlike in the life insurance industry, a recent review of practices in stockbroking has not been undertaken. The Inquiry considers that ASIC should review current remuneration practices in stockbroking and advise Government on whether action is needed.
The Inquiry believes that better aligning the interests of financial firms with consumer interests, combined with stronger and better resourced regulators with access to higher penalties, should lead to better consumer outcomes.
42 Smith, J 2009, Professionalism and Ethics in Financial Planning, Victoria University, Melbourne, page 347.
43 Deloitte 2012, FOFA Perspective: Advice delivery, Financial Services Risk and Regulatory Review, Deloitte, Sydney, page 19.
44 Roy Morgan Research 2014, Data provided to the Financial System Inquiry, 5 November 2014, Australians aged 14+.
45 Australian Securities and Investments Commission (ASIC) 2013, ASIC Stakeholder survey, ASIC, Sydney, page 31. Survey conducted by Susan Bell Research, covering 1,468 stakeholders.
46 Australian Securities and Investments Commission 2014, Second round submission to the Financial System Inquiry, page 46.
47 Australian Securities and Investments Commission (ASIC) 2014, Report 413: Review of retail life insurance advice, ASIC, Sydney, page 6.
48 Australian Securities and Investments Commission (ASIC) 2014, Report 413: Review of retail life insurance advice, ASIC, Sydney, page 5, 42.
49 However, note that the Financial Services Council and Association of Financial Advisers have now established a working group to address the issues raised by the ASIC report; Financial Services Council 2014, John Trowbridge to chair FSC-AFA life insurance working group, media release, 17 October.
50 Australian Securities and Investments Commission (ASIC) 2013, ASIC accepts enforceable undertaking from Macquarie Equities Ltd, media release, 29 January; ASIC 2011, ASIC accepts legally enforceable undertaking from UBS Wealth Management Australia, media release, 17 March.