It started with so much promise.

Two of the three major industry associations, the Financial Services Council (FSC) – representing primarily the big end of town – and the Association of Financial Advisers (AFA) – representing financial advice practitioners – agreed to work together, forming the Life Insurance and Advice Working Group (LIAWG) in response to the ASIC Review of Retail Life Insurance Advice 2014.

The Financial Planning Association (FPA) chose not to participate, leaving FSC and AFA to till the rocky ground of life insurance industry reform together.

The chosen architect of the LIAWG Report, John Trowbridge, has impeccable credentials. An actuary, his experience ranges from competition in retail financial services, to capital structure issues, system stability, regulation, life and general insurance and banking deregulation.

Trowbridge brought to the LIAWG a depth of capability, experience and expertise and provided significant intellect and insight to help address the substantial challenges identified in the ASIC report.

The resulting Trowbridge Report raises some critical questions and suggests meaningful change for the industry to improve the quality of life insurance advice. What happens now is critical in determining the shape of the industry and its broad church of participants into the future.

However, based on the reaction to the report thus far, and the Government’s expressed desire that change should be implemented in “weeks, not months”, we may have lost another chance to work together effectively for coordinated industry reform.

Have we looked far enough ahead and considered how the various impacts and implications of the Recommendations might play out?

Has the LIAWG report been taken as an opportunity to entrench the status quo of certain parts of the industry as opposed to a lightning rod for open and constructive debate about reform?

Will the LIAWG recommendations improve the quality of financial advice while at the same time encourage more Australian consumers to seek advice and have appropriate levels of insurance in place?

If we rush into implementing the recommendations as they are, the answers to these questions will unfortunately only be learnt the hard way through a reform process that risks distorting the industry structure with potentially significant unintended consequences.

If fewer consumers seek advice and insurance levels decline as a result, no one wins.

Transparency builds trust

As the LIAWG Report process started some early signs were concerning, first evidenced in the submissions process. Transparency builds trust and, given the importance of this process as the latest cog in the relentless wheel of industry reform, the benefits of public submissions in broad canvassing and debate of industry views should have been apparent to the LIAWG. Yet submissions to the working group were private.

In addition, the timeframe for submissions (and delivery of the Report itself) was incredibly short and bridged a traditional holiday period, giving little preparation time for industry participants who have day jobs, yet did not want to miss the opportunity to actively engage in such a critical reform initiative. The subsequent leaking of the FSC submission, and its similarity to the final Trowbridge report, was an interesting sideline in this story.

Significant reaction

The publication of the report itself has, not unexpectedly, resulted in significant reaction. What is perhaps surprising is the differential nature of this reaction. Advice practitioners are up in arms, with the AFA distancing itself from the very report it played a key role in commissioning and shepherding through to completion.

One of the most controversial recommendations of the Trowbridge report was the “reform model” to move the industry away from up-front commissions. The intent of this recommendation is to remove potential conflicts and poor advice caused by high up-front commissions, as identified in the ASIC Report. What the reform model proposes, however, is an unprecedented distortion of a segment of the industry. In effect, the proposal caps the revenue that advisers can earn per client from insurance products.

While this outcome allows product manufacturers to effectively fix the cost of the distribution side of providing the product, as proposed this Recommendation will negatively affect on advice business sustainability and practice valuation.

In practice, advisers can charge advice fees on top of this product revenue “cap”. Advisers will need to carefully consider the cost of service provision over time and consumer capacity to pay significant fees in addition to the reform model to ensure the advice provided is appropriate and consistent with best interest obligations.

Importantly, it’s not known whether consumers will pay for advice containing insurance under this approach. This should be of concern to all in the industry – if consumers aren’t buying, all parts of the value chain will be affected.

Advice quality needs to improve

There is no doubt advice quality in life insurance needs to improve; and also no doubt that an up-front commission model risks providing an incentive for inappropriate advice. But are there alternative proposals to regulating advice margins?

What would happen if, for example, an independent consultant recommended a cap on platform costs? Or credit card interest rates? Or retail bank profits? There are existing models in the life insurance industry such as hybrid commissions, potentially supplemented with reasonable advice fees, which would achieve structural adjustment that both addresses the issues raised in the ASIC Report and do not distort adviser business models (or business valuations).

In terms of responses to the Trowbridge Report, life insurance manufacturers have been somewhat less overt. The ASIC report (and hence Trowbridge’s terms of reference) focussed on the need to improve the quality of life insurance advice. Reform of the sector cannot ignore upstream elements of the value chain. But with submissions not made public, these views remain hidden. What is clear, however, is that where a product manufacturer also has direct ownership of financial advice through salaried or otherwise controlled financial advisers, the stand-alone commerciality of providing financial advice becomes less important – and so do and key issues for non-aligned advisers, such as the value of their business, which is a function of the revenue it earns.

The Trowbridge report recommendations said nothing about the role of product manufacturing in the value chain, yet were bold in recommendations to modify advice business models. Life insurers need to be profitable and have adequate capital reserves, as dictated by APRA; but the inequity of targeting one part of the value chain requires deeper examination as further light is shone on the Report recommendations. In particular, it needs to justify setting a precedent in recommending artificial intervention in this part of the value chain.

Aligning regulatory frameworks

Subject to appropriate grandfathering arrangements using the FoFA reforms as a guide, alignment of regulatory frameworks across insurance, investment and superannuation products is a logical step. However, this should go further than what has been proposed.

Opening up licensee approved product lists (APLs) should also apply to platform operators on licensee APLs. That is, platform operators also should be required to include the requisite number of retail insurers on their various superannuation/investment platforms, regardless of who owns the platform operator.

Another key issue for consideration is the driver for future product innovation. For example, with ‘guaranteed access to distribution’ through diversification of licensee APLs, the impetus for innovation and service standards from life insurers may decline. This may be an unintended consequence of this recommendation.

Codes of Conduct

Infocus supports development of a Code of Conduct for the Life Insurance Industry. Importantly, the purpose of these types of documents must be considered before we rush into the scoping or, worse, into the implementation phase.

The purpose of a code of conduct is to establish and enforce minimum standards to deliver consumer confidence in the industry for which the code is being developed. In this context, why would the Trowbridge Report recommendations consider it appropriate to only have life insurance product manufacturers develop a Code? Wasn’t the Trowbridge Report about improving the quality of life insurance advice?

If we are committed to the Trowbridge Report recommendations about enhancing culture and seek to (re)build consumer confidence in life insurance advice, we need to be engaging a broad stakeholder group that at the very minimum includes licensees, the advice industry and consumer group representation.

We must simply stop talking to ourselves and start engaging with external stakeholders.

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