New legislation introduced into Parliament will remove the life insurance exemption from the ban on conflicted remuneration and instead substitute new “benefit ratio” rules for life insurance products. These laws follow the Government’s announcement last year, on which we have previously reported, that it would seek to implement recommendation 24 of the Financial System Inquiry.
New “benefit ratio” rules will be used to determine whether a life risk product falls within the exemption to the ban on conflicted remuneration in section 963B Corporations Act 2001 (Cth). These amendments are proposed in the Corporations Amendment (Life Insurance Remuneration Arrangements) Bill 2016 and will commence on 1 July 2016 (or from the date of Royal Assent, whichever is the later).
The “benefit ratio”:
- is to be determined by ASIC;
- is the ratio of the benefit received by the financial services licensee (or their representative) and the “policy cost” for the product; and
- is to be calculated when the product is issued and in each year the product is continued.
One of two benefit ratio requirements must apply to fall within the proposed conflicted remuneration exemption:
- that the benefit ratio is the same in the year in which the product is issued as it is for each year in which the product is continued; or
- that the benefit ratio is less than or equal to the amount determined by ASIC as an acceptable benefit ratio for that year and clawback arrangements are satisfied in relation to the benefit.
In essence, the new clawback arrangements are an obligation to repay “all or part” of a benefit received by a financial services licensee (or its representative) if the product is cancelled within the first 2 years after it is issued to a retail client. ASIC will determine the minimum amount that must be repaid by the financial services licensee (or representative) to satisfy the clawback test.
Each of these tests seriously restrict the practice of paying upfront commissions and are designed to limit an adviser’s incentive to churn clients into a new product to receive a new upfront commission.
A failure to meet these new rules will lead to the remuneration being banned conflicted remuneration. Benefits received under an arrangement entered into before commencement of the legislation and where the life product is issued within three months after the commencement day are unaffected by the reforms, with commissions received from those products being grandfathered.
Although in theory level commissions are retained, maintaining a constant benefit ratio year after year is difficult to achieve given the definition of “policy cost” when calculating the benefit ratio. Policy cost is the sum of:
- premiums payable for the product for that year;
- fees payable for that year to the issuer of the product;
- additional fees payable because the premium is paid periodically rather than in a lump sum; and
- any additional amount prescribed by the regulations.
Accordingly, we expect many advisers will effectively be required to implement clawback arrangements and abide by ASIC determined benefit ratios as premiums and fees fluctuate over time, unless regulations (or amendments to the Bill) are passed to correct this potential issue.
While the explanatory memorandum for the Bill expresses Government’s intention that ASIC will gradually limit the permissible benefit ratio year by year until 1 July 2018, there are no safeguards in-built into the legislation to ensure such an approach as ASIC is given an unfettered power to determine an “acceptable” benefit ratio. It follows that perhaps only limited reliance should be placed by industry on the Government’s previous guidance that benefit ratios would be capped as follows:
- 80 per cent from 1 July 2016;
- 70 per cent from 1 July 2017; and
- 60 per cent from 1 July 2018,
together with a maximum 20 per cent ongoing commission.